ARR isn’t Dead! But it is Evolving.
The AI Era – Variable pricing models and new revenue streams
The days of simple, fixed-fee pricing in SaaS are over. More and more companies are moving beyond the traditional model of per-user-per-month pricing and good-better-best tiers. AI-centric products are introducing new monetization strategies tied to consumption, outcomes, and success. SaaS companies are introducing tokens and credits to offer access to features and entitlements. The result is that the monthly fees generated from a customer vary month-to-month and are not known in advance. What does that mean for ARR?
Rethinking your ARR Calculation
SaaS companies are taking various approaches to their ARR calculations. The variations center around three key areas :
- Start and end dates – Does ARR start on the contract effective date? Or should it be aligned with implementation and go-live?
- Revenue streams to include – Can ARR include monthly fees? Revenue from usage-based pricing? Professional services?
- Formula calculation – Do you calculate ARR by multiplying MRR by 12? Or by annualizing GAAP revenue?
Download the Three Ways to Calculate ARR white paper to understand the key questions you need to consider when defining a policy for annual recurring revenue.
Defining Your ARR Policy
Which revenue streams are recurring?
Are there revenue streams that act, look, and smell like recurring revenue even though they don’t meet the textbook definition of ARR? If so, perhaps they should be included in the calculations.
Usage-based pricing
If the revenue generated from usage-based pricing contracts is predictable and consistent, in aggregate across your customer base, and the majority is tied to annual contracts then it may be appropriate to include in your ARR. Examples of how SaaS companies calculate ARR for usage-based pricing.
Monthly plans
If the historical revenue generated from customers on monthly plans, in aggregate across your customer base, is consistently trending in a diagonal upwards line then it may be appropriate to include in your ARR. Examples of how SaaS companies with monthly plans calculate ARR.
Professional services
If your enterprise customers need a premium customer support package on top of your core subscription that is priced as a monthly recurring fee, then it may be appropriate to include in your ARR. Examples of SaaS companies that report professional services in ARR.
What is most relevant?
Are there revenue streams that are recurring, but are not long-term focus areas for your business that create a potentially misleading drag on ARR? If so, perhaps they should be excluded from the calculations.
Non-core product lines
If your business made an acquisition of a $5M startup primarily to secure ownership of its generative AI business that represents 60% of the revenue, then it may be appropriate to exclude the other $2M of legacy products you intend to sunset from your ARR.
Non-core customer segments
If your business began by selling to small businesses, but has since shifted to large enterprises then it may be appropriate to exclude the recurring revenue from the non-core (SMB) segments from ARR.
Even if you are satisfied with your current approach, it is only prudent to understand the different approaches being used to calculate ARR to be confident that your reporting provides the best insight into recurring revenue growth.
