How to calculate NRR: A full guide for SaaS businesses

According to ChartMogul, SaaS companies with a net revenue retention (NRR) of 100% or higher grow twice as quickly as those with a lower NRR. This statistic highlights the importance of mastering this metric for any SaaS business aiming for sustainable growth.

In this guide, we'll go over everything you need to know about NRR, from its definition and importance to the step-by-step calculation process. The goal? Provide you with the know-how to track and analyze your NRR.

You'll also learn about common pitfalls to avoid when calculating NRR and the impact of NRR on your profits. 

Before we learn how to calculate NRR, we first need to understand what NRR means. 

What is NRR?

NRR is a vital metric for SaaS businesses. It basically tells you how much recurring revenue you've kept from your existing customers over a specific period, such as a month or a year.

Think of it this way: NRR also factors in any expansion revenue from those customers. Think upsells, cross-sells, or upgrades. It also accounts for any revenue lost due to churn — customers leaving or downgrading their subscriptions.

Why is NRR so important?

For SaaS companies, NRR provides insights into business health and growth potential. A healthy NRR indicates strong customer satisfaction and a sticky product. It suggests that customers find enough value in your offering to stay with you and potentially even spend more.

NRR is also a key metric for investors. They use it to assess the long-term viability and growth trajectory of SaaS businesses.

Understanding how to calculate NRR and track NRR metrics is essential for any SaaS business that wants to succeed. It can help you:

• Identify areas for improvement: A low NRR might signal issues with customer satisfaction, pricing, or product value.
• Make informed decisions: NRR data can guide decisions about product development, customer success initiatives, and marketing strategies.
• Secure funding: A strong NRR can make your business more attractive to investors.

In the next section, we'll dive deeper into the key components of the NRR metric. After that, we’ll explain the NRR calculation process. 

Essential components for calculating NRR

Now that you understand why NRR is so important, let's explain how to calculate NRR. To determine your NRR, you'll need to gather a few key pieces of information. Think of these as the ingredients in your NRR recipe:

• Starting MRR: This is your monthly recurring revenue at the beginning of the period you're measuring.
• Expansions: This component includes any extra revenue from existing customers (upsells, cross-sells).
• Contractions: This part encompasses revenue lost due to downgrades.
• Churn: This component is revenue lost from customers who completely stopped using your service.

Let's break down each component in more detail:

Monthly recurring revenue (MRR)

MRR represents the predictable revenue your business generates each month from your existing customer base. It forms the foundation for many SaaS financial metrics, including NRR. MRR tracking is crucial for understanding your revenue streams and business performance.

Example:

Imagine a SaaS company offering a project management tool with three pricing tiers:

• Basic: $50/month
• Pro: $100/month
• Enterprise: $250/month

At the start of the month, they have:

• 50 customers on the Basic plan
• 30 customers on the Pro plan
• 10 customers on the Enterprise plan

Their starting MRR would be calculated as follows:

• Basic: 50 customers x $50/month = $2,500
• Pro: 30 customers x $100/month = $3,000
• Enterprise: 10 customers x $250/month = $2,500

Total starting MRR: $2,500 + $3,000 + $2,500 = $8,000

Expansion revenue

This is the revenue generated when your existing customers expand their spending with your business. It's a great indicator of customer satisfaction and product stickiness. Expansion revenue can come from various sources, such as:

• Upsells: Customers upgrading to a higher-priced plan
• Cross-sells: Customers purchasing additional products or services
• Seat expansion: Customers adding more users to their accounts (common in per-user pricing models)

Example:

During the month, the SaaS company from the previous example sees the following expansions:

• 5 Basic customers upgrade to the Pro plan.
• 2 Pro customers upgrade to the Enterprise plan.
• 3 Enterprise customers add 5 extra users each at $50/user/month.

The expansion MRR would be:

• Basic to Pro: 5 customers x ($100 - $50) = $250
• Pro to Enterprise: 2 customers x ($250 - $100) = $300
• Enterprise user expansion: 3 customers x 5 users x $50/user = $750

Total expansion MRR: $250 + $300 + $750 = $1,300

Contraction revenue

Contraction revenue represents the revenue lost when customers downgrade their subscriptions or reduce their usage. It's the flip side of expansion revenue. Contractions can occur due to:

• Downgrades: Customers moving to a lower-priced plan
• Seat reduction: Customers reducing the number of users on their account
• Reduced usage: Customers consuming less of a usage-based service

Example:

In the same month, the SaaS company experiences the following contractions:

• 2 Enterprise customers downgrade to the Pro plan.
• 4 Pro customers reduce their user count by 2 each, with each user costing $50/month.

The contraction MRR would be:

• Enterprise to Pro: 2 customers x ($250 - $100) = $300
• Pro user reduction: 4 customers x 2 users x $50/user = $400

Total contraction MRR: $300 + $400 = $700

Churned revenue

Churned revenue is the revenue lost when customers cancel their subscriptions entirely. It's a critical component of NRR and a key indicator of customer health and product-market fit. High churn rates can significantly impact a SaaS company's growth and profitability.

Example:

Sadly, the SaaS company also had 3 customers churn during the month:

• 1 Basic customer
• 2 Pro customers

The churned MRR would be:

• Basic: 1 customer x $50 = $50
• Pro: 2 customers x $100 = $200

Total churned MRR: $50 + $200 = $250

How to calculate NRR

Alright, let's get down to the nitty-gritty and learn how to calculate NRR. Follow these four steps to determine your NRR:

Step 1: Establish your starting MRR

First things first, you need to determine your monthly recurring revenue (MRR). You must determine your MRR at the very beginning of the period you're analyzing. The resulting figure will provide the baseline for your NRR calculation.

To calculate your starting MRR, simply add up all recurring subscription revenue from your existing customers at the start of the month.

Remember: Only include recurring revenue from customers who were already with you at the start of the period. Don't include revenue from new customers acquired during that time.

Step 2: Calculate expansion revenue

Next, it's time to calculate your expansion revenue. This is the revenue generated from existing customers who increased their spending with you during the period. Keep track of all upsells, cross-sells, and plan upgrades. Each of these actions contributes to your expansion revenue.

Pro tip: Implement a system for accurately tracking these expansions. This implementation could involve using a CRM or a billing software platform.

Step 3: Deduct contraction and churned Revenue

Now, it's time to account for any revenue lost during the period. As we discussed earlier, this includes both contraction revenue (from downgrades) and churned revenue (from lost customers).

Remember: Contractions and churn can seriously impact your NRR, so it's crucial to track them diligently.

Step 4: Compute your NRR

Finally, with all the necessary data in hand, you can calculate your NRR using the following formula:

NRR = (Starting MRR + Expansion - Contraction - Churn) / Starting MRR * 100

Let's illustrate with an example:

• Starting MRR: $10,000
• Expansion revenue: $2,000
• Contraction revenue: $500
• Churned revenue: $1,000

NRR = ($10,000 + $2,000 - $500 - $1,000) / $10,000 * 100 = 105%

In this example, the NRR of 105% indicates that the business grew its recurring revenue from existing customers by 5% during the period.

Common challenges and mistakes in calculating NRR

Even with the best intentions, some common pitfalls can trip you up when calculating NRR. Let's shed light on these pitfalls and offer some guidance to help you avoid them:

1. Overlooking or underestimating downgrades

It's easy to get caught up in celebrating expansion revenue, but don't forget about the impact of downgrades. Failing to accurately account for contraction revenue can lead to an inflated NRR.

Tip: Implement a system for tracking downgrades just as meticulously as you track upgrades. Regularly analyze downgrade patterns to spot issues with your product, pricing, or customer success efforts.

2. Inconsistencies in MRR tracking

Inconsistent tracking of your MRR can create a ripple effect, leading to inaccuracies in your NRR calculation. This issue can happen if you're:

• Not tracking MRR consistently (e.g., sometimes monthly, sometimes quarterly)
• Failing to account for changes in pricing or billing
• Not properly reconciling MRR data from different sources

Tip: Establish a standardized process for tracking MRR. Confirm that everyone involved in data collection and reporting follows the same procedures. Regularly audit your MRR data for inconsistencies and errors.

3. Ignoring customer segmentation

Calculating your overall NRR is a good starting point, but it doesn't tell the whole story. Different customer segments may exhibit different behaviors, and ignoring these nuances can obscure valuable insights.

Tip: Segment your customers based on factors like plan type, industry, or company size. Calculate NRR for each segment to identify areas of strength and weakness. This approach can help you tailor your strategies for different customer groups.

4. Misinterpreting the impact of churn

While churn is an important factor in NRR, it's paramount to understand its context. A high churn rate isn't always a bad thing, especially if it's offset by strong expansion revenue, or if churned customers don’t actually fit your ICP.

Tip: Analyze churn in conjunction with other metrics like customer lifetime value and customer acquisition cost. A high churn rate might be acceptable if your customer lifetime value is higher than your customer acquisition cost.

5. Relying on manual data entry

Manual data entry is prone to errors, which can throw off your NRR calculation.

Tip: Automate your data collection and reporting as much as possible. Use integrations between your CRM and billing system to guarantee data accuracy and consistency.

How Orb empowers data-driven revenue growth

We've explained how to calculate NRR and highlighted its value for SaaS businesses because we understand how important this metric is. 

Plus, effectively tracking the underlying revenue movements that drive NRR requires a flexible billing platform that can handle complex pricing models and provide real-time visibility into customer behavior.

That's where Orb becomes the clear answer.

Orb is a usage-based billing platform designed to unlock your usage data, enabling flexible pricing, accurate billing, and faster growth. By ingesting all raw event data into Orb RevGraph, Orb helps you understand and optimize your revenue streams in real time.

Here's how Orb helps you understand revenue dynamics:

• Real-time usage tracking: Orb's raw event architecture captures every customer interaction, providing instant visibility into usage patterns and revenue trends that directly impact metrics like NRR.
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• Flexible pricing experimentation: With Orb Simulations, test how different pricing models affect your revenue using historical data before rolling out changes. This rapid iteration capability helps you optimize pricing strategies that drive expansion revenue.
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• Granular reporting: Orb's built-in reporting provides detailed insights into revenue, usage, and customer billing. Segment customers by various attributes to analyze revenue trends and identify your most valuable customer groups.
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• Easy integrations: Connect Orb with your existing tech stack, including CRMs, payment gateways, and accounting platforms. These integrations ensure consistent data flow for comprehensive revenue analysis.
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• Usage-based pricing support: Orb's architecture is built for consumption-based models, allowing you to track usage precisely and identify expansion opportunities. The Orb SQL Editor makes it easy to define new pricing metrics without engineering involvement.
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• Accurate billing and invoicing: Orb RevGraph ensures precise billing calculations with zero data loss, reducing revenue leakage and building customer trust through transparent, error-free invoicing.

Ready to unlock your SaaS growth potential with flexible, accurate billing? See how Orb can power your pricing strategy and drive revenue growth, with different plans for companies at all stages.