A complete guide to net dollar retention rate - Cloudy

Net dollar retention rate (NDR) - Its definition, formula, and uses

The valuation of SaaS companies is different from traditional companies. In subscription-based businesses, revenues are predictable and recurring. That's why we study revenue in ARR and MRR for SaaS companies. B2B SaaS companies with enterprise and contractually-obligated customers prefer ARR over MRR.

Churn hurts the most when you run a SaaS business. The customers leaving your platform always trouble the finances as CAC (Customer Acquisition Costs) are higher than what you spend to provide customer care service. So, the net revenue dollar retention rate is a SaaS metric that studies how well a company retains its customers and upsells or cross-sells them to increase its revenues.

Net dollar retention rate is a useful metric that quantifies a business's ability to retain customers and grow its revenues from existing customers and sends a strong message to potential investors and lenders.

What is the net dollar retention rate?

Net dollar retention rate calculates growth or shrinkage in ARR or MRR within existing customers segment over a particular period of time. It does not include New MRR. Thus, a high net dollar retention rate means revenue growth and high customer engagement.

Before calculating the net dollar retention rate, you first have to set a particular period of time over which you need to calculate the net dollar retention rate. If that set period is a short span of time, say some months, you will need to use MRR values.

How do we calculate the net dollar retention rate?

To calculate the net dollar retention rate, you need Starting MRR, Expansion MRR, Contraction MRR, and Churn MRR. The formula for calculating the net dollar retention rate is:

NDR formula Select an Image

We can calculate the net dollar retention rate by plugging in the values in the equation above. But the question is, what are Starting MRR, Expansion MRR, Contraction MRR, and Churn MRR?

For a better understanding, we are going to define these terms in separate sections. We will also calculate the net dollar retention rate for the SaaS company A, which has three subscription packages to sell: basic at $20/month, advanced at $30/month, and premium at $50/month.

Starting MRR

It is the value of MRR at the start of the period you want to calculate the net retention dollar rate for.

Consider that company A had 30 basic users in January 2022. As each basic user pays $20 per month, the company generated a revenue of 20 * 30 = $600. So, the starting MRR is $600.

Expansion MRR

Expansion MRR is the increase in MRR through upselling and cross-selling to existing customers.

For our example of Company A, we assume that ten basic users upgraded their membership to advanced in the same month. Also, five basic users upgraded their membership to premium. So, the Expansion MRR will be (10 10) + (5 30) = $250.

Contraction MRR

Contraction MRR is the decrease in MRR when customers downgrade their membership plans.

We assume that Contraction MRR is zero for our company A as no one downgraded their plans.

Churn MRR

Churn MRR quantifies the loss of customers for a SaaS company. Churn MRR is how much revenue we lose when customers altogether leave our platform.

Company A lost 5 basic users in January 2022. The Churn MRR is thus 5 * 10 = $50.

NDR Calculation

NDR formula calculation Select an Image

Putting our values in the equation, we calculate the NDR to be 107% for January 2022. However, the calculations are complex for big SaaS companies with multiple packages and add-ons. NDR defines how efficiently a SaaS company retains its customers and sells them upgrades and add-ons. Please note that NDR doesn't consider New MRR.

Why is it important to calculate NDR?

SaaS founders and entrepreneurs spend a lot of energy understanding their business numbers. They deploy a handful of metrics to do a financial check-up of their company. NDR is one of those metrics.

NDR helps analyze if a business has been able to retain its customers. And if the retention is good, is the business upselling or cross-selling its customers? NDR answers that for you.

A high NDR for sure helps fundraise and crowdsource. SaaS public companies with high NDR win market confidence at the end of the day.

Moreover, you can also study NDR in cohorts, which lets you identify your best customers.

How do we increase NDR?

To increase NDR, expansion MRR should increase, and contraction MRR and churn MRR should be ideally zero.

Expansion MRR increases when a SaaS company upsells and cross-sells its customers.

Contraction MRR is reined in when customers don’t downgrade their plans.

Churn MRR should ideally be zero. But customers do leave in the real world. However, you can retain them by providing them with a competitive product and excellent customer care service. Gathering regular feedback from them lets you enhance your product and enables you to develop add-ons. Remember that the costs spent to retain customers are lower than those spent on acquiring customers.

Conclusion

NDR is a useful SaaS metric that studies revenue growth within existing customers segment. It quantifies the company's ability to retain customers and grow its revenues and communicates with the equity investors.

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