ARPU in SaaS: Calculating and Optimizing Average Revenue Per User
Jordan T. McBride Sep 8 2015
Getting to know your customer is what separates the losers from the winners in the SaaS world. When you break down a successful business you will find 99.9% of the time that they have a strong hold on who their customers are and an even better grasp on where that customer finds value in their product.
This starts with quantifying your customer personas and trickles down deeper into your SaaS metrics as time passes and the business grows. The real secret sauce to understanding your customer is being able to understand your Average Revenue Per User (ARPU). This metric allows you to identify trends and implement change that can shift the trajectory of your business towards that large pool of SaaS profits we all dream of.
So to better understand ARPU let's take a deep dive into what it is, why it's important and ways that you can optimize this metric to catapult the success of your SaaS business.
1. What is ARPU?
2. Why You Should Care About ARPU
3. Why Understanding ARPU Is So Important
4. What does ARPU tell you about your SaaS business?
5. What to Include in ARPU
6. What You Should Not Include In ARPU
7. How To Calculate ARPU
8. Three Ways to Optimize ARPU
9. Is ARPU related to customer churn?
10. How can a company that targets the SMB market increase ARPU?
What is ARPU?
ARPU stands for average revenue per user, or in some cases, average revenue per unit. ARPU is a formula used to calculate average revenue received per user, or unit, over a period of time. This calculation allows businesses to deepen their analysis of growth potential on a per customer level and helps them model revenue generation capacity. ARPU is calculated by dividing total revenue by average users during a period. Due to its role in modelling growth, ARPU is one of the most important revenue metrics for SaaS subscription businesses.
Why You Should Care About ARPU
To sum up ARPU in one sentence: it's the average amount of monthly revenue that you receive per user.
People say ARPU is a "vanity metric" (a metric that isn't actually useful). Those people are using ARPU incorrectly, because while not the deepest metric, when calculated and broken down properly this metric helps you identify trends in a group of customers booked within the month against different cohorts and segments. When graphing this metric you can identify price points that customers are selecting more than others, along with being able to identify upsell/down sell trends - a major factor in the efficacy of your SaaS business model.
Tracking ARPU allows you to plan for the long-term and the short-term. On one end it can be the base for accelerating your Monthly Recurring Revenue (MRR) growth through higher paying customers. Higher ARPU is also a source of fuel for your customer Lifetime Value (LTV) goals, ensuring that your SaaS business is on the trajectory path that it needs to be for optimal success in the long term.
Why Understanding ARPU Is So Important
Understanding your ARPU figure is a birds eye view into how well your SaaS company is actually doing, especially when breaking down the information by segment and cohort. The higher the ARPU for a company, the better the chance that the company is able to extract more cash in the future. Additionally, if you're able to have a high ARPU relative to the value you're providing or the company's revenue, you know you have a product that's driving a better value ratio. In summary though, here's why APRU is important:
Indicates the health of your business financially
If your ARPU is sub $100, then you know you need to get a metric ton of customers to grow a sustainable company. In this manner, ARPU allows you to see what kind of business you need to be from a pricing and value perspective. Most often times ARPU is the "canary in the mind" indicating that your product may be too cheap in a market that isn't big enough. Alternatively a high ARPU in a large market indicates you're off to the races in terms of growth and prosperity.
Product validation that you're extracting enough value from your personas
One of the biggest mistakes we see from companies is that they're targeting small or enormous customers and the ARPU isn't high enough for the value that's being provided. For instance, if you're selling a product to Disney and they're getting $1M worth of value in time, cost, etc. efficiencies, then you should be charging at least $100k for that product. ARPU helps your product team see if they're aligning the value of the product to the right customer.
Validation that your marketing and sales teams are driving the right deals
ARPU should be increasing consistently over time, especially if you're just starting out in the SaaS game. The reason for this constant need for improvement is because it indicates that your sales and marketing value propositions and targeting are constantly getting better quarter over quarter. Essentially, you're becoming more efficient.
What does ARPU tell you about your SaaS business?
ARPU for different segments of your customer base gives you feedback on how current processes are working and helps you make decisions for the future of your company. Understanding ARPU will tell you about:
Growth of your MRR and LTV
In the short term, ARPU directly affects MRR. The more revenue individual customers contribute each month, the more monthly revenue intake for your company. ARPU also affects the long-term growth of your customers' lifetime values. The revenue a single customer contributes each month sums over their entire lifetime with the company to add up to their lifetime value—so increasing ARPU increases LTV.
The financial viability of your business
If you have low ARPU, you need a lot of customers to reach MRR goals each month. If you have high ARPU, you don't need as many customers to reach goals and grow quickly. Low ARPU in a small market might be a warning sign that your company is not set up for long-term success, while high ARPU in a large market means excellent opportunity for revenue growth.
Price alignment and product validation
Low ARPU might be a sign that you're not adequately extracting value from certain buyer personas for the service that you're providing to them. For example, enterprise clients are likely seeking a lot of value from your product, which you should monetize by pricing according to the value they're receiving.
The efficiency of your sales and marketing team
ARPU should be increasing over time as sales pitches improve and value propositions get clearer and more targeted. Increasing ARPU means that you're onboarding more of the right customers and selling them on the value they're interested in. This helps you create a more efficient sales and marketing system.
Segmented ARPU can also give you concrete information about popular plans and trends in cross-selling and up-selling. Imagine you offer 4 plans: a $15/month plan, a $45/month plan, a $75/month plan, and a $150/month enterprise plan. In calculating the ARPU for each group of customers on each plan and comparing the number of customers at each ARPU level, you can see which plan is most popular.
Your $45/month plan is your most popular plan, with 500 customers paying $45 in ARPU each month. You can look at the value that's included in that plan to understand what makes this plan popular with customers.
This graph also shows that while 300 customers on your $75 plan are indeed paying $75 each month, 75 customers on the $75 plan are actually paying $90 because they were cross-sold an additional feature. This would help you conclude that you can add another tier in between your $75 tier and your $150 tier to better monetize these mid- to upper-market customers.
What to Include in ARPU
Average Revenue Per User (ARPU) is a tabulation of all revenue coming in from your active users divided by the total number of customers that revenue came from. Here are the items that you should include in your ARPU calculations:
Monthly Recurring Revenue: The total amount of recurring revenue that your business brought in for the month.
Account Upgrades: a subsection of MRR that represents the upgrade dollars from the current customer base that you have
Account Downgrades: this includes the total dollar amount of customers that have downgraded their service. This is important because downgrades represent money lost from current customers that have not churned.
Lost MRR from churned customers: This subsection of MRR is a tallying of the MRR that you lost from customers who actually churned, not those who’ve canceled.
Total Paying Customers: Include all of the customers that have paid for your service within the month and have active accounts. If you have “free users” they shouldn't go into the ARPU calculation because they are not providing revenue for your business.
What You Should Not Include In ARPU
The key to getting accurate ARPU metrics is to realize that it is a tabulation of your current customer base and the money that they have spent with you for the month. Additionally, it should be noted that ARPU is a “momentum metric” just like MRR/ARR that thrives on purity.
- Don’t include “free” items
- Don’t include inactive customers
One of the quickest ways to mess this up is by including items such as “free” or “inactive” customers that you are not generating any revenue from. Conversion is truth, so if someone's not paying you, then they shouldn't be included in your ARPU. If you do include them, you will end up watering down your revenue average for the month and providing investors/stakeholders with a distorted image of how the company is performing.
How To Calculate ARPU
The formula for calculating APRU isn’t terribly difficult, all you have to do is take your total MRR and divide it by the number of customers you have. This ARPU calculation is for monthly ARPU.
Take the SUM of all your active customer MRR and divide that by the total number of customers. Keep in mind that this calculation is done in a monthly time frame.
Three Ways to Optimize ARPU
ARPU is the trend identifier metric that allows you to really get to know your customers. The more ARPU you can generate, then the better your SaaS business is doing. Don’t forget that ARPU is what gives you the insight to catapult your business forward by increasing MRR/ARR and extending your customer LTV.
Here are four actionable ways you can optimize ARPU for your SaaS business.
Add-Ons, Value Metrics, and Upgrades
Any way you can absolutely increase the amount of revenue from your customers month over month should be considered. The easiest way to do this is to make sure that a value metric is central to your pricing strategy to bake in expansionary revenue. An alternative to this strategy is to make sure you have a clear add-on and upgrade strategy.
Ensure your retention is on point, especially for larger customers
MRR churn is directly connected to your ARPU, as leaking customers (especially large ones) will reduce your customers and your total revenue. Make sure you're running a proper retention process.
Make sure you're targeting the right customer personas
You may be absolutely deflating your ARPU by targeting too many small, distracting (and expensive) low revenue customers. If you're not in the consumer space or a space with hundreds of thousands (if not millions) of potential customers, then you shouldn't be chasing sub $100/m customers. Make sure you quantify your buyer personas properly and target the right ones for growth.
Is ARPU related to customer churn?
High ARPU customers are valuable to your SaaS company for many reasons; namely, they contribute large portions of your MRR. However, high ARPU customers are also a huge asset for your company because higher ARPU is correlated with lower user churn.
User churn is an insidious drain on your SaaS company. It dwindles your user base and as a result, you have to work much harder to replace lost users and acquire additional users in order to grow. That's why loyal customers who won't churn are so valuable to a company, and why retention is so important to SaaS companies.
Lower user churn also means customers stick around longer. This can mean higher LTVs and more opportunity for your company to monetize these customers through cross-sells and up-sells.
High ARPU customers retain better than low ARPU customers.
In our study of 941 SaaS companies, we found that customers with 4-digit ARPU were nearly 50% less likely to churn than customers with 1- or 2-digit ARPU.
While our data shows correlation and not causation, there are many reasons why high ARPU customers retain better than low ARPU customers. Since they pay more each month, they likely have a greater need for the service you offer and find more value in your service than low ARPU customers. High ARPU customers may also be large customers with annual contracts. Annual plans, as opposed to monthly plans, give customers less opportunity to churn.
How can a company that targets the SMB market increase ARPU?
If your company provides a low-cost solution to serve small businesses, that doesn't mean death to your ARPU. Targeting the SMB market is a good place for a growing SaaS company to start, and there are opportunities here to monetize your customers even if providing a high-cost solution won't work for your company.
The key to monetizing these customers is to add value and expand pricing over time. Catering to the SMB market can get your foot in the door at a customer's company. Then you can increase your share of their wallet over time by:
- Marketing feature upgrades
- Cross-selling additional services
- Encouraging plan expansions along a value metric
- Marketing feature upgrades
This will increase your customers' ARPU over time. It's essential to have these expansion strategies in place if you cater to this market. As Constant Contact CEO Gail Goodman describes in her talk, “The Long, Slow SaaS Ramp of Death,” a business won't survive for very long with only a handful of low ARPU customers. You need to communicate value and expand quickly.
Figure out your foot in the door for your naturally-low ARPU customers in the SMB market. Then cross-sell and up-sell customers as they themselves grow and need more value from your product. This allows you to acquire customers at a price point that works for them in their early stages, and grow their ARPU over time as their needs increase and your business matures.