It used to be easy to focus in on the key metric for your business. It was sales. Every month or quarter you would add up all the products or services you had sold and that would be your sales number and generally the first and most important number you would focus on. It was all fairly simple and sales/revenues/cash were in many ways I interchangeable.
But over the last ten years or so an ever increasing percentage of the economy has become based on a subscription based model. You no longer buy the product or service; instead you buy the right to use it for a period of time.
In this way the standard metrics of measuring a business don't work so well. Take Netflix as an example. Prior to Netflix we would have probably gone and purchased movies and TV box sets from a store. That store could then easily measure its sales and revenues at the end of every period.
But Netflix charges $8.99 per month for access to its whole library of content. The company can only recognize revenue once a service has been delivered so it can only add $8.99 per subscriber per month onto its overall revenue number every month. I'm guessing that Netflix keeps its subscribers on average for many years and therefore the $8.99 is only a tiny percentage of their overall value. As they get to the end of a period, whether it's a quarter or a year, the contribution subscribers will make to the revenue number depends on when they were signed up. So actual revenues presents an incomplete picture. It's clearly important for accounting purposes but it's not the best and most forward looking indicator for the health of the business.
This has led to the introduction of MRR (monthly recurring revenues) and ARR (annualized recurring revenues) as a way of addressing this issue. This means you are no longer constrained by a specific accounting period but can look at the on-going monthly revenue and extrapolate that out for an annualized figure. This is more forward looking and definitely a more useful metric for a subscription style business.
But I would argue that to layer on the new recurring revenue on top of the base level revenue you carried into the period has the effect of 'burying' the new sales. For example you could be growing your ARR but the underlying sales trend might be moving in the wrong direction.
I believe the best single indicator of a company's health is growth. And growth is best represented by new revenues. Therefore I would advocate breaking out new recurring revenues in every period as the key single metric to focus on for a subscription busines. I would also propose an annualized rather than monthly figure because the annual period is the one that most people think about first and also you should be pretty sure that almost all your customers will stay for at least a year and therefore it's more in line with their expected revenue contribution.
At MessageLabs, the anti-virus/anti-spam SaaS business I co-founded, we introduced this metric very early on. We actually called it 'NARR' which stood for net annualized recurring revenue. It was basically new annualized revenue added with any partner revenue share deducted hence the 'net' piece.
We founded MessageLabs in 2000 and introduced NARR in the very first year. It remained the core metric that drove the business all the way through to our sale to Symantec in 2008. I was talking to an early investor about this recently and he said he thought we had probably invented the ARR metric and I think he might be right.
There are of course other metrics to that you should have within your dashboard and I’m not going to go into them all in this post. But I think it really helps to have a single metric that the company is galvanized around - it certainly helped us.
The only change we made over the years was, as the market became more competitive and we started seeing more churn, we also netted off the lost annualized revenue to arrive at a true net figure. So if your churn becomes material (more than 10% of the ARR every year) then I think it makes sense to net it off the new ARR figure otherwise it can distort the true picture of new ARR added.
So my conclusion is the have everyone in the company obsessing over new ARR as the single most important metric in any subscription/SaaS business.