A recent discussion on a Slack channel we participate in showed how dangerous just blindly using the generally accepted ratio for KPIs without using reason based on your company.
Annual Recurring Revenue (ARR) according to SaaSOptics[i] “…is defined as the value of the contracted recurring revenue components of your term subscriptions normalized to a one-year period.”
SaaSOptics also provided us with a description of the calculation:
“To effectively use ARR as a metric in your business, you must have term agreements with a minimum duration of one year, or the majority of your term agreements must be one year or more. It is typically adopted by subscription businesses with multi-year agreements.
There are no defined rules for the determination of what to include in ARR. Typically, it will include only contractually committed, fixed subscription fees.
Since one-time fees are non-recurring, they are almost always excluded from ARR calculations. “
Back to the Slack Discussion
So, the question to the group was,
“Has anyone found a good solution to dealing with the inherent conflict between company beneficial renewal discounts and company and team specific churn and renewal goals and reporting? For example, if as a company you want to greenlight 10% renewal discounts for moving customers from monthly to annual invoicing, locking in a 3-year deal, etc.”
For those who are confused by his term “churn”, he defined it as “context meaning contraction or down sell.” But also said that you need to report this as ARR and how do you have internal goals around ARR retention.
Obviously, extending a month-to-month to a multi-year is a win, but giving a discount is a loss. If one were to calculate this activity, then ARR would show a negative variance where it is a positive variance.
How to handle it?
This is where looking at numbers that as a basis have a changing nature against the KPI and where dips and pops may or may not be valid need an explanation. In other words, you can’t just report in January ARR = $5K and in February its $4.9K and assume ARR really dipped, which isn’t a favorable event or in our case accurate.
There were two suggestions, both very similar. One was to do what the US Government does with Unemployment figures. They release a figure. Of course, the stock market does something crazy, but I digress. Then a month or two later they release the adjusted figure for the prior period which includes better data.
So, you have two ARRs for January, Original and Adjusted for conversion(s), etc. This way you can compare.
The other suggestion was building a separate system for tracking ARR, using discounts and other factors. While this response was geared for the internal vs external number, it is essentially the same concept.
Whatever you, the company decides, the KPI must be standardized, so that the company has a useful data point in which to make decisions that are based on a reality.
If it isn’t to the generally accepted formula, a note must be given so the reader understands the KPI. Nothing is worse than a miscommunication of a KPI for outside readers.
What do you think?