Companies that offer services on a subscription basis face the dilemma of monthly or annual revenue. So, let's talk about ARR, which stands for recurring yearly revenue, or MRR, which stands for monthly income.
1 – MRR: Definition, Advantages, and Disadvantages
Every subscription-based business faces the challenge of defining its recurring revenue. MRR (Monthly Recurring Revenue) becomes a central metric for companies offering monthly contracts, particularly in SaaS mode.
1.1 – What is MRR?
MRR stands for Monthly Recurring Revenue and refers to the total monthly value of all subscription-based contracts. Since client subscriptions can fluctuate, the calculation must account for these variations. MRR involves customers paying monthly for the service rather than annually.
1.2 – How to Calculate MRR for SaaS Companies
To calculate MRR for a SaaS company, the following elements are considered:
Revenue from new contracts
Add-ons or upgrades to existing contracts
Deductions for downgrades or contract reductions
Removal of revenue from canceled subscriptions
1.3 – Advantages and Disadvantages of the MRR Model
Managing a SaaS business using MRR presents both challenges and opportunities.
Disadvantages:
Lack of long-term visibility: Since customers commit monthly, it’s hard to predict future revenue or maintain a stable cash flow, affecting long-term financial planning and development projects.
Churn management: It is more difficult to track customer churn—those who cancel subscriptions—which impacts both revenue and customer retention strategies.
Advantages:
Higher pricing: Typically, services priced under the MRR model are more expensive than those offered with annual contracts (ARR), which can boost overall profitability despite the shorter commitment.
2 – ARR: Definition, Advantages, and Disadvantages
Now, let’s explore the ARR (Annual Recurring Revenue) model, another key approach for SaaS businesses. How does it work, and what are its benefits and challenges compared to MRR?
2.1 – What is ARR?
ARR stands for Annual Recurring Revenue, representing the total value of customer subscriptions over 12 months. Similar to MRR, it considers various factors that influence the customer base and services, but ARR subscribers commit to at least one year.
2.2 – How to Calculate ARR for SaaS Companies
The formula for calculating ARR involves the same factors as MRR, but on an annual scale:
Revenue from new subscriptions
Upgrades to existing contracts
Deductions for contract downgrades
Removal of canceled subscriptions
The analysis of these elements helps track recurring income and understand how customer behavior influences the company's revenue over time.
2.3 – Advantages and Disadvantages of the ARR Model
SaaS companies that secure annual contracts benefit from increased stability, but some trade-offs exist.
Advantages:
Long-term commitment: Customers are locked into a one-year commitment, making cash flow projections more reliable. This also reduces the risk of churn for the duration of the contract, giving companies more confidence to invest in growth and long-term projects.
Better cash flow management: ARR allows for easier financial planning, as future revenue is more predictable.
Disadvantages:
Lower pricing: SaaS companies often offer lower prices to customers who commit to long-term contracts, reducing profitability compared to MRR. However, the upfront cash flow and potential interest generated from payments received in advance can offset this.
Inflexibility: If you need to make significant changes to your service mid-year, adjusting prices or contract terms for existing customers can be challenging until the renewal period.
Conclusion: ARR or MRR?
Ultimately, the choice between ARR and MRR depends on your SaaS company's business model and customer preferences. While MRR offers higher flexibility, ARR provides greater visibility into future revenue and allows for more stable financial planning. Many companies lean towards ARR for its long-term stability despite the potential for slightly lower pricing.
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