Software

MRR doesn't work for usage-based models

MRR is a good KPI for subscription businesses, not usage-based billing models.

MRR is an insufficient metric when tracking the success of a business with usage-based billing (UBB). As the SaaS world transitions from subscription based billing to UBB, it's of utmost importance that we also adapt definitions of important metrics and KPIs that are used to measure the financial health of a company.

Being from a SaaS world, you probably have an idea what MRR is. If not, here is a quick refresher:

What is MRR?

MRR stands for Monthly Recurring Revenue. In the simplest terms, it is the amount of recurring revenue your business is making, normalized by month.

It's the top line number that gives you:

  • A quick insight into how your business is performing hence giving you the ability to communicate to investors a single number closely related to the health of the business.
  • Added predictability of your business growth (by measuring the change in MRR over time)
  • Overview of whether your customers are returning to use your product.

These critical insights are what make MRR the holy grail for SaaS businesses.

Here is the formula:

As you can see, this definition lets you compute the recurring revenue across your customers by multiplying the average subscription amount with the total number of customers. Any change in this number directly correlates subscription upgrades, downgrades and customer churn.

MRR does a great job on reporting on business health for recurring subscription businesses.

Why MRR isn't enough for UBB

‍ Simply put, UBB is non-recurring and MRR only includes fixed recurring subscriptions amounts.

Usage is dynamic. It can grow or shrink by the second and depends on several factors including time and customer behavior. Hence the traditional definition of 'recurring revenue' doesn't work here. MRR doesn’t factor any of this behavior in its reporting. 

Let's take a specific example of AWS, a pioneer of usage billing. AWS charges for time, storage, number of queries etc. All of these are highly variable metrics that have different patterns throughout the day, week and year. The number of queries might be extremely high during the holiday season but might cool off in the other parts of the year. None of this usage-based revenue would get reported in MRR. 

If we can't use MRR for Usage-based revenue, then how do we report on UBB revenue?

Ultimately, we need to transform the variable usage into more reliable usage totals that can then be reported as KPIs for UBB.

How to report revenue on UBB models? 

In order to reliably report on recurring revenue for a highly variable model like UBB, you would need to add some certainty / reliability to the dynamic usage data. 

The best way to do this is to smoothen out the usage data by incorporating granular per-day historical usage. With a smoother usage graph, you can more confidently report on past, current and future UBB revenue.  

Here we would like to introduce a new KPI that encapsulates this metric of reporting - MRRU. MRRU (Monthly Recurring Revenue Usage) is a complimentary KPI for MRR on usage-based billing models. MRRU smooths out fluctuating usage data into a predictable metric.  

Here are the characteristics of MRRU:

  • It incorporates per-day usage related revenue. More granular data is used to accurately calculate recurring usage.
  • The formula gives the latest usage the most relevance. The usage on each prior day is given exponentially lower weight. This means that recent usage revenue will be strongly correlated with the MRRU on a particular day.
  • It gives you a consistent way of combining usage across time and customers into a single number.

For the mathematically savvy, here's the formula for calculating MRRU:


where

and

We believe that MRRU will become table-stakes for UBB financial health reporting.

MRR Expansion & Contraction

As with the previous definition of MRR, it is important consider MRRU along the four dimensions: New, Churned, Expansion and Contraction.

Specifically with MRRU, new and churned don't hold value because usage is only growing or shrinking ('new' usage is simply growth in usage).

This definition of MRRU very easily lends itself to expansion and contraction. We can figure out the calculated MRRU for the previous time period and see if there is an increase or decrease in current time period. This lets you easily determine trends in your customer's 'recurring' usage.

How can I easily calculate MRRU

Calculating MRRU can be complicated to do on your own. You can use Octane to simplify MRRU reporting.

We store usage on a very granular level and report to you both your subscription based MRR and your usage based MRR on one dashboard. Using the data that we have, we determine the tunable parameters of the formula to most accurately represent usage-based MRR for your business.

With this modern MRR formula, you can confidently adopt usage-based billing without the fear of not having visibility into important SaaS metrics!

What does the future hold?

As we transition to a world with more companies are shifting to a usage-based billing model, we will see KPIs like MRR or ACV insufficient metrics for reporting business health. Even today, publicly traded companies with UBB models are constantly outperforming analysts expectations.

To keep up with the fast growth of UBB companies, It is now time to start updating the way we measure their performance!