Why Net Dollar Retention is Pivotal to SaaS Success
Net Dollar Retention (NDR) isn’t the most talked-about metric out there, but it’s becoming an increasingly important number for SaaS companies trying to gauge the health of their business and demonstrate value to investors.
Net Dollar Retention — also referred to as Net Revenue Retention — reflects your recurring revenue from existing customers, taking into account cancellations, downgrades, pause requests, cross-sells, and upsells. This complete view is critical to your business because it gives you an essential understanding of customer happiness and business health.
This is the formula for calculating NDR in a given period:
NDR = (Starting MRR + expansion – downgrades – churn) / Starting MRR x 100
Your company’s NDR is a bottom-line metric that shows you, plain and simple, how well you retain and maximize revenue from existing customers — both of which are essential for SaaS companies to stay viable in the long term. Read on to learn why NDR is a must-track metric for SaaS companies.
NDR gives you a deeper understanding of long-term revenue retention than MRR
While Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR) include new customer acquisitions, NDR focuses on retention of your existing customer base, which is a much better indicator of long-term financial viability.
When you acquire customers, your MRR and ARR shoot up. However, this can give you a false sense of security because customer acquisition is a less reliable source of revenue than customer retention. Market changes, like those brought by the COVID-19 pandemic, can slow down new customer acquisition, forcing SaaS companies to prioritize existing customers. With existing customers responsible for a third to half of total revenue growth, even at start-ups, companies need to discover opportunities to provide relevant solutions and expand customer value. Besides, the cost of retaining and expanding subscriptions is much lower compared to the cost of acquiring new ones.
Since NDR focuses on upgrades, downgrades, and churn, it tells you whether your efforts translate into customer value (which in turn translates to more stable revenue).
It is no surprise, then, that even for investors, NDR has become the metric to answer whether businesses can retain and expand high-value customers. In fact, a comparison of companies with equal ARR growth rates showed that the ones with NDR rates of over 100% commanded significantly higher valuations than those with 90% NDR rates. This is because companies with NDR rates over 100% are able to achieve growth just by expanding the accounts of their existing customers, even without acquiring new customers.
Measuring your NDR rate is the smarter thing to do because it exclusively tracks fluctuations within existing customers, so you get a deeper understanding of how happy your customers are and how likely they are to stick around. This is more valuable in the long term because you get a sense of how leaky your bucket is — or not — and can focus your efforts on plugging those leaks.
NDR represents your SaaS’s ability to delight customers more directly than NPS or CSAT
Other measures of customer delight, like Net Promoter Score (NPS) and Customer Satisfaction Score (CSAT), rely on a range to understand whether customers are going to stick around and upgrade via customer opinion. But NDR cuts to the chase by looking at retained revenue as a signal of customer satisfaction.
NPS asks customers, on a scale of 1 to 10, how likely they are to recommend the product while the CSAT measures customer health by providing a range of satisfaction levels, from extremely dissatisfied to extremely satisfied. NPS isn’t entirely useful because it measures intention, and research suggests that intention is not a reliable metric. It points you to a likelihood but doesn’t guarantee the customer’s future actions. Similarly, the CSAT reflects short-term sentiment based on the last touchpoint and how a customer is feeling at a moment in time. This doesn’t work because they are roundabout questions to understand one very simple question: “Are we doing a good enough job for you to continue spending the same (or more) money with us?”
NDR takes a more direct approach. It looks at whether customers are happy to loosen their purse strings and buy upgrades or are feeling lukewarm and choosing to downgrade. When you measure NDR, you can assess how well-positioned you are to continue growing your business.
But creating this compound interest on your existing revenue base can be achieved only through the value you deliver to customers and motivating them to stick. With NDR shining a spotlight on this value exchange, you have far greater insight into customer sentiment than a Net Promoter Score or a green/yellow/red dashboard.
NDR accurately reflects the importance of the high-value low-value customer gradient
If you look at raw churn rate, you only know how many customers churn. NDR, on the other hand, looks at the value of each of those customers and reflects the degrees of impact different customer segments have on your revenue retention.
The difference is that churn rate points out the percentage of your customers that moved on from your company. NDR points to the percentage of your recurring revenue that you lost over a given period. That’s an important distinction because you could lose 10 small accounts, and your churn rate would look terrible, but your revenue might not change that much. Likewise, you could lose one enterprise account, and your churn rate would look insignificant, but your revenue loss would be substantial.
For example, if you have 100 customers, of which 90 make up for $10,000 a year in revenue and 10 account for $1 million a year, you know that the 90 customers comprise your low-value segment and the 10 enterprise accounts are the ones filling your revenue bucket. You could afford to lose a few of the 90, but if you lose one of the top 10, your NDR will tank.
NDR is a reflection of your customer’s time-to-value
Time-to-value (TTV) is a measure of the time it takes a customer to first experience the value of your product. The shorter your time-to-value, the higher your NDR. To shorten time-to-value, you need to streamline implementation processes and lead your customers toward their first aha moments. Then it’s a domino effect. They get excited about using the product more, become deeply engaged, and are more likely to continue recognizing the value and stick around, driving up your NDR.
Customer collaboration and cross-customer visibility need to be at the core of this approach to shorten TTV and boost NDR. And it needs to start from day one, even before the customer signs the deal. Set clear expectations with the customers, communicate responsibilities, and hold them accountable with the help of customer success plans that steer them toward quick value.
Use NDR to inform your customer success approach
Don’t be fooled by the formulaic appearance of Net Dollar Retention. It truly is synonymous with customer success and can be used to devise a proactive strategy that ensures your customers are sticking with you. The new era of customer success is all about focusing on expansions in addition to churn, and your NDR rate is the one to guide you towards protecting (and multiplying) the revenue you worked so hard to achieve.
As you calculate and track your company’s NDR, note how much is coming from high-value vs. low-value customers and use that to inform your customer success strategy by staying close to the high-value accounts and collaborating with them to achieve their goals. After all, the companies achieving top-tier revenue retention rates have one thing in common: they have a clear picture of long-term financial security because they are aligned with their customers.
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