Q&A: why NRR is important

Q: Ayman, why NRR is important? In my company, yes I care about existing clients but I am focusing in bringing new clients as this define growth.

A: In the SaaS and subscription economy, growth driven purely by customer acquisition is no longer sufficient. Don't get me wrong, customer acquisition is important but not the only Winning serum.

However, true, sustainable, and I repeat sustainable, growth comes from Net Revenue Retention (NRR)— for those who are not acquainted by this term, it is a metric that indicates how much revenue you can expand from your existing customer base.

What is NRR?

NRR measures revenue growth from existing customers by accounting for:

• Renewals
• Upsells and Cross-sells
• Downgrades and Churn

The NRR Formula

NRR=((Beginning ARR + Expansion ARR - Churned ARR - Contraction ARR)/Beginning ARR)×100

Where:

• Beginning ARR = Annual Recurring Revenue at the start of the period.
• Expansion ARR = Additional revenue from existing customers through upsells and cross-sells.
• Churned ARR = Revenue lost due to customer cancellations.
• Contraction ARR = Revenue reduction from existing customers due to downgrades or usage decrease.

A high NRR indicates not only strong customer retention but also the ability to grow revenue organically without excessive acquisition costs.

Why NRR is a Critical Metric

• NRR > 120% reflects hyper-growth and efficient capital allocation.
• NRR = 100% signals stable growth and solid retention.
• NRR < 100% points to revenue contraction and potential retention issues.

Real-World Implications

All type of investors (VCs, PEs and even M&A bankers) are starting to focus on NRR nowadays. For example, M&A bankers while valuing a company can place a premium on companies with high NRR in the form of:

EV = (EV/revenue)_ Rev multiple _ NRR/100

Whereas Growth PE funds, especially Growth 1 and Growth 2 funds, are very cautious to pay for what we call "Shell growth" -- very high rate of new customer acquisition, but with a detracting revenue stream from existing customer base. Some even call it "Ponzi growth", as you are adding new revenue from new clients to cover lost revenue from existing clients.

Also there is equation tying NRR with EBIT margin that usually PE uses (will talk about it in later posts) that shows the org design of the commercial function and how company is using its sales force.

VCs investing in different states of early stage enterprises (ESEs) started focusing on NRR after several start ups reflected Shell growth or Ponzi Growth.

So short answer, NRR is very important metric right now especially for SaaS companies and other tech verticals. Customer base growth is not the only game in town any more.