For subscription and recurring revenue startups, revenue retention is an important factor in long term success. Revenue retention is the measurement of how much revenue you are still able to capture over a given time period from a group of customers. This can include expansion or upgrade revenue (Net Revenue Retention) or it can exclude it (Gross Revenue Retention). Expansion revenue, which is additional revenue above the initial purchase price that a customer buys. Expansion revenue (which can lead to a Net Revenue Retention of greater than 100%) is typically the sign of a successful and sticky recurring revenue business. Unfortunately, it can also be misleading, we will explain why your Net Revenue Retention also matters. First let's look at the two formulas
Net Revenue Retention = (Renewal MRR + Upgrade MRR - Churn MRR - Downgrade MRR) / Beginning MRR
Gross Revenue Retention = (Renewal MRR - Churn MRR - Downgrade MRR) / Beginning MRR
The big difference between Gross and Net Retention is the removal of Upgrade MRR. It might not seem that significant, but it means the two of these can tell two very different stories. Let's get into an example of how just reporting net revenue retention can be misleading. Take the two following SaaS/Subscription startups:
If you had simply reported Net Revenue Retention, they both look roughly the same and relatively healthy (105% and 107%). Company A even has greater expansion or upsell MRR which might seem more attractive. The issue is that if you breakdown that 10% net retention, the $10,000 in upgrade MRR is hiding 10% revenue churn which is high. We call this a "false-bottom", with 10% revenue churn, eventually the number of existing customers willing to upgrade will max out, and your upgrade MRR will dry up and your net retention will begin to plummet back down towards your gross retention of (in this case 85%) which is not sustainable for a healthy subscriptions business.
Company B achieves a 107% net revenue retention with half the expansion revenue and a 12% improvement in gross retention. This dynamic is far more sustainable long term, given that Company B has 80% less revenue churn (2% vs 10%).
Expansion/upgrade revenue is an important part of a healthy recurring revenue/subscription business. But ensuring that those upsells aren't masking churn is why when breaking down your revenue you need to look at all of the components of your revenue retention and factor in gross retention as well to get a more complete picture of a startup.