Why Retention Revenue is Important in SaaS

Written by
Ross Andrewsarrow icon

Why Retention Revenue is Important in SaaS

Written by
Ross Andrews

Retention Revenue is the measure of how much revenue is left over after a startup has retained their customer month-to-month. It’s an important metric for subscription startups to calculate in order to understand their true CAC payback and profitability, so how do we get there?

First you take top-line revenue, or the total amount of all of the subscriptions paid to you in that month. First you will want to calculate your gross revenue which is your total revenue minus your CORS (cost of revenue sold) which is typically hosting costs for software/tech companies, for services or physical goos this is more complicated, but the formula for Gross Revenue is below:

  • Gross Revenue = Revenue - Cost of Goods Sold

After finding Gross Revenue we can now calculate our Retention Revenue. To get retention revenue you need to find your cost of servicing, marketing and success for your existing customer each month. Similar to how you calculate CAC by adding up sales and marketing costs.

You will wan to add up the cost of your customer success, customer service teams and customer marketing expenses to get your “retention expense” which is the cost that you had to incur to keep your customers (and their revenue). The formula to then calculate retention revenue is as follows:

  • Retention Revenue = Gross Revenue - Customer Service Costs- Customer Success Costs - Customer Marketing Costs

Retention Revenue is the take how revenue at the end of the month after you have kept your customers. Using retention revenue is a more accurate way to understand the profitability. While there are other operating expenses that fall outside of the above retention expenses, on a per customer basis that is the best way for a startup, particularly one with recurring revenue, to understand your unit economics.

Think about a startup with a $2,500 CAC and a customer with a MRR of $300, that is a CAC Payback period of 8.3 months which is pretty good. But if we calculate their retention revenue that same customer only generates $180 in take home revenue at the end of the month making that CAC payback closer to 14 months. Now that might seem like a negative, but what this reveals us is an opportunity. We now have multiple levers to pull to drive towards profitability and sustainable growth. Maybe you do an analysis and realize you could automate the most common customer service requests and drive down your retention costs. Maybe you highlight your idea customer and tailor marketing messaging to drive down CAC. You can always upsell/add new features to increase your average monthly revenue as well.

A lot of early-stage SaaS companies avoid digging this deep for fear of the initial negative picture it paints. But the reporting economics off of top-line revenue actually can hurt growth long term and limits your visibility into growth levers and operational efficiency. Take the time to drill down to retention level metrics and you uncover a path to growth and sustainability for your startup.

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