SaaS 102 #39 What is NDR? How is it Calculated?
One of the biggest differences between traditional software companies and SaaS companies is that SaaS companies usually follow a subscription-based pricing model.
For traditional software companies, once a product has been sold to the customer, the deal is finished. But for SaaS companies, the moment the product is sold is the moment they start to provide services.
This is because SaaS companies can continually create more revenue through subscription upgrades from their existing customers.
For SaaS companies that follow a mainly subscription-based revenue model, whether they can retain customers and persuade them to upgrade their subscriptions directly decides whether they can grow and survive. In this article, I’ll introduce a metric which measures how well a company can keep and expand revenue from its existing customer base: Net Dollar Retention (NDR).
1. What is NDR?
NDR is a percentage value that represents how much subscription revenue SaaS companies can retain and expand from their existing customer base.
When the NDR of a SaaS company is above 100%, additional income from customer subscription upgrades is greater than reduced income due to customer churn or customer subscription downgrades.
For a SaaS company, an NDR of above 100% demonstrates that the company’s existing customer base is continuing to expand the company’s revenue growth. The higher the NDR, the more the company’s customer base is expanding its revenue.
On the other hand, if a SaaS company has an NDR of less than 100%, this shows that the company’s existing customer base is not expanding the company’s revenue. This rings alarm bells for the company’s operations. Unless the company is still continuing to add new customers, then its SaaS business is already on a downward path.
The following example can help to illustrate how NDR works:
- Suppose that a SaaS company has 10 customers, and the subscription fee for each customer is 10 US dollars. In this scenario, the company’s total subscription revenue is 100 US dollars.
- After a period of time, six of those customers upgrade their subscription to 20 US dollars. One customer downgrades their subscription to 5 US dollars, and three customers cancel their subscriptions. The company’s total revenue from subscriptions is now 125 US dollars.
- For this cohort of ten customers, the retained subscription revenue has increased from 100 US dollars to 125 US dollars. The revenue retention rate is 125%, and the NDR is also 125%.
Even with customer churn, the company has still achieved a 25% increase in revenue. This is because the company has received sufficient expansion in revenue from the customers which it has kept.
As well as that, those customers which remain will almost always be the company’s key customers. They are the customers who are not only difficult to lose, but who are also likely to further expand their use of the company’s services.
When we look at it this way, we can see that NDR is a metric which does more than show us how well a SaaS company can increase revenue from its existing customer base. NDR can also help SaaS companies to identify and focus on target customers. By creating value for target customers, SaaS companies can maximize the amount of value they create for themselves.
2. How to calculate NDR
To find out how to calculate a company’s NDR, we can refer to the NDR calculation methods published in the annual reports of public SaaS companies.
Here I’ve quoted Slack’s Form 10-K report (Page 75), which describes how to calculate NDR:
“We calculate Net Dollar Retention Rate as of a period end by starting with the MRR from all Paid Customers as of twelve months prior to such period end, or Prior Period MRR. We then calculate the MRR from these same Paid Customers as of the current period end, or Current Period MRR. Current Period MRR includes expansion within Paid Customers and is net of contraction or attrition over the trailing twelve months, but excludes revenue from new Paid Customers in the current period, including those organizations that were only on Free subscription plans in the prior period and converted to paid subscription plans during the current period. We then divide the total Current Period MRR by the total Prior Period MRR to arrive at our Net Dollar Retention Rate.”
To simplify, we can take the basic methodology described in the quoted text from Slack above, and express it in the following formula:
NDR = Current Period MRR / Prior Period MRR
This formula can be explained more clearly through the use of examples. For instance, this is how we can calculate NDR for June 30, 2022:
- Prior Period MRR represents the MRR from 12 months before the Current Period MRR. So for this example, Prior Period MRR is the total MRR for all customers on June 30, 2021.
- Current Period MRR refers to the MRR for the same cohort of customers as the Prior Period MRR, taken 12 months after the Prior Period MRR. For this example, that’s the MRR taken on June 30, 2022. This figure includes all expansion MRR, contraction MRR, and churn MRR for this cohort of customers during this period. MRR from new customers gained within this 12-month period is not included in this figure.
- To calculate NDR for June 30, 2022, the Current Period MRR described above can then be divided by the Prior Period MRR.
The methodology Slack uses to calculate NDR isn’t difficult to understand. But there are some aspects that need to be clarified:
Why is the time period 12 months?
When we calculate NDR for a company, we compare the MRR for the same cohort of customers at the start and end of a 12-month period. But why do we select a 12-month period?
The 12-month time period isn’t selected randomly. The time period used to calculate a SaaS company’s NDR should be the same as the subscription renewal period for that company’s main business. This effectively ensures that customer payments after they renew their subscriptions are included in the calculations.
If the time period used to calculate NDR is too short, most customers will not renew their subscriptions before the time period expires. The MRR will not change significantly, and the calculated NDR will tend towards 100%.
If the time period used to calculate NDR is too long, the calculated NDR will not show the results of recent business operations. The probability of the data containing noise will also be increased.
The main business of our company is our Enterprise business. Our Enterprise customers renew their subscriptions every 12 months. As a result, we use a 12-month time period to calculate our NDR. Using a 12-month time period to calculate NDR is a universal industry standard for SaaS companies, including Slack, whose methodology we have drawn upon above.
What does “the same cohort” mean?
When we calculate a company’s NDR, we first take the MRR for all the customers that the company had 12 months previously. We then compare that MRR to the MRR for that same cohort of customers 12 months later.
The reason using the same cohort of customers is emphasized is because a company’s customers can change on a daily basis. An NDR calculation method needs to calculate MRR for a fixed cohort of customers. In this way, we can ensure that NDR effectively reflects revenue retention for this cohort of customers as they move through a subscription cycle.
Suppose that one year previously, a company had 10 customers. In this case, 12 months later we follow all the expansion, contraction, and churn for those ten customers. The MRR from other customers that have been added during that 12-month period won’t be included in the NDR calculations.
It should be noted that this same cohort of customers can be all the company’s customers at a certain point in time, or a particular cohort of customers at a particular point in time. Calculating NDR for different customer cohorts can provide different perspectives.
For example, NDR calculated with all the company’s customers can provide an overall assessment of that company’s revenue retention ability. We can also calculate NDR using only a certain product’s customers to evaluate the contribution of a particular product to company revenue retention.
3. NDR with ChartMogul
On ChartMogul we can find the following NDR page. The first thing we need to clarify is that ChartMogul’s calculation methodology differs from Slack’s, as they use different types of customer cohorts.
（Image source: ChartMogul Blog)
If we take a closer look, the Cohort Value column in the figure above shows the MRR amount for each cohort of new customers added each month.
In each row, the percentage values displayed to the right of the Cohort Value column show how much MRR was retained for that month’s cohort of new customers after N months. For example the “86.55%” which is circled in red in the figure shows the MRR for customers who were new in January 2022 after they had been using services for four months. It is also the retention rate for the end of May 2022.
ChartMogul uses the same month-by-month approach when calculating NDR. Slack’s methodology is to use all customers at a certain point in time as the customer cohort. ChartMogul’s methodology is to use new customers added each month as customer cohorts. As ChartMogul divides customer cohorts by month, each cohort of new customers added each month has its own corresponding NDR.
As well as that, ChartMogul doesn't only show revenue retention after a 12-month period. They also show revenue retention for cohorts of new customers starting from their initial month, and continuing on a monthly basis thereafter. This means ChartMogul’s NDR methodology shows data for each month during an individual cohort’s first year, and can also be extended beyond a 12-month time frame.
As Slack and ChartMogul use differing methodology to calculate NDR, readers may have some questions about when each respective methodology should be used.
When should we use Slack’s methodology?
When we need to evaluate a company’s overall NDR performance, we will use Slack’s methodology. This is because the customer cohort that Slack uses is all customers at a point in time 12 months in the past. When compared to ChartMogul’s customer cohorts of new customers added each month, the customer cohort used in Slack’s calculations is more comprehensive. The NDR which Slack’s methodology produces is also more representative of the company’s overall performance.
As well as that, when we analyze the overall NDR performance of a company, as well as looking at the NDR rate itself, we should also look at the directional trend in which the NDR rate is moving.
For a mature SaaS company, NDR should not fluctuate too wildly. Slack’s methodology can describe a more stable and reasonable NDR trend chart. Because the customer cohorts used by Slack are comparatively large, the chances of the NDR rate fluctuating excessively due to one or two customers is relatively small.
On the other hand, the cohorts of new customers added each month used according to ChartMogul’s methodology are comparatively small. This makes it easier for the NDR rate to see large, disproportionate fluctuations due to the influence of individual customers.
The final point that needs to be clarified is, the methodology Slack uses to calculate NDR is the universal standard across the SaaS industry. This means that if we use Slack’s methodology to calculate our own NDR, we can then compare our NDR to other SaaS companies, and better understand our position in the industry. This can make NDR a more complete and effective strategic tool for our company.
When should we use ChartMogul’s methodology?
ChartMogul’s methodology shows NDR for each cohort of new customers added each month on a monthly basis after they become customers. This produces NDR results on a more detailed level than Slack’s methodology. ChartMogul’s methodology is more suitable for evaluating SaaS companies or products that are in their early stages.
Early stage SaaS companies and products lack sufficient customer volume and monthly data to use Slack’s methodology to calculate MRR for all customers over a 12 month period. For Slack’s methodology to have sufficiently large reference value, it’s necessary to have at least 18 months of data to work with. Fortunately, ChartMogul’s method of calculating based on new customers added each month can resolve the issue of insufficient historical data.
At the same time, by observing directional trends in the monthly MRR for new customers added each month, we can judge if a product is on the right track.
For example, the following ChartMogul screenshot shows the MRR for cohorts of new customers added each month from January until October, 2022. We can see that for each customer cohort, NDR increases after the end of the first subscription month. This shows that resources are being invested into these products effectively.
On the other hand, if a lot of resources are being invested into a product, and yet there is no clear change in the NDR directional trend, then the product strategy might need to be adjusted.
Once SaaS companies or products are nearly at maturity, large changes to product strategy are very rare. NDR trends for new customers added each month will also tend towards stability. As long as there is sufficient historical data available, SaaS companies can start to use Slack’s methodology to calculate a more comprehensive NDR.
4. Using ChartMogul to calculate Slack-methodology NDR
Even when we use Slack’s methodology to calculate NDR, we can still use ChartMogul as a calculation tool.
For example, to calculate NDR for June 30, 2022, using Slack’s methodology, we would carry out the following steps on ChartMogul:
1. Select June 30, 2021 to June 30, 2022 as the time period.
2. Add the filter “Subscriber since is on or before,” to lock in the customer cohort as all customers on June 30, 2021.
3. Find the MRR for this cohort for June 2021 (for this example, let’s suppose this MRR = 1,000 US dollars.)
4. Find the MRR for June 2022 for the same cohort of customers (for this example, let’s suppose this MRR = 1,300 US dollars.)
5. Finally, NDR for June 30, 2022, can then be calculated as follows: NDR = 1,300 US dollars/ 1,000 US dollars = 130%.
To help consolidate your understanding of NDR, why not try using the steps above to calculate NDR yourself?
Summary
For SaaS companies that follow a subscription-based model, NDR is an extremely useful metric which measures their ability to keep customers, and how likely their existing customers are to upgrade their subscriptions.
NDR is a percentage value that represents how much subscription revenue SaaS companies can retain and expand from their existing customer base.
Two of the main methods of calculating NDR are:
- Calculating NDR for a cohort of customers over a 12-month period. This is the method used by Slack and is the standard across the industry.
- Calculating NDR on an ongoing monthly basis for cohorts of customers that start subscriptions in a specific month. This is the method used by ChartMogul and is useful for companies or products that are in their early stages and lack large amounts of historical data.
When used in the right way, NDR is an extremely useful metric to assess the performance and potential of SaaS products and companies.
I'm Teddy, Co-Founder & CEO of AfterShip, SaaS 102 is a series of articles where I share my experience in SaaS startups.
We are looking for great SaaS sales talent and welcome you to join us at careers.aftership.com.
(Article translated by Joseph O'Neill)