Businesses use different types of metrics to keep track of their performance. The average revenue per user (ARPU) is one of these metrics. Although businesses in different sectors can use it, it’s common among companies with a recurring revenue model, such as SaaS companies.
This guide will take a closer look at ARPU, why it is important, how to calculate it, the pros and cons, and how companies can increase their ARPU.
To learn more about other terms commonly used in venture capital, check out our complete VC Glossary.
The average revenue per user (ARPU) measures the revenue generated by each active customer over a particular period of time. Companies use it as a profitability indicator based on the amount of cash generated from each subscriber.
Subscription-based businesses with customers who make repeat purchases, particularly use ARPU, as it can tell how much active users spend on subscriptions. Tracking ARPU over time can help businesses measure growth and make smart projections.
ARPU is much more detailed than the commonly used monthly recurring revenue (MRR). This is because it focuses on the spending of every customer.
Understanding the average revenue per user is essential. Although businesses are not required to calculate this metric by accounting principles, it’s necessary because it provides valuable information about revenue generation and growth capabilities.
When calculated properly, ARPU helps identify monthly upsell and downsell trends and customers’ most preferred price points. These factors are essential in measuring the sustainability of the SaaS business.
Additionally, ARPU allows you to make short-term and long-term plans for the company. You can use it to accelerate the Monthly Recurring Revenue (MRR) growth and attract higher-paying customers. It can also help your Customer Lifetime Value (LTV) goals by ensuring that the SaaS business achieves long-term success. Users who contribute more revenue to your company every month increase your monthly revenue intake.
Although ARPU does not get much hype like MRR and other metrics like annual recurring revenue (ARR), it’s important because it directly impacts your ability to scale the business. For instance, if your business has a low ARPU of $10 per month, this might not bring in enough revenue to cater to marketing campaigns or staff costs.
Therefore, you’ll need to acquire more customers to achieve a high MRR and ARR. Tracking the ARPU helps you understand your customers and learn more about what drives them to spend. With this information, you can better strategize how to increase your ARPU and grow your business.
ARPU can also be used to change the course of the business. For instance, if your company’s total revenue and customer base are growing, but the ARPU is stable, it could mean that your product or service is underpriced. This should prompt you to explore a different pricing tactic to grow the ARPU.
To calculate ARPU, you must define the standard period – for most companies, this is usually a month.
Here’s the formula to calculate average revenue per user:
Total monthly revenue or monthly recurring revenue (MRR) / Total number of active users
For example, if your company’s MRR is $500,000 and the total number of subscribers is 500, you divide the MRR by the number of users. The APRU is $1,000.
The average revenue per user metric is considered too general. Therefore, companies need to factor in some additional variables for it to make sense for the business. Here are some of these variables.
Users have different needs; therefore, your ARPU will change based on how you define them.
● Paying customers vs. free: If your business has free trial customers, you should not factor them in as you calculate the average revenue per user. Since they are not generating total revenue, they will skew your numbers.
● Seats vs. accounts: SaaS businesses have multiple options for their customers. You need to consider if the account has multiple users.
● Service period: You need to separate the loyal and new customers when calculating the ARPU to get an accurate representation of how each customer segment is performing.
The churn rate indicates the number of users dropping your company’s services. If you lose more customers to your competitors, this will impact your ARPU. Losing higher-paying customers will affect your numbers more than losing lower-paying customers.
Customers are more likely to spend more if your SaaS business has various add-on features and paid plans. You need to monitor what services your customers gravitate to help you understand which subscription tiers drive the most revenue.
If you calculate ARPU, you’ll learn more about your business. Here are some key things you’ll understand from knowing your ARPU.
If you have a low ARPU, this could indicate that you are not extracting value from all your customers. If you have enterprise clients, they are more likely to demand more value; therefore, you should monetize this by adjusting your pricing accordingly.
ARPU improves the value of your sales pitches. You can increase it by bringing in the right customers and selling them the products they desire. This makes your marketing and sales programs more efficient.
Your ARPU helps you determine the financial viability of your business. If it’s low, reaching the monthly MRR goals becomes harder and jeopardizes your chances of long-term success. However, if it’s high, you have the potential to grow quickly and increase your revenue.
If you are looking to maximize the earning potential of your SaaS company, here are the strategies you can use to increase the average revenue per user.
As you develop pricing models, avoid building your customer base on bargain pricing alone. Provide your subscribers with multiple subscription plans to get more users. Additionally, you can promote and package the most popular pricing tier to attract more users.
Now that the users on a free plan are not factored in when calculating ARPU, you need to examine the extent of your free services. You don’t have to eliminate the forever-free plans, but you can make some tweaks to make them more appealing. If you plan to change features in the free plan, you should add some helpful features and give the users a heads-up.
Your average revenue per user is more likely to increase if you provide more opportunities for customers to spend money on your service. If your SaaS company adds optional add-ons to your subscription plan, it gives customers more flexibility and provides additional revenue from your existing customers.
While you should pay attention to all your customers, you should prioritize the larger accounts to keep them loyal. You can keep them from switching to your competitor by providing one-on-one and speedy services to such clients. For instance, you can include a VIP service in the pricing plan, like dedicated customer support services.
You can improve your ARPU by keeping track of trends. By paying close attention, you can spot when the average revenue is on a downward trend or is improving and make the necessary changes.
ARPU is used in different sectors, including:
● Telecommunications companies like Verizon, AT&T, and others track the average amount of total revenue generated per mobile phone subscriber. The revenue includes monthly billings and income from incoming calls.
● Subscription services: Cable companies like Comcast Corp. use ARPU to forecast future service revenues generated from their customer base.
● Social media: Companies like Meta Platforms Inc. and Snap provide ARPU numbers to investors.
Here are the pros and cons of ARPU.
● It helps businesses identify strengths and weaknesses.
● It’s a point of comparison against the competition.
● If the ARPU is high, it’s a bragging point.
● The number is distorted because its a macro-level measure that doesn’t factor in all the company details
● ARPU is dismissed as a “vanity metric” – a metric that’s unhelpful in some cases. Businesses focus more on MRR and ARR.
● Metrics such as the churn rate and user growth are more useful in measuring business performance.
If you run a subscription-based business, the average revenue per user is an important metric for measuring your growth over a specified time period. Ensure that you factor in all the variables when calculating your company’s ARPU to get the most accurate results. Additionally, you should carefully monitor the ARPU and find ways to keep improving it. This will, in turn, increase your company’s MRR and ARR.
To learn more about other terms commonly used in venture capital, check out our complete VC Glossary.
An operating agreement is a legal document used by companies to define their organizational structure, roles and duties of owners and other key parties involved in the business, and methods for handling all transactions that occur within the company.
Stock options in startups work as a form of equity payment that allows an employee to purchase a certain number of shares of company stock at a specified price.
An over-allotment option allows companies to issue extra shares of their stocks beyond those that they initially planned or announced when they go public (or offer other securities). It’s also known as a “greenshoe option”.
Participating preferred stock is a type of preferred stock that gives the holder the option to receive dividends equal to or greater than the customarily defined rate at which preferred dividends will be paid to preferred shareholders.
