Annual recurring revenue (ARR)
ˈan-yə(-wə)l -yü-əll ri-ˈkər-iŋ -ˈkə-riŋ ˈre-və-ˌnü -ˌnyü
Annual recurring revenue (ARR) is a core metric for subscription-based businesses. It reflects the recurring revenue generated in a calendar year and provides visibility into growth trends and financial health. For example: If a subscriber buys a three-year plan for $9,000, the ARR is $3,000 per year.
Difference between ARR and total revenue
When evaluating a company’s financial performance, there are several key metrics companies can use. Two of the most important are ARR and total revenue. ARR tracks the subscription-related revenue a brand expects to generate within a year, while total revenue measures revenue generated from all sources, both recurring and non-recurring.
How The Athletic minimized failed payments and scored millions
Difference between ARR and MRR
ARR measures annual recurring revenue, while MRR measures monthly recurring revenue. In other words, MRR is the total amount of revenue a business expects from subscribers in a given month. Subscription businesses use ARR for long-term analysis and MRR for short-term performance indicators.
Why is annual recurring revenue important?
ARR measures the overall health of a subscription business. Measuring ARR over multiple years makes it easier to measure the impact of strategic decisions on year-over-year growth. This deeper visibility ensures more accurate forecasting and guides resource allocation.
How to calculate annual recurring revenue?
To calculate ARR, determine the total revenue your business generates from recurring subscriptions over a year. Include revenue from add-ons and upgrades, and subtract revenue lost because of cancellations and downgrades during the same period.
Simplified, the formula for ARR is:
Subscription revenue + additional revenue - cancellations and downgrades
For example, imagine a business with $100 million in annual subscriptions. The brand also generates an additional $5 million in upsells and services. Furthermore, the company loses $4 million to cancellations and downgrades.
The subscription business would calculate their ARR like this:
$100 million + $5 million - $4 million = $101 million in ARR.
How to improve your annual recurring revenue
Reduce churn
There are many tactics you can use to reduce customer churn; the most effective and efficient is to reduce involuntary churn caused by failed payments, which, by some estimates, accounts for 50% of overall churn. Most enterprise-level businesses partner with a third-party vendor like Butter to automatically retry failed payments.
Diversify revenue streams
Offer multiple subscription tiers, add-ons (upselling), and complementary products (cross-selling). As an illustration of the latter strategy, consider Athena Club, which rocketed to popularity because of the company’s shaving kits. The New York-based company also offers various shaving creams and oils that pair well with their razors.
Acquire new subscribers
While it is easier said than done, bringing in new subscribers will increase your ARR. Consider growing your product offerings, expanding into new markets, and offering free or discounted trials. The Athletic offers a solid example of how to acquire new subscriptions. Since launching, the digital sports newsroom has gradually expanded its coverage to new cities and sports.
Use a tiered pricing strategy
This strategy enables consumers to select the product or service that best suits their needs, and ensures your brand is attractive to a broader audience. Another benefit of this strategy is customer growth. A subscriber might start on the lowest tier, and as their needs grow, they will move up to a higher tier.
Some tips:
- Use clear value propositions: Subscribers shouldn’t be confused about the product or service they receive with each tier.
- Minimize choice: You don’t want to confuse your potential subscribers, so limit the number of tiers you offer. A three-tier pricing plan is common, but it might not be right for your business.
- Use scalable tiers: Design your tiers in such a way that subscribers are incentivized to move to a higher tier. In other words, subscribers should get more features and access, with higher tiers.
For inspiration, look no further than MasterClass. The education and self-betterment provider offers three tiers: standard, plus, and premium. The benefit of higher tiers is that subscribers can access courses on more devices and download the content so they can learn from anywhere.
