Net dollar retention is the most important metric in SaaS. We find that companies with great net dollar retention (100%+) grow quickly and are more cash efficient than those with mediocre or poor net dollar retention. They’re also far more attractive to acquirers and VC.
Sprout Social, which provides software for managing social media and recently went public, is a good example of what great net dollar retention looks like. As their prospectus states:
“We use dollar-based net retention rate to evaluate the long-term value of our customer relationships, because we believe this metric reflects our ability to retain and expand subscription revenue generated from our existing customers. Our dollar-based net retention rate for the years ended December 31, 2017 and 2018 was 108% and 106%, respectively. Our dollar-based net retention rate excluding our SMB customers for the years ended December 31, 2017 and 2018 was 118% and 115%, respectively.
We calculate dollar-based net retention rate by dividing the organic ARR from our customers as of December 31st in the reported year by the organic ARR from those same customers as of December 31st in the previous year. This calculation is net of upsells, contraction, cancellation or expansion during the period but excludes organic ARR from new customers. We have a history of attracting customers that increase the size of their subscriptions with us over time.”
Sprout’s retention is especially prolific given a high portion of their customer base is SMB, which tends to churn at a really high rate relative to enterprise. They have 23,000 customers generating $78mm of annual revenue so the average revenue per customer annually is only $3,400. The chart below illustrates the ARR from each customer cohort as of the end of each year presented. Each cohort represents customers that made their initial purchase from us in a given year. The 2015 cohort includes all customers as of the end of fiscal 2015.
This is exactly what you want your cohorts to look like: the graph is steepening meaning newer customers are getting even more value out of your product than older customers, likely because the company is getting better at identifying and selling to the ideal customer.
In summary, have a maniacal focus on net dollar retention. Make sure the figure is above 100% and that newer customers cohorts are more prolific than older cohorts. Do that, and you’ll be on your way to building a great SaaS business.
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