Why is Net Dollar Retention important to SaaS startups? 

Net Dollar Retention (NDR) is a vital metric for Software as a Service (SaaS) or subscription-based companies. SaaS companies need to retain customers, since SaaS businesses deliver a service that is used by a customer over time. NDR evaluates the growth or decline in revenue from a company’s existing customer base over a specified period, factoring in expansions, churn, and contractions.

Net Dollar Retention evaluates customer satisfaction and the value they derive from a product, showing you how well you keep and upgrade your customers. It also demonstrates the efficiency of growth from existing customers, often a more cost-effective revenue source than new customer acquisition. And changes in NDR are warning signs to founders – negative changes can mean there is a product or customer service issue, and positive improvements can show that new growth has been unlocked, typically from product feature enhancements. 

 For venture capitalists, NDR reflects a startup’s health, growth potential, and attractiveness as an investment opportunity. In essence, high NDR signals strong product-market fit, efficient growth, and improved profitability prospects, which are critical for both startup founders and investors.

How do you calculate NDR? 

The refined formula for NDR is:

Net Dollar Retention = [(Starting MRR from existing customers + Expansion - Churn - Contraction) / Starting MRR from existing customers] * 100%

Where:

Starting MRR (Monthly Recurring Revenue) from existing customers is the revenue at the start of the period from those customers who were already with the company.

Expansion is any increase in revenue from existing customers (e.g., due to upsells, cross-sells, or price increases).

Churn is the lost revenue due to existing customers canceling their subscriptions.

Contraction is the lost revenue due to existing customers downgrading their subscriptions or reducing their usage.

Note that the formula does not take into account new customer growth.

Understanding NDR

If the NDR is over 100%, it suggests that the revenue from existing customers is growing, even without factoring in new customer acquisition. This implies strong customer satisfaction and effective upselling or cross-selling strategies.

Contrarily, if the NDR falls below 100%, it implies that the company is losing revenue from its existing customers. This could indicate problems with product quality, customer satisfaction, or pricing. It also signifies that to maintain its current revenue level, the company would need to continually bring in new customers, which can be an expensive and unsustainable strategy.

Do you calculate NDR monthly?

There is no hard and fast rule on what time frame to use to calculate NDR. Monthly is a common time frame to calculate NDR, but it won’t make sense for every business, especially if there is noise (such as late renewals or upgrades) in how customers pay or renew. Many CFOs prefer to calculate NDR quarterly or on a rolling three month basis, as this can help smooth out some of the noise.

What is a good NDR?

Jason Lemkin of SaaStr has published some charts showing Net Revenue Retention - which is another way of saying Net Dollar Retention - is typically 102% at the annual mark. He also notes that gross retention is 92%; that’s the percentage of paying customers who are retained. So this clearly shows how a SaaS startup can increase pricing/penetration into an existing customer cohort to boost revenue while still having a decent customer churn rate of 8% annually. A couple of other items to note from Jason’s piece are that 1) NDR goes up as the size of contracts increases and 2) when a startup gets over $10M in ARR it also improves.

What is a good NDR?

Why does Net Dollar Retention matter to startups?

Healy Jones

In my experience, both running SaaS business and investing in / and advising them, NDR is an incredibly powerful metric. I’ve seen this metric presented in several ways, but almost always based on a cohort of users. Founders should have either a manually created spreadsheet that tracks churn and net dollar retention, or should use a tool to monitor it.

At first, the easiest and most useful cohorts to track, in my opinion, are cohorts based on monthly signup/customer acquisition. Here is an example of what such a chart looks like; as you can see, this company unlocked something that boosted NDR that cascades through the cohorts retention metrics. 

NDR Chart Example

Retention at Month after Signup

  Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9
Jan 23 100% 95% 90% 86% 86% 90% 95% 99% 104%
Feb 23 100% 92% 87% 87% 92% 96% 101% 106%  
Mar 23 100% 95% 95% 96% 97% 98% 99%    
Apr 23 100% 99% 101% 103% 105% 107%      
May 23 100% 102% 104% 106% 108%        
Jun 23 100% 104% 106% 108%          
Jul 23 100% 103% 105%            
Aug 23 100% 107%              
Sep 23 100%                

Reasons why Net Dollar Retention matters to startups

NDR is a crucial metric for startup founders and venture capitalists (VCs) for several reasons:

1. Customer Satisfaction and Product Value: High NDR indicates that customers find value in the product or service and are willing to either maintain or increase their spending. This suggests that the product or service is meeting or exceeding customer expectations, leading to customer satisfaction and loyalty.

2. Efficiency of Growth: Positive NDR implies that the existing customer base contributes to the growth of the company, which is often a more cost-effective way to grow revenue than acquiring new customers. The cost of upselling or cross-selling to existing customers is typically lower than the cost of customer acquisition.

3. Predictability and Sustainability of Revenue: Recurring revenue from existing customers (reflected in a high NDR) provides a more predictable and sustainable source of revenue than constantly having to acquire new customers.

4. Unit Economics and Profitability: Companies with a high NDR often have better unit economics (like customer lifetime value to customer acquisition cost ratio, or LTV/CAC) and can become profitable more quickly. This is because increasing revenue from existing customers often involves lower costs than acquiring new customers.

From a VC perspective, NDR is an important metric because it is a clear indicator of the startup’s health and potential for growth. A startup with a high NDR is likely to have a strong product-market fit, satisfied customers, efficient growth, and better profitability prospects. These factors make the startup a more attractive investment opportunity.

Additionally, VCs often use NDR as a benchmark to compare the performance of different startups in their portfolio or in the market. This helps them make informed decisions about where to allocate their capital for the best potential returns.

In summary, NDR can provide valuable insights into a startup’s customer satisfaction, efficiency of growth, revenue predictability, and profitability, which means it’s essential for both startup founders and VCs.

An example of NDR at a SaaS company

Let’s compare two similar SaaS companies with slightly different net dollar retention rates to showcase how big of an impact minor improvements to this SaaS metric can have.

1.  Both SaaS companies start with 100 customers, each paying $1,000 a month. So, the starting MRR for both companies is $100,000 (100 customers * $1,000).

2. One company has a monthly NDR of 5%, while the other has a monthly NDR of -1%.

3. Each company adds 5 new customers a month, each paying $1,000. 

In the first month, the first company’s existing customers will contribute $105,000 (5% increase over $100,000) while the second company’s existing customers will contribute $99,000 (-1% decrease from $100,000). In addition, both companies will add 5 new customers, each paying $1,000, contributing an additional $5,000. 

So at the end of the first month, the first company’s MRR will be $110,000 ($105,000 from existing customers + $5,000 from new customers), and the second company’s MRR will be $104,000 ($99,000 from existing customers + $5,000 from new customers).

However, for the subsequent months, we need to take into account the monthly NDR for the existing customers and the new customers added each month. Therefore, the calculation for the end of the year will be more complex, as the existing customer base and its associated revenue will change each month.

Let’s fast forward to the end of the year, assuming that the monthly NDR rates remain constant:

  • For the first company with a monthly NDR of 5%, its revenue from existing customers will compound monthly. After 12 months, the starting MRR will have grown to approximately $179,585. 
  • For the second company with a monthly NDR of -1%, its revenue from existing customers will also compound monthly but in a decreasing manner. After 12 months, the starting MRR will have shrunk to approximately $89,463.

Throughout the year, each company adds 5 new customers a month, each paying $1,000. This contributes to an additional MRR of $60,000 by the end of the year.

So, at the end of the year:

  • The first company’s total MRR will be approximately $239,585 ($179,585 from existing customers + $60,000 from new customers).
  • The second company’s total MRR will be approximately $149,463 ($89,463 from existing customers + $60,000 from new customers).

So, the first company, with a 5% monthly NDR, ends the year with approximately $90,122 more MRR than the second company, which has a -1% monthly NDR. That’s a 60.3% increase (($239,585 - $149,463) / $149,463 * 100%) over the second company’s MRR. 

This demonstrates the power of positive NDR even more starkly. When applied on a monthly basis, a positive NDR can significantly grow a company’s revenue, while a negative NDR can lead to a substantial decrease, even if the rate of new customer acquisition is the same.

Churn and a negative NDR are part of some business models

A negative NDR doesn’t necessarily mean a company is on shaky ground. Instead, it might indicate that the company’s growth strategy is more focused on acquiring new customers than on expanding revenue from existing ones. As long as the company can continue to attract new customers at a cost that’s lower than the lifetime value of those customers, this strategy can lead to sustainable growth.

In fact, some successful SaaS companies have managed to thrive despite negative NDR by leveraging innovative, high-impact customer acquisition strategies. These can include digital marketing, partnerships, referrals, freemium models, or other growth-hacking techniques. The key is to ensure that these acquisition channels are cost-effective and scalable.

Some markets will have high churn – for example, subscription companies serving restaurants. The restaurant industry is notorious for having a large number of businesses that fail every year, so it would make sense that a SaaS company selling into that market would have a higher churn rate. 

Kruze cares about this metric too!

However, it’s important to note that negative NDR and customer churn should still be monitored and managed. High churn rates can indicate issues with product quality, customer satisfaction, or pricing strategy. Therefore, while focusing on customer acquisition, companies should also strive to minimize churn and increase customer lifetime value.

As expert SaaS-focused CPAs, we understand the importance of tracking and improving key financial metrics like Net Dollar Retention. NDR is crucial for understanding customer satisfaction, the efficiency of growth from existing customers, and for identifying potential issues related to your product or customer service. It also provides an indication of your startup’s health, growth potential, and profitability prospects, making it an essential metric for both founders and venture capitalists.

Remember, a high NDR indicates strong product-market fit, efficient growth, and better profitability prospects. Understanding and improving this metric can significantly boost your company’s performance and attract potential investors.

If you have any questions or need further assistance in understanding or improving your company’s NDR or other financial metrics, don’t hesitate to reach out to us. We’re here to help you navigate the complexities of SaaS financial metrics and to support your company’s growth journey.

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