Understanding customer retention metrics is crucial for any SaaS company's success. While customer acquisition metrics often take center stage, a company’s long-term growth and profitability often hinge on its ability to retain and expand its existing customer base.
In the SaaS industry, customer retention is measured in several ways, including customer churn, customer lifetime value, and others. Among the most insightful of these metrics are your startup’s gross retention and net retention rates. Neither metric is inherently better than the other; each metric tells a different but equally important story about the health of a subscription-based business.
If you’re not sure about the difference between these metrics, we’re here to help. Read on as we explore the key differences in gross retention vs. net retention and explain why understanding both is essential for making informed business decisions.
The Importance of Retention Metrics in SaaS
Customer retention is the lifeblood of any subscription-based business. In the SaaS industry, where customer acquisition costs are typically high, retaining existing customers is far more cost-effective than acquiring new ones. Strong retention rates indicate customer satisfaction, product stickiness, and the potential for sustainable growth. They’re also a key indicator that your business has found product-market fit and is providing its customers with a product that truly meets their needs.
Retention metrics aren’t just about the utility of your software, however. They also serve as leading indicators of business health. They help predict future revenue streams, identify challenges in your customer success strategy, and guide strategic decisions about product development and customer service initiatives. Weakening retention numbers should cause alarm, whereas strong retention numbers are a key indicator of a business’s potential for financial success.
Investors view retention metrics as crucial indicators of a company's long-term viability and growth potential. Strong retention gives a company a solid revenue base that affords businesses plenty of opportunities to compound revenue through upsells and cross-sells, whereas weak retention metrics are a red flag that a company has yet to find product-market fit.
There are several different types of retention metrics in SaaS––many of which we explore in our Guide to Financial Metrics for Tech Companies. Today, we’re going to drill down into two metrics that are often conflated: gross retention vs. net retention.
Understanding Gross Retention Rate (GRR)
Gross retention rate, also known as logo retention or customer retention rate, measures the percentage of customers or recurring revenue that a company retains over a specific period, excluding any expansion revenue from upsells or cross-sells.
This metric provides a pure measure of customer satisfaction by focusing solely on a company’s ability to retain existing business.
Calculating Gross Retention Rate
The formula for calculating gross retention rate is:
Where:
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- Starting MRR is the monthly recurring revenue at the beginning of the period
- Downgrades represent any reduction in subscription value from existing customers
- Churn represents lost revenue from customers who canceled their subscriptions
For example, let's say a SaaS company starts the year with $1,000,000 in annual recurring revenue (ARR). Throughout the year, they experience $30,000 in downgrades and lose $50,000 in ARR from customers who canceled their subscriptions. Their gross retention rate would be:
GRR = ($1,000,000 - $50,000 - $30,000) / $1,000,000 x 100 = 92%
This means the company retained 92% of its initial revenue.
Evaluating Gross Retention Rate
It’s important to track GRR on a regular basis. Many companies find it helpful to track this on a monthly, quarterly, and annual basis, and to look at this data across several customer cohorts. You might, for instance, break out GRR for smaller customers vs. GRR for enterprise-level businesses, or evaluate your GRR by industry to determine the niches where you have the strongest product-market fit.
You should also consider how your company’s GRR stacks up against industry benchmarks. Across the SaaS industry, the median GRR is 89%, with those in the top quartile of companies boasting GRR rates of 95% or better. Smaller, fast-growing companies tend to have lower GRRs, whereas large, established businesses that primarily serve enterprise customers tend to have higher GRRs.
It’s important to remember that Gross Revenue Rate only tracks how well a business retains revenue from its existing customers. It doesn’t account for any expansion to that revenue through upgrades or the revenues driven by new customers. That’s why it’s so important to not only track GRR but to track NRR too.
Understanding Net Retention Rate (NRR)
Net retention rate, also known as net dollar retention (NDR) or net revenue retention (NRR), measures the percentage of recurring revenue retained from existing customers over time, including expansion revenue from upgrades, cross-sells, and upsells. This metric provides a more complete picture of your ability to retain and grow revenue from your existing customer base.
Calculating Net Retention Rate
The formula for calculating net retention rate is:
Where:
-
- Starting MRR is the monthly recurring revenue at the beginning of the period
- Upgrades represent additional revenue from existing customers
- Downgrades represent any reduction in subscription value
- Churn represents lost revenue from customers who canceled
Let’s stick with our previous example. As a refresher, the company had $1,000,000 in starting MRR and experienced $30,000 in downgrades and $50,000 in churn. During the period, the company also generated $200,000 in expansion revenue from existing customers through upsells and upgrades. Their net retention rate would be:
A net retention rate of 112%, well above 100%, indicates that revenue growth from existing customers more than offset any losses from churn and downgrades.
Evaluating Net Retention Rate
It’s important for SaaS companies to be able to demonstrate a positive or near break-even NRR. Without this, companies will constantly be fighting an uphill battle to replace the revenue they’ve lost from their existing customers. Like GRR, companies should track NRR on a regular basis, creating cohorts for different time periods and types of customers.
NRR is so important since it’s a predictor of long-term growth. If your company can grow revenue from existing customers after accounting for churn, it’s capable of growing even without acquiring new customers. Data shows that SaaS companies have a median NRR of 101%, with companies in the top quartile achieving NRRs of 111% or better.
Like GRR, the larger and more well-established a company is, the better it tends to be able to drive high levels of NRR, since there tend to be better upsell opportunities among enterprise clients. Companies with an Average Contact Value (ACV) of less than $5,000 have a median NRR of 95%, whereas those with ACVs of $10,000 - $25,000 have a median NRR of 106%, according to data from Benchmarkit.
Investors tend to assign higher valuations to companies that have strong net retention rates since this indicates the company is primed for organic growth and can create additional value in its relationships with customers.
Key Differences: Gross Retention vs. Net Retention
Gross retention and net retention offer complementary insights into customer retention and growth. Gross retention strictly measures how well a company retains existing customers. Net retention, which includes expansion revenue, highlights both retention and growth potential.
Gross retention maxes out at 100% since it only tracks retained revenue. Net retention, on the other hand, can exceed 100% when expansion revenue surpasses churn and downgrades, signaling organic growth within a company’s existing customer base.
From a strategic perspective, evaluating gross retention helps leaders identify retention challenges and product-market fit, while an analysis of net retention rates reveals upsell effectiveness and expansion opportunities. Investors prioritize net retention as a key growth indicator, but gross retention remains important for assessing the stability of a company’s customer base. Together, these metrics provide a comprehensive picture of how well a company retains its core revenues.
An Additional Retention Metric: Logo Retention Rate
There’s a third retention metric that it’s important to measure: logo retention rate, also known as logo churn rate. This metric measures the percentage of customer accounts (or "logos") that a company retains over a specific period, regardless of the revenue associated with those accounts. This metric provides unique insights into customer satisfaction and product stickiness by focusing on the raw number of customers your business retains, rather than the monetary value of their contracts.
Calculating Logo Retention Rate
The formula for calculating logo retention rate is:
For example, if a SaaS company starts the year with 1,000 customers and ends with 920 customers (after losing 80 customers), their logo retention rate would be:
This means the company retained 92% of its customer accounts.
Evaluating Logo Retention Rate
Logo retention rate should be monitored alongside revenue-based retention metrics to get a complete picture of customer satisfaction and business health. A high LRR with a lower GRR might indicate that while you're keeping customers, they're downgrading their subscriptions. Conversely, a lower LRR with a high GRR could suggest that while you're losing smaller customers, your higher-value customers remain satisfied.
Industry benchmarks for logo retention vary significantly based on customer segment and pricing model. Enterprise-focused SaaS companies typically see higher logo retention rates, often 90% or better, while companies serving small and medium-sized businesses might see lower rates due to the inherently higher churn in that market segment, typically of around 70%.
Breaking down logo retention by customer segments can reveal valuable insights. Evaluating logo retention rate against the following filters can reveal all kinds of interesting insights about your business:
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- Customer size (enterprise vs. SMB)
- Industry vertical
- Product tier
- Customer lifecycle stage
- Geographic region
Understanding these patterns can help identify where your product has the strongest market fit and which customer segments might need additional attention from your customer success team.
Leveraging a Comprehensive Suite of SaaS Metrics for Success
Both gross and net retention rates are essential metrics for SaaS companies to track and understand, as is a company’s logo retention rate. While gross retention provides clarity on your ability to retain existing business, net retention offers insights into your capacity for growth within your current customer base. Logo retention rate paints a broader picture about your business’s product-market fit.
At G-Squared Partners, we help SaaS companies develop comprehensive financial strategies that leverage these and other key metrics to drive growth and sustainability. Our team of experienced financial professionals works closely with companies to implement robust tracking systems, analyze trends, and develop strategies to improve financial performance metrics.
Whether you're looking to improve your retention rates, establish better financial management systems, or need guidance on interpreting these metrics in the context of your business, G-Squared Partners can help. Our expertise in SaaS financial management ensures that you're not just tracking the right numbers but using them to make informed decisions that drive business success.
For more information about how G-Squared Partners can help your SaaS company optimize its retention metrics and financial performance, contact us today.
