Running a subscription business isn't easy. While the prospect of long-term, recurring monthly revenues is compelling, organizations that receive most of their revenue through subscriptions still face many of the same challenges as traditional companies.
The need to continuously attract new customers and expand market reach doesn't go away with the subscription model. The churn rate is notoriously high for many subscription-based companies, and certain industries tend to turn over their customers more than others.
While many subscription-based organizations focus on revenue-related metrics like Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR), billing subscription metrics are also crucial to driving revenue and profitability.
Billing subscription metrics track payment approval rates, losses, and the effective cost of earning subscription revenue. Tracking both billing subscription metrics and conventional revenue measurements allows companies to benefit from a comprehensive understanding of their sales performance.
It's important to remember that organizations don't generate revenue in a box. Costs are associated with every dollar a business earns. Billing subscription metrics provide significant insights into the effectiveness of marketing dollars, the quality of consumers, and impacts from macroeconomic changes like inflation and wages.
The 3 Most Consequential Subscription Billing Metrics
Many organizations focus on common KPIs concerning revenue generation, customer retention, and renewal rates. While these metrics are essential, sales and marketing managers can't afford to ignore subscription billing measurements.
Subscription billing metrics are essential for understanding the effectiveness of the billing function. These metrics highlight the actual cost of billing customers and build awareness of how many sales fail due to chargebacks, refunds, or declined transactions.
Here are the top three subscription billing metrics crucial to companies seeking smooth sailing for payment processing.
1. Percentage of What is Collected vs. Owed
Not every subscription transaction is approved. Expired cards, changed bank accounts, and mismatches in customer data can all lead to a declined transaction. Even worse, the data being passed to your processor may be creating ‘False Declines’ that account for XX% of ecommerce declines.
Sometimes, customers report their card stolen, or certain red flags lead the issuing bank to refuse payment.
To calculate the Percentage of What is Collected vs. Owed, follow this simple formula:
(Approved Invoices/ Total Invoices attempted) x 100 = % of Approved Transactions
For example, consider a company that charges 2,000 customers monthly subscriptions to a music streaming service. Of all the billed subscriptions, banks approve 1,800 transactions. The organization has an approved transaction rate of 90%.
Obviously, the higher the transaction approval rate, the better. Declined transactions result in lost revenue, something no company wants.
Preventing Declined Transactions
If management finds that the rate of approved transactions for recurring payments is decreasing, defensive efforts are needed. To take action, the company will want to determine the main drivers of declined transactions.
Companies that have international customers can improve approval rates by ensuring they have local acquiring in their most impacted regions. Local acquiring allows for in-country processing with a licensed provider for that region/country. This enhancement is available with many of the best in class services of Adyen and Worldpay, but certain niche markets may require separate agreements depending on your use case.
Since credit and debit cards expire every few years, it's wise to invest in an automated account updater for the billing system. Automated account updaters collaborate directly with banks to refresh cardholder details anytime a card expires or when a new card number is issued on the account. Traditionally this has been done by sending batches to your processor or provider and consuming the responses. With the recent adoption of Network Tokenization, however, Real-Time account updater has been growing in popularity for supporting providers and augments the increase in approvals seen with legacy batch account updater functionality.
With an automated account updater system, there's no need to contact the customer directly and ask them to update their billing information. The system handles the process with no outside intervention necessary.
2. Percentage of Loss
There is an inverse correlation between Chargeback rate and Approval rate. In other words, the higher your chargeback rate, the lower your approval rate. Not every consumer will want to continue their subscription. In some cases, subscribers may find they no longer need the service, or it isn't what they expected to receive. Others may not recognize the subscription expense and request a chargeback from their bank.
Both of these situations often result in a chargeback or request for a refund from the subscriber. In most cases it’s best to issue the refund rather than incur the chargeback. Organizations must comply with their client's wishes to avoid a negative reputation. However, both chargebacks and refunds reduce client retention and revenue, so businesses are wise to review this metric and seek methods to improve it.
To calculate the percentage of loss, follow this formula:
((Revenue chargebacks + Refunds) / Total Sales) x 100 = % of Loss
Management should combine both refunds and chargebacks when calculating this metric while ensuring teams are equipped to manage refund and chargeback metrics independently on a weekly/monthly/daily basis as your use case requires . For example, consider a business with monthly sales of $40,000. During the month, customers request $600 in refunds, while banks issue $200 of chargebacks. The percentage of loss is 2%.
(($600 Refunds + $200 Chargebacks) / ($40,000 Monthly Sales) x 100 = 2% Loss
Improving Percentage of Loss
There are two primary ways to improve the percentage of loss. They include offering free trials for new subscribers and providing a billing descriptor that customers can easily understand on their bank statements.
Providing a short free trial or nominal cost allows clients to determine if they benefit from the company's product or services. Many subscription-based organizations offer a one or two-week trial period to new customers. During that time, the consumer has adequate time to discern if the subscription meets their needs.
It’s imperative regardless of the offers in the market that your business provide clear communication and simple methods for canceling the service. If the client doesn't want the subscription, they can cancel within the given time frame. Cancellations during the trial period don't impact the company's billing function and mitigate the need for larger refund or chargeback exposure.
An organization's billing processor usually provides billing references referred to as a billing descriptor . Poorly-named references spark confusion among customers. For example, customers will likely request chargebacks if the company's name is Fresh Food, but the billing reference is 123 DeliveryInc.. The client may believe the subscription charge to be fraudulent or a mistake. Additionally a scenario where cohabiting individuals have one partner that manages the finances. Billing descriptor clarity is important so anyone will easily be able to identify the charge.
3. Effective Cost
Effective cost is simply a measure of the expenses associated with processing monthly subscriptions. The calculation of effective costs includes every fee connected to both billing and payment processing. Typical expenses include monthly service fees, transactional costs, currency exchange, and platform fees in addition to your payment processor, interchange, gateways, and any related intermediaries.
To calculate a company's effective cost of payment processing, add up all the associated monthly fees. The below formula provides the percentage of the effective cost for the month:
(All Processing Costs / Total Monthly Revenue) x 100 = % of Effective Cost
Consider a company with $1,000 in payment processing fees, $50 in gateway costs, and $100 lost to currency conversion. The same organization has $20,000 in monthly revenue. The effective cost of all of the business's transactions is 5.75%, as calculated below:
(($1,000 + $50 + $100 All Processing Costs) / $20,000 Monthly Revenue)) x 100 = 5.75% Effective Cost
Costs associated with processing may appear insignificant when examined individually. It's not uncommon for a single transaction to show just a few cents of processing costs. However, aggregated monthly processing expenses can make a considerable dent in revenues.
More recently, Network fees like ‘Misuse auth fees’ for un-reversed auths, Non-Compliance Fees, and fines for retry and recycle attempts can be listed separately on statements or in charges. Also consider that retained Amex merchants receive a separate Amex statement as do various other offering. More often than not businesses don’t have a clear picture of their actual fees. It’s Revolv3’s recommendation to monitor this metric and trending monthly at the very least.
Reducing Effective Cost
Reducing effective costs rests largely on negotiating better terms with payment platforms, banks, and processors. Financial managers can review the expenses charged by each outside organization and look for other providers that provide the same benefits at a lower cost. If significant expenses arise from network compliance, currency conversion, processing fees, or additional intermediaries like a gateway, it’s likely consolidating services and pricing will help the overall cost metric.
Standard Subscription Metrics
Many organizations ignore subscription billing metrics in favor of the more standard subscription KPIs. While companies should pay attention to subscription KPIs, ignoring subscription billing metrics puts your company at a disadvantage. . Senior leadership should ensure they monitor both for optimal business performance.
Here are 10 of the most common KPIs that subscription companies monitor and what insights they provide to business managers.
1. Monthly Recurring Revenue (MRR)
Monthly Recurring Revenue provides subscription companies an estimated monthly revenue from all subscribers. GAAP or IFRS do not accept monthly recurring revenue as a revenue recognition principle. Still, it's an excellent tool for forecasting and determining when sales increase or are beginning to show signs of decline.
Calculating MRR is relatively simple. Multiply the current number of subscribers by their subscription purchase amount to obtain the expected MRR:
# of Subscribers x Subscription Rate = MRR
Consider a subscription-based company that offers a monthly service for $10. To keep the example simple, we'll assume the company provides no other services at differing rates. There are 5,000 subscribers.
5,000 Subscribers x $10 Subscription = $50,000 MRR
Using MRR, the company can estimate how much revenue it expects to earn over the following months or years, accounting for certain factors like forecasted growth or customer retention.
2. Annual Recurring Revenue (ARR)
Annual Recurring Revenue is another method for estimating revenue over time. ARR is also helpful for comparing income yearly to evaluate whether tweaks need to be made to the sales model to keep it thriving.
Similar to MRR, the ARR calculation involves multiplying the number of subscribers by their subscription rates. However, to extend the calculation to account for yearly revenue, the monthly earnings are multiplied by 12 months:
# of Subscribers x Subscription Rate x 12 Months = ARR
Using the example from MRR, on an annual basis, the same company has an estimated ARR of $600,000.
5,000 Subscribers x $10 Subscription x 12 Months = $600,000
There are limitations to ARR. The calculation does not account for new customers, lost customers, or subscription billing costs. Building these factors into the ARR calculation improves the accuracy of the forecast. If the company plans to use ARR for estimation purposes, include as much known information as possible.
3. Average Revenue Per User (ARPU)
Average Revenue Per User is useful for market segmentation analysis, financial modeling, and comparisons. The metric calculates how much revenue each person generates within a given time frame.
To calculate ARPU, divide total revenue by the number of subscribers:
Total Revenue / # of Subscribers = ARPU
Consider a subscription company with $50,000 in monthly revenue and 40,000 clients. The monthly ARPU is $1.25.
$50,000 Total Revenue / 40,000 Subscribers = $1.25
Organizations can further their ARPU analysis through specific market demographics and revenue streams.
4. Churn Rate
The churn rate measures the percentage of customers who cancel their subscriptions during a given period. A high churn rate in the subscription-based revenue model indicates potential problems with the targeted market or the subscription service itself.
To calculate the churn rate, use the following formula:
(# of Customers Lost in A Period / # of Customers at Beginning of Period) x 100 = % Churn
An organization that loses 1,800 customers and has 30,000 customers at the beginning of the period has a 6% churn rate.
(1,800 Customers Lost / 30,000 Customers at Beginning) x 100 = 6% Churn
Certain industries have higher churn rates than others. Often, companies that follow a retail model lose more clients than those in sectors such as financial services and insurance.
5. Renewal Rate
In any given period, customers can choose to renew their subscriptions or cancel them. The renewal rate indicates the percentage of clients who decided to keep their subscriptions versus those who canceled.
To calculate the renewal rate, use the below formula:
(# of Customers Who Renewed Subscription / # of Customers Due to Renew) x 100 = Renewal Rate
During a given quarter, 3,000 customers are up for renewal. Of the 3,000 customers, 2,400 decide to renew their subscriptions. The company has an 80% renewal rate, as calculated below:
Companies should compare renewal rates each period to determine if any concerning changes warrant investigation.
6. Days Sales Outstanding
Days sales outstanding (DSO) measures how long it takes for a company to collect its outstanding accounts receivable. DSO isn't as important for subscription-based companies that bill monthly or quarterly since they usually don't provide services on a credit basis. Instead, the company collects a prepayment for their products for the following period.
However, some subscription-based organizations do bill after products are delivered. Those that bill following delivery will need to track DSO. The calculation for DSO is:
(Accounts Receivable / Net Credit Sales) x Number of Days = DSO
For example, consider a company with $400,000 in outstanding accounts receivable at the end of September. The company made $750,000 in sales on credit during the month.
($400,000 Accounts Receivable / $750,000 Net Credit Sales) x 30 Days = 16 DSO
Thus, the company collects its credit sales within 16 days on average.
7. Conversion Rate
The conversion rate quantifies how many customers take specific action during a set period. Organizations that obtain most of their sales through online platforms use conversion rates to measure the efficiency of their marketing campaigns. The conversion rate effectively evaluates the number of people who sign up to receive promotional emails, purchase a service, or visit a landing page.
The company must decide what action it wishes to measure with the conversion rate. If sales are the primary concern, management can use the below formula:
(# of Sales / Total Number of Site Visitors) x 100 = Conversion Rate
An e-commerce site with 60,000 monthly visitors and 2,400 sales has a conversion rate of 4%.
Organizations should seek to maximize conversion rates to grow revenue and expand market reach. It's helpful to compare conversion rates over time to benchmark optimal performance.
8. Customer Acquisition Cost (CAC)
Customer acquisition cost (CAC) measures the expense of obtaining a new customer. Companies can calculate CAC across marketing activities, such as social media and advertisements. It's also helpful in determining the marketing cost associated with each sale.
To calculate CAC, use the following formula:
Sales and Marketing Expense / Number of New Customers = CAC
A subscription-based organization with $100,000 in quarterly marketing expenses and obtains 10,000 new customers during the period has a CAC of $10 per customer.
$100,000 Sales and Marketing Expense / 10,000 New Customers = $10 CAC
Management can compare CAC with the Customer Lifetime Value metric to determine the value obtained per customer.
9. Customer Lifetime Value (LTV)
Customer lifetime value represents the total amount a business expects to earn from its affiliation with an individual customer. Comparing LTV with CAC assists management with understanding whether its cost to acquire customers results in a reasonable profit.
To calculate customer lifetime value, follow two steps. First, determine the Lifetime Value per customer using the below formula:
Average Value of Sale x # of Transactions x Retention Period = Lifetime Value
A subscription-based company with an average sale of $10 per month, 12 monthly billings, and retention of 1 year has a Lifetime Value per customer of $120.
$10 Per Month Sale x 12 Transactions x 1 Year Retention = $120 Lifetime Value
The second step in calculating LTV is multiplying Lifetime Value by the profit margin for each product:
Lifetime Value x Profit Margin = Customer Lifetime Value
To continue with the example, assume the profit margin of the subscription-based company is 20%.
$120 Lifetime Value x 20% Profit Margin = $24 Customer Lifetime Value
When comparing LTV with the CAC of the previous example, the cost to acquire the customer results in $14 extra profit for the company for each new customer.
Finally, earned revenue is the actual revenue obtained during a specific period that reflects products and services delivered to the buyer. Under GAAP and IFRS accounting standards, earned revenue occurs when ownership of the service transfers from the company to the purchaser.
Subscription-based companies recognize earned revenue during single accounting periods. For example, a company whose customer purchases a subscription for service for $10 per month with a one-year subscription term will recognize monthly revenue of $10. The company does not recognize the entire $120 subscription value as earned revenue at the time of purchase.
Monitoring a subscription business is an involved process that includes many different factors. In addition to considering simple revenue and marketing measurements, companies should review how much they lose to the cost of their billing services and declined transactions. Any subscription revenue platform worth its weight will include built-in metrics that go further than the standard KPIs. An effective platform genuinely looking out for its customer's needs considers payment costs and offers optimization solutions tailored to the subscription company's requirements.
Revolv3 is a revolutionary subscription billing platform that utilizes artificial intelligence and business logic to manage subscriptions and optimize billing processes. Using Revolv3, organizations gain access to the critical billing and revenue metrics they need to maximize performance. Revolv3's innovative APIs offer developers complete customization and deliver the industry's highest credit card approval rates. Learn more about Revolv3's services and improve your subscription billing metrics today!