How to Analyze the Health of Your Subscription Business

by Chargify Blog

As many leading companies know, customer subscription management isn’t a “set it and forget it” concept. It is important for businesses to constantly analyze the health of their subscription model to make sure it is truly working for their customers and their bottom line. In fact, if a software company is growing at only a 20 percent rate per year, there is a 92 percent chance the business will cease to exist within just a few years.

So if you want to make sure your subscription business is firmly on the right trajectory, you need to be ready to do what it takes to set up and maintain your own analysis framework.

Why Establish an Analysis Framework

Companies of all types—from startups to long-established global brands—have been able to successfully use subscriptions to facilitate a stream of open-ended, predictable revenue and offer customers the services they want without locking them into inflexible contracts.

Throughout the customer lifecycle, however, your subscription billing platform should be prepared to collect and consolidate data from across your enterprise not only to properly bill your customers, but also to better understand how they are using your services.

Data such as responsiveness to pricing, churn, conversion rates, and recurring revenue should be at your fingertips. Armed with this information, your business can better:

  • Understand the health of its subscription business
  • Provide management with actionable insights to refine operations
  • Forecast potential churn and identify mitigations
  • Refine pricing models
  • Track customer demand
  • Update product offerings
  • Plan for the future

So what metrics does your company need to have in place to measure the health of your subscription business, and what impact would this information have on your growth?

Objectively Measuring Your Subscription Business

Several key components need to be in place before you implement metrics as a way to monitor the performance and growth of your subscription business. First, you need a data modeling, analytics, and forecasting platform that can collect, consolidate, present, and track all of the data coming in from across your enterprise and translate it into the relevant metrics.

Secondly, the right metrics for the scope and maturity of your business need to be identified, which can build upon those identified below. For example, the metrics selected and the target ranges can vary as organizations move out of their “scale” and ”optimize” phase and into your “stabilize” phase.

Finally, the metrics selected need to be benchmarked against industry best practices, your peers, and, when available, past organizational performance.

Identifying Metrics

There is no need to reinvent the wheel when it comes to identifying metrics to monitor your business’ performance. However, it is important to pick the right ones that reflect the unique nature of a SaaS subscription business.

Whether you already have a metrics-driven approach to evaluating your subscription business or you are just getting started, here are some best practice metrics to kick-start your analysis effort:

Monthly Recurring Revenue

Monthly recurring revenue (MRR) is the revenue that a subscription business is projected to receive based on current and upcoming subscriptions. MRR is often cited as the key metric for a subscription-based business to watch for as it can capture growth or change from month to month in new customers.

However, your business needs to be ready to peel back the layers behind your MRR figures, especially when usage based billing is a big component of your operations. First, MRR can be skewed by changes in revenue due to customer upgrades or downgrades as well as promotional discounts. In these cases, MRR can be broken out by just including new customers or even calculating lost MRR from customers that have churned.

But, most notably, when customer consumption is highly variable, nonlinear data points can make MRR figures less valuable. In these situations, usage based data can be overlaid in one of two ways: showing incremental growth/decline or total usage. In other cases, when usage based consumption is consistent overtime and across the customer base, the associated revenue can be woven into the overall MRR metrics.

Average Revenue per User

Average revenue per user (ARPU) calculates the total revenue collected per month divided by the total number of active subscribers contributing to that revenue over the same period of time.

This metric can offer a business a look into the depth of services it is providing for each customer, to demonstrate both growth in customer usage and breadth in the number of services they utilize. Although a small number of deeply loyal and active customers can skew the ARPU figure, monitoring trends in ARPU can help to identify churn before it happens so adjustments can be made to pricing, product portfolios, or services.

Customer Churn

Next to MRR, churn can offer a key top-line metric for subscription-based businesses, showcasing the total number of subscribers that have let their subscriptions end over a certain period of time. Churn can be calculated by dividing the total number of subscribers at the beginning of a period—usually a month—by the number of subscribers who have left in that same period of time.

Churn can be further broken down to show voluntary and involuntary churn. Variable or increasing involuntary churn could point to the need for increased proactive communication with your customers about continuing use of your platform or the need for Dunning functionality, which can offer alternate payment collection and reminders of failed payments.

Trial Conversion Rate

Another way for your business to track growth is through trial conversion rate (TCR). This figure captures the number of customers who ultimately become paying subscribers following a free trial period.

To determine TCR, divide the number of new customers who converted from free trials to paying members over a specific period of time by the total number of trials initiated over the same period of time. TCR shows the efficacy of offering a free trial as a method to attract new customers. When viewed alongside the total cost to offer the free trial to customers, changes to the free trial program—either to the length of the trial or to the services available during the trial—can be made to help balance out the structure of the offering.

Lifetime Value

Lifetime value (LTV) calculates the average profit made from each customer over a specific period of time, usually from sign-up to departure. This figure offers a broad perspective on the health of your subscription business. To calculate LTV, multiply the average revenue per customer by your gross margin percentage, and divide that number by the current customer churn rate.

LTV can be analyzed across your entire customer portfolio or at the individual client level, representing which customers have been the most valuable to your brand, the maximum dollar amount your business should spend to acquire new customers, and which customers could benefit from additional add-on sales.

Customer Acquisition Cost

Customer acquisition cost (CAC) is common across many industries. However, this metric is particularly important for subscription businesses because, when paired with LTV, it shows the strength of your business model.

CAC is calculated by dividing the total marketing and sales budget expended by the number of new customers added during a specific period of time.

This value, which equates to a dollar figure, can show just how much your business is spending to acquire each new customer. You can evaluate CAC to determine the sustainability of your platform and your business’s growth trajectory over time.

Refining Your Subscription Management

Metrics like these, supplemented with additional figures that meet the needs of your business, can be used to help evaluate potential changes to your business and pinpoint potential pain points early.

For example, a sudden change in your business’s MRR can indicate that you should evaluate how receptive consumers are to new services or the impact of new types or frequency of customer outreach. MRR tracks closely with projected revenue, so it can even provide additional real-time insight into your business’s financial health.

By contrast, a low trial conversion rate could help a marketing team refine their advertising campaign to target customers who more closely align with the product offerings or potential add-on services, or who may be more open to trials or price changes. The same can apply for increases or decreases in customer churn, especially when a new product feature is introduced; developers and business leaders can use this information to increase promotion of the feature, make adjustments, identify similar new features, or refine its pricing.

Take Your Business to the Next Level

Every business is unique, but the best practices surrounding subscription management transcend the full range of industries. Your business needs to use all of the tools and data available to it to make sure it is leveraging its subscription-based model to its full potential.

If you are looking for a partner with the right platform and the right team to help your business dial in your operations, look to the Chargify team and their subscription management platform.

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