Monthly Recurring Revenue (MRR) is a measure of the predictable revenue stream of a company. In the software business, for example, it is merely the subscription revenue of the business. Venture capitalists almost always refer to Monthly Recurring Revenue as MRR and value it highly as a way of measuring the stability and growth potential of a business. The basic idea is simple: if it costs money to acquire customers, then it’s best if those customers are monthly subscribers so that you don’t have to worry about spending a lot of money finding new customers every month.
For that reason, MRR has become a hallmark feature of any new business, and not just an entertainment business like Netflix. These days, you can subscribe to almost anything as a monthly service. Just a few years ago, for example, everybody went to the supermarket to shop for food. Or they had food delivered to them on a one-off basis (whenever they were too tired to cook that night). Now, people subscribe to daily meal kits that are delivered, like clockwork, every day and every week.
Venture capitalists love the idea of MRR because it makes it much easier to value a business. And that’s especially the case if they are using a traditional financial model like the Discounted Cash Flow (DCF) model to figure out how much a business should be worth. If you can project stable, recurring cash flows well into the future; it makes it much easier to value a company based on current growth projections.
That being said, there are a variety of different ways to calculate MRR. The basic approach involves a customer-by-customer approach, in which you add up all the monthly fees of every single paying customer. But what if you have tens of thousands of customers? In that case, you might want to use the ARPA (average revenue per account) approach, in which you calculate the average amount paid by a subscriber each month, and then multiply that figure by the total number of customers. Using both of these approaches, it’s also possible to convert annual or lifetime (!) subscriptions into MRR figures. In the case of yearly subscriptions, for example, you’d divide by 12.
As well, there are different “flavors” of MRR. For example, “new MRR” is a measure of all new revenue from brand-new customers each month. And “expansion MRR” is the additional revenue generated by people upgrading their payment plans and subscription tiers. (That’s why companies are always pushing you to upgrade from your free plan – they want to boost their expansion MRR). There is also churn MRR, which is a reflection of paying customers canceling their subscriptions or downgrading to a lower tier. If churn MRR is too high, it might negate any new MRR you are generating. So retention is key.
As might be imagined, venture capitalists keep a close eye on MRR and all of its various versions. They are particularly interested in MRR growth, which is measured as (New MRR) + (Expansion MRR) – (Churn MRR). On a month-to-month basis, MRR growth needs to be showing positive momentum.