ARPU - how to use it efficiently

What is ARPU

The average revenue per user (ARPU) is a non-GAAP metric that shows how much revenue a SaaS company gets from one user. This metric allows investors and business development specialists to look at company growth from the ground up, accounting for the future from one customer's perspective.

To calculate this metric, you need to take the total revenue for a period and divide it by the average number of users during the same time. Keep in mind that the number of users can change within the timeframe, so take the average user size to ensure consistency.

The most common timeframe used in this calculation is monthly. However, if your business has more active day-to-day fluctuations, you might choose a weekly or daily timeframe. Other companies might only require a quarterly calculation. Everything depends on how often your customers complete a purchase or equivalent transaction.

For most SaaS companies, however, the ARPU will be calculated monthly, as subscriptions usually renew during that period. For a standard once-a-month calculation, a company’s ARPU should include the following numbers from your accounting records:

• Monthly recurring revenue (MRR): Quarterly or yearly numbers are useful in the long-run. However, most subscription-based companies use the MRR to keep an ARPU current and, therefore, more accurate.

• Account upgrades and downgrades: These numbers give more context to the MRR figure. If you had customers that bought a higher-tier package (upgrades) during the period, their total customer number stays the same. However, if all else remains the same, your ARPU will increase. The opposite is true for downgraded customers.

• Lost MRR from churned customers: This figure accounts for the amount of money you lost in total revenue during the month due to customers dropping your services. Here, the income and the number of customers decrease. 

• The total number of paying customers: This calculation should include all the paying customers with active accounts within the given month.

Some large corporations, like Facebook, will often publish their ARPU for the whole company, including dormant accounts. Sure, the company might have millions of users, but not all of them might be leveraging their services. The metric isn't about the total number of users but, instead, about the benefit each user brings. The average revenue should only cover the customers that both pay and use the service.

Calculate your ARPU without including the following:

• Free items, free tiers: Including these will skew the revenue stream, decreasing your ARPU, and won’t provide an accurate picture of the revenue generation sources. It's simple: free users don't add to your bottom line.

• Inactive customers: Besides the fact that these user accounts don't do anything to your metrics, they "take space." Thus there's no use in including them. They can add valuable knowledge regarding your customer base, telling you about the service drop rate among users. Still, some companies remove dormant accounts from their records after some time to ensure they have the right numbers.

Removing this unnecessary load from your accounting will give shareholders and investors a better look at your company's performance.

Although ARPU isn't as popular in SaaS as average recurring revenue (ARR) or monthly recurring revenue (MRR), it's still crucial. Some business owners confuse this metric with customer lifetime value (LTV). However, there is a crucial difference: LTV accounts for the customer's "lifetime,” while ARPU calculates a similar number for a given period. LTV also removes the variable costs from the equation.

When To Use ARPU

Some business owners say that ARPU is useless or a "vanity metric." We agree that it can be inaccurate at times, but only if you don't consider the variety of users. Implementing it in tandem with other analysis methods can offer valuable insights into many areas of your business. Besides, this metric can be a powerful ground for calculating and forecasting necessary figures, like financial or user growth, if you have defined customer segments.

Here’s where a cohort analysis becomes incredibly useful. There's nothing you can't analyze with the help of customer associations. Divide your users "per acquisition channel," "per payment tier," or other cohort definitions. With these data parameters, you can calculate ARPU and develop a deeper understanding of how to best conduct your business and where improvements are necessary. The average revenue per user might not be a deep metric, but it's more powerful in conjunction with cohort data.

Conduct Profitability Analysis

With proper segmentation, ARPUs can produce valuable insights into the profitability of each segment. Suppose your business has three tiers, and you want to find out which one brings you more revenue. An ARPU could yield such information and help you understand the most efficient promotion tactics.

A similar analysis can refer to users from different channels. Let's say that customers coming from Instagram buy more add-ons, which is the more profitable area for your software. This means that you need to find ways to increase customer influx from that channel.

Based on this information, you can task your marketing team to put more effort into Instagram ads and yield higher profit margins.

Consider ARPU’s Impact on MRR and LTV

Based on the calculation suggested above, ARPU growth connects directly with MRR. As the customer starts spending more money with your company (assume they buy a higher tier subscription or an add-on), the ARPU grows as well. Similarly, if the customer pays more money to the company every month, the LTV also increases. 

Compare Your Standing in the Market

It's always essential to keep an eye on the competition. Comparing ARPU with other businesses in the same niche is one way to place your company's profitability within context. This metric isn't new. ARPU actually has a long history in the telecom business.

With the emergence of SaaS companies and the subscription model in more recent years, this calculation has become one of the primary ways of making sure your firm stays relevant in the market.

Find the Right Customer Acquisition Channel

Most companies use LTV to determine which customer acquisition channels are more profitable. However, ARPU can give you a shorter-term bird's-eye view of that source.

Suppose you're a subscription-based software company with a YouTube channel, Facebook page, and Instagram account, and that you use all three sources equally to drive users to your website. In that case, you can account for how many customers each one brings you within one month and which tiers they prefer.

Once you analyze the customer profitability from each channel, you'll know which one to promote more. You can also review similar companies that use those social platforms, conduct a comparative analysis of their efficiency, and devise methods to improve yours based on the findings.

Check the Efficiency of Sales and Marketing Teams

All SaaS startups need to keep an eye on client behavior through sales and marketing departments. If your teams are working well, you're going to notice continued improvements in ARPU numbers.

Your marketing team should reach a decrease in customer acquisition cost, manage a more efficient channel targeting, and move toward an overall improvement in customer loyalty. If they do everything right, ARPU will grow.

Similarly, attracting a better customer base, selling the right packages, and upselling the existing users will positively impact the metric. 

Forecast for the Future

Using ARPU to calculate the projected revenue for the entire company is one of the most efficient methods. However, keep in mind that the calculation includes a lot of assumptions and variables. You should base any forecasted numbers on the previous customer flow and retention in order to maximize the accuracy of these assumptions.

You'll be able to derive more knowledge for the future if you track an ARPU for each period and compare it to the previous one. Such data will improve the forecasting and development tactics, thus making it easier to find blind spots in your marketing, financial planning, and larger business decisions. Additionally, you'll be able to generate more accurate sales predictions and more cohesive reports.

Some Good Insights You Can Get

Rethink the Price of Your Plans

Low ARPU value could suggest that your pricing model isn't working to its full potential. As we described above, the amount a client spends on a given plan might correspond with the channel they were funneled in from. As you isolate specific cohorts and track what they gravitate towards, you’ll be able to leverage their needs and build a larger following from that source. Doing so will improve the value and cost relation in your pricing tiers.

Exploring extra services and package deals is another area of potential leveraging. Suppose one add-on gives more value to the customer than the other, but they cost the same. You can adjust their pricing to reflect that value.

In addition to this change, it's also possible to tweak service costs to attract higher-paying loyal users. Having various tier prices, of course, is common and useful. Still, you should take care not to drive lower-paying customers away. At the same time, the higher-paying ones should feel they’re getting good value for the service.

Most SaaS companies use tags on their pricing pages to indicate the "most popular" plan, which includes the top value. You can use metrics like ARPU and SaaS dashboards to find out which of your payment tiers is more profitable for the company. The tools will also show the most valuable plan for the customer. Promoting these two on your pricing page will likely yield the highest pay off.

With this in mind, you might need to rethink any free plans your company has on offer. Of course, profit maximization shouldn't drive you to eliminate all items that have no cost attached. Instead, try to approach the process in a more granular way to hit the balance between giving your customers value and increasing business revenue.

Adjust Your Persona With the Most Valuable Clients

What does your ideal buyer persona look like? Have you been targeting lower-paying customers when you should've been looking at enterprise-grade users? Your software may provide better value to those with larger pockets.

Know your product and your ideal customer thoroughly. Make it your priority to talk to prospective clients and learn more about their needs. Find out what they expect from your SaaS product and dedicate yourself to getting them the value needed.

On the other hand, you shouldn't follow all the suggestions blindly. Otherwise, your product will develop haphazardly. Put the advice in perspective with your data and metrics, using tools like SaaS analytic dashboards.

Conclusion

Although some specialists might coin ARPU as a "vanity metric," it works well with cohort analysis. Per-user revenue, combined with another data point, gives you valuable information about several aspects of your business, like which acquisition channel is most efficient for growth.

Depending on where you source your customers, the gained insight can lead you to take advantage of some sources more than others.

Another aspect ARPU can be helpful with is correct pricing. If you can leverage the value in one or more tiers or add-ons, you should.

Revenue per-customer is also useful in choosing your most valuable client persona, improving sales and marketing team efficiency, and strengthening your forecasting abilities.