SaaS and Recurring-Revenue Metrics
Subscription businesses changed what "revenue" means. When customers pay every month instead of once, a whole new vocabulary appears — MRR, ARR, churn, net revenue retention, the Rule of 40 — and these metrics, not the raw P&L, are how SaaS companies are actually judged. For any engineer working at or evaluating a subscription business (which is most software today), these are the numbers that matter, and the logic behind them explains why SaaS companies behave the way they do.
Most modern software is sold by subscription (SaaS — software as a service), and recurring revenue has its own set of metrics that extend the unit-economics ideas. This post covers the recurring-revenue model and why it’s valuable, the core metrics — MRR/ARR, churn and retention, net revenue retention — and the Rule of 40. These are the numbers SaaS companies live by, and understanding them explains a huge amount of how subscription businesses operate and are valued.
Why recurring revenue is special
The subscription model — customers paying repeatedly (monthly/annually) rather than once — fundamentally changes a business’s economics, which is why it gets its own metrics:
- Predictable, compounding revenue. Recurring revenue is predictable: existing subscribers keep paying, so you start each period with a base of known revenue and build on it. This predictability is enormously valuable — it makes planning, forecasting, and valuation more reliable than one-off sales, where you start each period at zero. It also compounds: new customers add to the retained base, so revenue can stack upward over time.
- The value is in the relationship, not the sale. In a one-off model, the sale is the end; in subscription, it’s the beginning of a relationship that generates revenue as long as the customer stays. This shifts the whole business toward keeping customers (retention) rather than just acquiring them — because a customer’s value (LTV, from the unit-economics post) depends on how long they stay. Retention becomes central.
- It’s why SaaS is valued highly. Predictable, recurring, growing revenue with good retention is a valuable, durable business — which is why subscription businesses are often valued richly (on revenue multiples) compared to one-off-sale businesses. The model’s economics justify the distinct metrics and the premium.
The recurring model reframes the business around a retained, compounding base of revenue and the ongoing relationship with customers — which is why it needs metrics that capture recurring revenue, retention, and their growth. Those metrics start with measuring the recurring revenue itself.
MRR and ARR
The foundational SaaS metrics measure the recurring revenue itself:
- MRR (Monthly Recurring Revenue) — the total predictable revenue the company earns per month from subscriptions. It’s the heartbeat metric of a SaaS business: the recurring monthly revenue base, tracked closely as it grows (or shrinks). ARR (Annual Recurring Revenue) is the annual equivalent (roughly MRR × 12) — the yearly recurring revenue run-rate. Companies use MRR (often for smaller/monthly) or ARR (often for larger/annual contracts) depending on their model.
- It’s about recurring revenue specifically. MRR/ARR count the predictable, recurring subscription revenue — not one-off fees or variable usage that isn’t recurring. This focus on the recurring base is the point: it’s the reliable, compounding revenue that defines the business.
- MRR changes tell a story. MRR moves through several forces: new MRR (from new customers), expansion MRR (existing customers upgrading/paying more), contraction MRR (existing customers downgrading), and churned MRR (customers leaving). Decomposing MRR growth into these components reveals the health of the business — healthy growth from new + expansion, drained by contraction + churn. This decomposition is more informative than the net number alone, because it shows where growth comes from and leaks.
MRR/ARR is the base SaaS metric — the recurring revenue run-rate — and understanding its components (new, expansion, contraction, churn) is how you read the dynamics of a subscription business. But the single most important dynamic, the one that makes or breaks a SaaS business, is retention — whether customers stay.
Churn and retention
Churn is the rate at which customers (or revenue) leave over a period; retention is the inverse (how many stay). Retention is arguably the most important thing in a subscription business:
- Churn erodes the base. Since SaaS depends on a retained, compounding base, churn is a leak in the bucket: every churned customer is lost recurring revenue and lost future LTV. High churn means you’re constantly refilling a leaking bucket — acquiring new customers just to replace lost ones — which caps growth and wrecks unit economics (short customer lifetimes mean low LTV, from the unit-economics post). Low churn means customers accumulate, and growth compounds.
- Retention drives LTV and thus the whole model. A customer’s lifetime value depends directly on how long they stay — so retention is LTV, and LTV vs CAC is the core of unit economics. Improving retention is often the highest-leverage thing a SaaS business can do: it raises LTV, improves unit economics, and lets growth compound. This is why subscription businesses obsess over reducing churn and keeping customers successful (connecting to the customer-success idea and, via the EQ/GTM series, to actually serving customers well).
- Churn compounds against you. Because it applies every period, even a “small” monthly churn rate compounds into large annual customer loss — so churn that sounds minor can be quietly fatal to growth. This compounding is why SaaS companies treat churn so seriously.
Churn/retention is the pivotal SaaS dynamic: it determines whether your revenue base leaks or compounds, drives LTV and unit economics, and is often the highest-leverage lever in the business. A SaaS company that can’t retain customers can’t build a durable base no matter how well it acquires — which leads to a metric that captures retention and expansion together.
Net revenue retention and the Rule of 40
Two higher-level metrics capture SaaS health especially well:
- Net Revenue Retention (NRR) — measures how much revenue from existing customers grows or shrinks over a period, combining expansion (upgrades) against contraction and churn. NRR above 100% is a powerful signal: it means existing customers, as a group, are spending more over time (expansion outweighs churn) — so the company would grow even with no new customers. That’s the hallmark of a strong SaaS business: the existing base compounds upward on its own. NRR below 100% means the base is shrinking (churn/contraction outweigh expansion) and must be refilled just to stay flat. NRR is one of the most-watched SaaS health metrics because it captures retention and expansion together.
- The Rule of 40 — a rule of thumb for SaaS health balancing growth and profitability: a company’s revenue growth rate plus its profit margin should be at least 40%. The idea is that growth and profitability trade off (you can grow fast while unprofitable, or grow slowly while profitable), and a healthy SaaS company should sum to ~40%+ across the two. It’s a quick check that a company is either growing fast enough, profitable enough, or a healthy balance — capturing that early-stage SaaS can justify low/negative profit if growth is high, but the combination must clear the bar.
These metrics — NRR (does the existing base compound upward?) and the Rule of 40 (is the growth/profitability balance healthy?) — are how SaaS businesses are judged at a glance, extending the raw MRR/ARR and churn numbers into signals of durable health. NRR above 100% and clearing the Rule of 40 are the marks of a strong subscription business.
SaaS/recurring-revenue metrics extend unit economics for subscription businesses: the model is valuable because revenue is predictable and compounding, measured by MRR/ARR (the recurring base and its new/expansion/contraction/churn components); churn/retention is the pivotal dynamic (it drives LTV and whether the base leaks or compounds); and NRR (existing-base growth) and the Rule of 40 (growth + profitability ≥ 40%) capture overall health. These are the numbers modern software businesses live by. Next: budgeting and forecasting — planning the financial future.
Key takeaways
- Recurring revenue (subscriptions) changes a business’s economics: it’s predictable and compounding (start each period with a retained base and build on it), shifts focus from the one-off sale to the ongoing customer relationship (retention), and is why SaaS is valued richly — justifying its own distinct metrics.
- MRR (Monthly Recurring Revenue) / ARR (annual, ≈ MRR × 12) measure the predictable recurring revenue base, and decomposing MRR change into new, expansion, contraction, and churned MRR reveals the business’s health better than the net number — showing where growth comes from and leaks.
- Churn (customers/revenue leaving) vs retention is the pivotal SaaS dynamic: it erodes or compounds the base, directly drives LTV (retention is LTV) and unit economics, compounds against you every period (small churn → large annual loss), and is often the highest-leverage lever — a SaaS business that can’t retain can’t build a durable base.
- Net Revenue Retention (NRR) measures existing-customer revenue growth (expansion vs contraction/churn): above 100% means the existing base compounds upward on its own (would grow with zero new customers — the hallmark of a strong SaaS business), below 100% means it leaks and must be refilled to stay flat.
- The Rule of 40 (revenue growth rate + profit margin ≥ 40%) is a quick health check balancing growth and profitability — capturing that early SaaS can justify low/negative profit if growth is high, but the combination must clear the bar; NRR and the Rule of 40 are how SaaS health is judged at a glance.