NRR Factor Analysis and PER (Potential Expansion Revenue)
Steven Forth is CEO of Ibbaka. Connect on LinkedIn
Duane Kotsen and his colleagues at Marlborough Street Partners have introduced an important new SaaS metric: Potential Expansion Revenue or PER. The initial article on this is Now that Churn is under control – do you know your Potential Expansion Revenue?
What is this new PER metric and why does it matter?
Basically it is the potential additional revenue from inside your current customer base.
Let’s take a really simple example. There is a SaaS company with 1,000 customers, average revenue per customer of $10,000 and revenues of $10,000,000. There are several companies in Ibbaka’s customer base that look like this.
Let’s look a bit deeper, the smallest customer generates $5,000 in revenue per year, the largest $100,000. Now if this company could get all of its customers to $100,000 its revenues would go from $10 million to $100 million (simple math).
That is not realistic. But if there is a customer at $100,000 it may be possible to raise the average revenue per customer to $15,000 (for a 50% revenue increase to $15 million) or even $20,000 (doubling revenue to $20 million). The equation for PER is as follows:
PER = Potential Average Revenue - Current Average Revenue x Number of Current Customers
Most companies do not know this number and do not manage it. Managing PER includes estimating it, having a plan to increase how much of the potential is realized, and finding ways to expand PER.
A related number is PER Attainment. What percentage of your PER are you currently realizing? Here the equation goes like this.
PER Attainment = GRR / (PAR x Number of Customers)
where PER is Potential Expansion Revenue, GRR is Gross Recurring Revenue and PAR is Potential Average Revenue.
Another way to express this is at the customer level.
PER Attainment = (GRR/Number of Customers)/PAR
The two equations are equivalent.
The hard thing here is to estimate a reasonable number for Average Revenue per Customer. There are a number of ways to approach this.
Given your current pricing metric(s), what would revenue be at full adoption? This approach is useful when there are pricing metrics that can be estimated from outside the company. Given the popularity of ‘users’ as a pricing metric, estimate how many potential users there are at a company and then apply your pricing model.
How will revenue per customer change if usage increases? This is relevant to companies that include a usage metric (the top performing SaaS companies have hybrid pricing models that include a usage metric).
Estimate your value capture ratio (VCR, the percent of value to customer captured in price). What is your target VCR? What would revenue per customer be if you were realizing your target VCR across the customer base?
What should your PER Attainment ratio be?
One can expect the PER Attainment Ratio to change over time. For early stage companies it is likely to be quite low, probably in the 5-10% range. This will also be true of companies that are engaged in a land grab where the number of customers is more important than the revenue per customer (the generative AI foundation model companies like Anthropic, Mistral and Open.ai have been playing this game). As companies and markets mature a target of 30% or so is more appropriate. If a company has PER Attainment of more than 80% it is likely operating in a saturated customer base and the focus needs to be either bringing in new customers or expanding its offers so that it can increase PER.
Summarizing this, we get the following ranges.
5-10% - Very low, there should be a lot of opportunity to grow inside the existing customer base
11-20% - Low, increasing revenue from existing customers should be a priority
21-40% - There is room for improvement
41-60% - Good performance, maintain but do not count on increasing PER as a major growth driver
61 - 80% - On the high side, may be over optimizing
> 80% - The current customer base is likely tapped out, find other ways to grow
How can companies increase their PER (Potential Expansion Revenue)?
Potential Expansion Revenue (PER) measures the maximum revenue you can expect from each of your customers and adding it up. The maximum revenue is dependent on the pricing model. If your pricing model is too simple it artificially constrains PER. If it is too complex it makes it harder to attain PER.
One frame to use in looking at your product architecture and pricing model is your Net Revenue Retention (NRR factors).
Begin by looking at each of the positive factors. Are they at play in your packaging and pricing model? If the answer is ‘no’ then PER will be low. So your first job is to activate them.
Growth in Package - the simplest way to switch this on is to add a usage based pricing metric
Upsell - this requires some form of packaging where there are upsell paths. The most common approach to this is tiered packaging or Good Better Best (GBB packaging).
Cross sell - this requires something to cross sell. It could be a separate product line (think of how Hubspot has organized its products -Marketing Hub, Sales Hub, Operations Hub, Commerce Hub, Service Hub). Another opportunity could be to sell add on consulting and professional services. Some companies win incremental cross sell revenues by acting as resellers.
How can companies increase their PER Attainment ratio?
Once you have designed your packaging and pricing in a way that expands PER you need to execute. There are a number of things you need to do here.
Upsell and cross sell paths need to be mapped - for sales, on the website, in the pricing and packaging model.
Sales needs incentives to execute on upsell and cross sell and support them with tools and resources
Customer success needs incentives to increase usage and to otherwise grow in package.
What gets measured gets managed. If Potential Expansion Revenue is important to your business you need to estimate it and them measure PER attainment.
Expect boards to start asking leadership teams about these metrics.
NRR Factor Analysis
Ibbaka will soon announce a new tool for NRR factor analysis called NRR Analyze. This application let’s you see the contribution of each factor to NRR performance, see trends, and drill down into customer by customer data. Insights from NRR Analyze will help you to estimate PER and to analyze PER attainment.
Screenshot of Ibbaka NRR Analyze
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