Understanding Dollar-based Net Retention Rate and Churn | 7investing
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Understanding Dollar-based Net Retention Rate and Churn

April 12, 2021

There are many ways to measure the impact of customers leaving or churning in a recurring revenue model. Dollar-based net revenue retention rate (DBNR), sometimes referred to as net retention rate (NRR), is a commonly cited metric for measuring retention.

Before diving into DBNR, let’s define churn.

Customer Churn

Churn measures the percentage of customers that leave within a measurement period. As an example, suppose that there are four customers at the beginning of the year. If we are left with only three of them at the end of the year, then churn is ¼ or 25%.

Retention is (1 – churn) or 75% for our example.

Note that churn doesn’t measure the impact on revenue of customer departures. That’s where DBNR comes in.

Many software companies utilize a “land and expand” strategy. They initially sell some modules to a customer, and then over time, look to sell additional modules. And it needn’t just be new software modules. There could be more seats of the same software across an organization or more usage of the existing software if a usage-based charging model is used.

Dollar-Based Net Retention Rate

With DBNR, companies try to understand how more revenue from existing customers might offset revenue loss due to churn. Specifically, it is looking at customers that remain across two adjacent periods (i.e., the common set) and compares the revenue generated by these customers at the start of the period versus the end of the period. If total revenue from this group increases, there is a net expansion; it is a net reduction if it decreases.

Let’s work through a couple of hypothetical scenarios to see how DBNR might play out. As we did above, we will assume that we have four customers at the beginning of the year, with one churning at the end of the year. Suppose that each customer was spending $1,000/year at the beginning of the period. We will vary the spending at the end of the remaining customers’ period and see how DBNR changes.

Start 

End, Scenario 1

End, Scenario 2

A, $1,000/yr

A, $1,000/yr

A, $2,000/yr

B, $1,000/yr

B, $1,000/yr

B, $1,500/yr

C, $1,000/yr

C, $1,000/yr

A, $1,000/yr

D, $1,000/yr

Churned

Churned

DBNR

100%

150%

Let’s start with our first scenario. At the end of the year, we are left with three customers (A, B, and C). These three customers were responsible for sales of $3,000. At the end of the period, they were responsible for the same amount of sales. DBNR is thus 100%. Interestingly, while there is customer churn, that isn’t captured by the DBNR calculation.

Our second scenario has both A and B increasing usage, while C’s use remains unchanged. Total sales from A, B, and C at the end of the period is $4,500. Compared to the initial $3,000, this is 50% more, so DBNR is 150%. Again, our customer-level churn is 25%, but our DBNR measure is 150%.

All of this is not to say that DBNR isn’t practical. Instead, the point is that DBNR tells us how much more customers that decide to stay are willing to spend over time. It is an indication of a service’s usefulness to its customers. It doesn’t directly consider the bleeding of revenue due to churn.

Key Takeaway

We don’t want to look at any metric in isolation. DBNR is best viewed alongside revenue growth and customer-level churn data. However, the latter is often not provided by companies. As a general rule of thumb, we expect dollar-based net retention rates in the 110% or more range from best-in-class enterprise software companies. Companies making more extensive lands tend to, by definition, have lower DBNR numbers. Ideally, we want to see a solid DBNR coupled with high sales growth alongside low customer churn numbers.