What is Expansion Revenue?
Expansion Revenue is the incremental recurring revenue that a SaaS company generates from its existing customer base via upselling, cross-selling, add-ons, and other strategies.
In the SaaS industry, expansion revenue—or “Expansion MRR”—becomes an increasingly important component in the business model of late-stage companies with regard to its long-term sustainability in achieving profitable growth.
Table of Contents
- How Does Expansion Revenue Work?
- Why Does Expansion Revenue Matter?
- What is the Expansion Revenue Strategy?
- How to Calculate Expansion Revenue
- Expansion Revenue Formula
- Expansion MRR Rate Formula
- What is a Good Expansion MRR Rate in SaaS?
- What are the Benefits of Expansion Revenue?
- Expansion MRR Calculator — Excel Template
- Expansion Revenue Calculation Example
How Does Expansion Revenue Work?
The expansion revenue measures the value that a SaaS or software-based company retrieves from its existing customer base across a specified period.
While the time frame to analyze a SaaS company’s expansion revenue can either be on a monthly or annual basis, the former is far more common.
Why? SaaS businesses must identify and capitalize on opportunities that emerge in the market in real-time by frequently analyzing and monitoring the expansion MRR, a necessity to operate in competitive markets.
The monthly billing cycle inherent to the SaaS business model creates the necessity to quickly respond to changes in customer needs, adapt to new market developments (i.e. external threats), and capitalize on opportunities to derive more revenue.
The difference between the use-case of expansion MRR and expansion ARR pertains mostly to where the SaaS business is currently at in its lifecycle.
- Expansion MRR ➝ The monthly recurring revenue (MRR) is the more practical metric, particularly for early-stage SaaS startups that must continuously hone their customer acquisition strategies, identify patterns in customer usage patterns that present opportunities to improve growth and improve upon their product mix to ensure the needs of their target end market are met.
- Expansion ARR ➝ In contrast, the annual recurring revenue (ARR) is more applicable to established, late-stage companies that have obtained significant market traction and growth to date; thereby, their priorities shift more toward improving their profitability and protecting their existing market share from external threats.
Why Does Expansion Revenue Matter?
Initially, the focus of most early-stage companies in their go-to-market (GTM) strategy is near-term oriented, considering the uncertainties surrounding the company’s current business model, market demand for its product offering, and revenue opportunity.
Since the effectiveness of a company’s customer acquisition strategies, the target customer profile and end market with whom the product resonates most, and the revenue opportunity in a market(s) are not yet known, the business model of an early-stage company must be geared toward continuous optimization, rather than a rigid structure.
Once the SaaS company becomes more established and manages to acquire more customers, its strategies must pivot to cater to its existing customer base over the course of time.
The number of potential customers in a market that can be acquired is limited by a constraint, but their needs are constantly expanding, creating monetization opportunities.
Hence, most late-stage SaaS companies derive a substantial percentage of their revenue from existing customers, which requires an in-depth understanding of the target end market, customer profile, and patterns in their spending behavior.
If the recurring revenue of a SaaS or subscription-based company is reliant on acquiring new customers, even in the later stages of its lifecycle, that implies a high churn rate (i.e. attrition).
Customer attrition is inevitable for all SaaS and subscription-based companies—especially earlier in the lifecycle—however, the churn rate must taper off over time.
Otherwise, there are likely underlying issues not being addressed by management, such as a mismatch in the product capabilities and customer needs, causing the revenue model to be unsustainable in the long run.
What is the Expansion Revenue Strategy?
The core strategies that drive expansion revenue (MRR) are the following three levers:
| Strategy | Description |
|---|---|
| Upselling |
|
| Cross-Selling |
|
| Add-Ons |
|
How to Calculate Expansion Revenue
The calculation of expansion MRR starts with identifying the revenue streams whereby expansion revenue is produced (e.g. upsell, cross-sell, and add-ons).
In the next step, the sum of each recurring revenue stream for each month is determined, from which the prior month’s expansion MRR is deducted (i.e. to ensure only the “incremental” MRR is computed).
The difference between the ending expansion MRR and the beginning expansion represents the expansion revenue for the current period.
However, the expansion MRR—as a standalone metric—offers minimal insights into the effectiveness of the business strategies and tactics employed by the company since it is not suited for comparative analysis (e.g. a comparison to historical periods to track trends and overall trajectory).
The more practical measure, termed “expansion MRR rate”, standardizes the expansion MRR metric by dividing the expansion MRR in a given period by the beginning expansion MRR, which is expressed as a percentage.
The step-by-step process to calculate the expansion MRR and the expansion MRR rate is as follows:
- Step 1 ➝ Calculate the Sum of Expansion Revenue Sources per Month (Upsell, Cross-Sell, Add-On)
- Step 2 ➝ Subtract the Difference Between the Ending Expansion MRR and Beginning Expansion MRR
- Step 3 ➝ Divide the Change in Expansion MRR by the Beginning MRR
- Step 4 ➝ Convert into Percentage Form (Multiply by 100).
Expansion Revenue Formula
The formula to calculate the expansion MRR equals the ending expansion MRR generated in the trailing month minus the expansion MRR at the beginning of the month.
Where:
- Ending Expansion MRR ➝ The incremental revenue generated from existing customers at the end of the current month.
- Beginning Expansion MRR ➝ The additional revenue from existing customers in the prior month.
The output quantifies the expansion revenue attributable to upsells, cross-sells, and add-ons to track how reliant a SaaS company’s recurring revenue growth is on extracting more value from existing customers instead of acquiring new customers.
The reason for summing the expansion MRR streams to arrive at the expansion MRR is that a company does not often present the data, creating the need to calculate the periodic change in expansion MRR.
Expansion MRR Rate Formula
The expansion MRR, as a standalone metric, provides minimal insights into the effectiveness of a SaaS company’s initiatives to improve its expansion recurring revenue—as mentioned earlier.
The more practical metric to analyze the expansion revenue of a SaaS company is the expansion MRR rate, wherein the expansion MRR is divided by the beginning MRR.
The difference between the ending and beginning expansion MRR reflects the change in expansion MRR, which reflects the incremental expansion MRR generated in a given month.
Converting the expansion MRR into a percentage facilitates “apples to apples” comparisons to its peer group—i.e. the competitors operating in the same (or an adjacent) industry—including tracking the historical trajectory in the expansion rate over time.
Expansion MRR Rate — Practical Application
Certain practitioners will divide the difference in expansion MRR by the beginning expansion MRR, not the beginning MRR. By comparing the change in expansion MRR to the beginning MRR, the proportion of MRR attributable to expansion MRR can be determined. However, consistency and an intuitive understanding of the underlying mechanism of the formula matter much more.
Either method can provide useful insights, but dividing by the beginning MRR is more broader in scope. For instance, suppose an early-stage startup that just started to generate expansion MRR. The expansion MRR rate could easily exceed 100%, which is not meaningful.
What is a Good Expansion MRR Rate in SaaS?
There is no reliable industry benchmark that an early-stage startup should target—albeit, the reference points of comparable companies, assuming the data is readily available in the public domain, can serve as a rough proxy for a SaaS company to understand its relative positioning in the market.
The utility of tracking the expansion MRR rate in the SaaS industry stems mostly from conducting a comparative analysis relative to historical data points, where the trajectory of the MRR expansion rate matters more than the gross percentage.
- Increasing Expansion MRR Rate ➝ Higher Expansion MRR (Effective Strategies)
- Decreasing Expansion MRR Rate ➝ Lower Expansion MRR (Ineffective Strategies)
SaaS companies aim to achieve an expansion MRR rate that exceeds its churn rate (or attrition rate), which is formally referred to as a negative churn.
The net MRR churn is calculated as the difference between the MRR lost from customer churn and downgrades to a lower-priced pricing plan (or tier).
The net MRR churn is the percent differential between the MRR lost and the MRR from expansion revenue.
The general rule of thumb for the expansion MRR rate—which most practitioners in the SaaS company abide by—is to ensure that the expansion MRR rate exceeds the customer churn rate (or negative MRR churn).
- Negative MRR Churn ➝ Expansion MRR Exceeds MRR Churn Rate
- Positive MRR Churn ➝ Churn Rate Exceeds Expansion MRR
What are the Benefits of Expansion Revenue?
If a SaaS business manages to operate at a net negative churn, its expansion recurring revenue offsets the lost revenue from customer churn and downgrades to lower-priced tiers.
Therefore, the gradual shift in a company’s total recurring revenue becoming more reliant on MRR expansion revenue facilitates negative MRR churn, higher customer lifetime value (CLTV), and shorter CAC payback period.
- Negative MRR Churn ➝ If a negative MRR churn is attained, most SaaS startups and venture capital (VC) firms perceive that sort of outcome in positive sentiment since the implication is that the company is capable of generating more expansion MRR from existing customers relative to the costs incurred from churned and contraction MRR.
- Higher Customer Lifetime Value (CLTV) ➝ If the customer lifetime value (CLTV)—or lifetime value (LTV)—increases, each customer contributes more revenue over the course of their entire relationship with the SaaS company, which improves its profitability, return on investment (ROI) in customer acquisition spend, and long-term stability with regard to recurring revenue.
- Shorter CAC Payback Period ➝ If the CAC payback period is shorter, a SaaS company can recoup the initial customer acquisition cost (CAC) more quickly, thereby improving its cash flow and profitability (i.e. less time is required to recover the investment).
Expansion MRR Calculator — Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Expansion Revenue Calculation Example
Suppose we’re tasked with calculating the expansion MRR and the net MRR churn for an early-stage SaaS business that recorded $50k in MRR in the prior month.
In the current period (Month 1), the SaaS company generated $3k in upsell MRR and $2k in cross-sell MRR, so the total expansion MRR is $5k.
The new MRR—the MRR from acquiring new customers—was $2.5k, while the churned MRR and contraction MRR were $1k and $500, respectively.
MRR Roll-Forward Assumptions
- Beginning MRR = $50,000
- New MRR = $2,500
- Expansion MRR = $3,000 + $2,000 = $5,000
- Churned MRR = ($1,000)
- Contraction MRR = ($500)
Given those assumptions, we’ll insert each figure into the MRR formula to calculate the ending MRR for Month 1, which totals $56k.
- Ending MRR = $50,000 + $2,500 + $5,000 – $1,000 – $500 = $56,000
In the next step, we’ll compute the expansion MRR rate—which equals the expansion MRR as a percentage of the beginning MRR—to arrive at an expansion MRR rate of 10%.
- Expansion MRR Rate = ($5,000 ÷ $50,000) = 10.0%
The expansion MRR of $5k and the expansion MRR rate of 10% imply that the SaaS business is effectively increasing its monthly recurring revenue (MRR) through upgrades and cross-selling, reflecting the company’s ability to enhance its revenue base from its existing customer pool.
Therefore, the incremental revenue obtained from existing customers through upgrades and cross-selling exceeds the revenue lost from customer downgrades and churn, as affirmed by the negative MRR churn rate.
In closing, a net negative churn is a favorable outcome, as it signifies that the company is not only retaining its customer base but also expanding its revenue from existing customers, contributing to a higher customer lifetime value (CLTV).
