Net dollar retention: Formula and strategies to improve it

NDR is a vital sign of your company's health, revealing how well you're growing revenue from your existing customers.

Let’s start with an explanation of net dollar retention and its role.

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What is net dollar retention (and why does it matter)?

Net dollar retention (NDR), sometimes also referred to as net revenue retention (NRR), is a vital metric for understanding the financial health of subscription-based businesses, particularly SaaS businesses.

It measures the percentage of recurring revenue retained from your existing customers over a specific period, while also accounting for any revenue growth from upgrades, cross-sells, and other expansions, minus any revenue lost from downgrades or customer churn.

Understanding revenue growth from your customer base

NDR reveals how effectively a SaaS company grows its revenue from its current customer base. A key insight NDR provides is the organic growth achieved without the need for new customer acquisition.

A high NDR means that your current users are finding growing value in your offerings. They are likely expanding their use, adopting more features, or moving to higher-priced plans. This shows strong user satisfaction and the efficacy of your customer success and value delivery strategies.

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Why NDR is a critical metric

Net dollar retention in the SaaS industry is a critical indicator closely watched by board members and investors. A strong NDR demonstrates the durability and long-term potential of a SaaS business. It suggests:

• Strong customer loyalty: High retention and expansion indicate customers are satisfied and see ongoing value.
• Efficient growth: Growing revenue from existing customers is often more cost-effective than acquiring new ones, leading to better capital allocation.
• Business scalability: An NDR above 100% implies that even without new sales, the company's revenue will continue to grow. This is a powerful signal of a scalable business model.
• Investor confidence: Investors view a high NDR as a sign of a healthy, growing, and sustainable business, making it a key factor in valuation and funding decisions.

Takeaway: In short, NDR offers a clear view of a SaaS company's ability to not only keep its customers but also to grow the revenue generated from them over time, highlighting the intrinsic value and stickiness of its offerings.

Note: The focus on growing revenue from existing customers, as highlighted by a strong NDR, connects directly with strategies like feature gating and having a well-structured enterprise billing system, both of which are key for revenue retention and growth within your user base.

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Net dollar retention formula (with example)

Calculating net dollar retention involves a straightforward formula that considers the changes in your recurring revenue from existing customers over a specific period, typically a month or a year. The formula is as follows:

Let's define each component of this formula:

• Beginning MRR (or ARR): This represents the total monthly recurring revenue (or annual recurring revenue) you had from your existing customer base at the start of the period you are measuring. It's your baseline.
• Expansion MRR (or ARR): This is the additional recurring revenue generated from your existing customers during the period. It includes revenue from:
  
  • Upsells: Customers upgrading to a higher-priced plan.
  • Cross-sells: Customers purchasing additional products or services.
  • Upgrades: Similar to upsells, often referring to moving to a more feature-rich tier.
  • Reactivation of previously canceled subscriptions or conversion from free to paid plans also fall into this category.
• Churned MRR (or ARR): This is the recurring revenue lost during the period due to customers who have completely canceled their subscriptions.

It's important to distinguish churn from contraction. Churn refers to the complete loss of a customer and their associated recurring revenue.

Contraction, on the other hand, refers to a reduction in recurring revenue from an existing customer due to downgrading their plan or removing add-ons. While the provided NDR formula explicitly includes churned MRR, some variations might include a separate "contraction MRR" component in the numerator. In those cases, the formula would look like this:

For our basic NDR formula, downgrades are often considered a form of negative expansion or are implicitly accounted for in the period-over-period change if you are comparing total MRR from the initial cohort.

However, to be precise, especially when analyzing the drivers of your NDR, tracking churn and contraction separately can be beneficial.

Let's look at a simple example:

Suppose a SaaS company starts a month with $50,000 in MRR from its existing customers. Over the month, some of these customers upgrade their plans, resulting in an additional $6,000 in MRR (Expansion MRR). However, some customers also cancel their subscriptions, leading to a loss of $2,000 in MRR (Churned MRR).

Using the net dollar retention formula:

In this example, the company has a net dollar retention rate of 108%, indicating that it not only retained all of its initial recurring revenue but also grew it by 8% from its existing customer base.

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Gross vs. Net retention: Key differences

Here's a chart to exemplify the difference between gross and net dollar retention:

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Gross revenue retention (GRR) focuses solely on the revenue retained from your existing customers at the beginning of a period, without factoring in any revenue growth from upgrades or cross-sells. It only accounts for the revenue lost due to churn and downgrades.

Think of GRR as a measure of your success in simply keeping your customers and the initial revenue they generate. The formula for GRR is:

GRR = (Beginning MRR − Churned MRR − Downgrade MRR)​ / Beginning MRR

NDR, on the other hand, provides a more complete picture. As we've discussed, it does consider the expansion revenue gained from existing customers through upsells, cross-sells, and upgrades, in addition to the revenue lost from churn and downgrades.

Therefore, NDR reflects the net change in revenue from your existing customer base. The NDR formula is:

NDR = (Beginning MRR + Expansion MRR − Churned MRR) / Beginning MRR​

The key difference lies in the inclusion of expansion revenue in the NDR calculation. Because of this, NDR can be above 100%, indicating that your existing customers are generating more revenue over time. GRR, however, will always be 100% or below, as it only tracks revenue loss.

Takeaway: GRR tells you how good you are at preventing revenue loss from your initial customer base, while NDR shows the overall health and growth potential of your revenue from those same customers, considering both losses and gains.

For a SaaS business, looking at both metrics provides a more nuanced understanding of customer retention and revenue trends. A high NDR coupled with a healthy GRR suggests strong customer loyalty and effective strategies for growth within your existing accounts.

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What’s a good NDR benchmark in the SaaS world?

Achieving a net dollar retention rate above 100% is generally considered a positive indicator for SaaS companies, suggesting revenue growth from the existing customer base.

However, what qualifies as a good NDR can be nuanced and often depends on the specific characteristics of your business. Here are some general segments and their typical NDR benchmarks:

• Overall SaaS: The median NDR for SaaS companies generally hovers around 100% to 110%. Aiming for this range indicates healthy retention and some expansion.
  
  
• A SaaS firm selling to small and medium businesses (SMBs): A good NDR benchmark for companies primarily targeting SMBs is often around 90%. This can be lower than enterprise-focused companies due to potentially higher churn rates in this segment.
  
  
• Enterprise-level SaaS organizations: For SaaS businesses selling to larger enterprise clients, a good NDR benchmark is typically higher, often around 125% or more. Enterprise clients tend to have stickier contracts and greater opportunities for upselling and cross-selling.
  
  
• High annual contract value (ACV) products: Companies with higher ACVs often exhibit higher NDRs. Benchmarks can be in the range of 110% to 140% or even higher, as these customers are more invested and have greater expansion potential.
  
  
• Growth stage: The stage of your company can also influence what's considered a good NDR. Early-stage companies might prioritize customer acquisition, potentially resulting in a lower NDR initially. More mature companies typically focus on expansion within their existing base, aiming for higher NDRs.

Factors such as your specific vertical, customer demographics, and market conditions can also impact what constitutes a good net dollar retention rate for your SaaS business. Continuously monitoring your NDR and comparing it against relevant industry peers is key for a full understanding of your performance.

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3 ways to improve your net dollar retention

To truly move the needle on your net dollar retention, a multifaceted approach is necessary. Focusing on expansion, offering adaptable plans, and providing billing transparency are powerful levers you can pull. Let’s look closer:

1. Expand via usage-based pricing

One effective way to grow revenue from your existing customer base and improve net dollar retention is by adopting usage-based pricing. With this model, customers are charged based on their consumption of your product or service. More usage directly translates to more revenue for your business.

It creates a natural alignment between the cost for the customer and the value they are receiving. As customers find more value and increase their usage, their spend grows organically.

This inherent scalability within your existing accounts contributes significantly to expansion revenue, a key component of a healthy NDR. It can attract a wider range of customers with different usage patterns.

Note: Learn more about usage-based pricing examples in our blog post on that topic.

2. Create flexible plans to scale with your customer

Offering flexible plans that can scale with your customers' growth is another crucial strategy for improving net dollar retention. This involves providing options like modular pricing and clear pathways for upsells.

Modular pricing allows customers to select and pay for only the features or capacity they need, offering greater control and often a lower entry point. As their business grows and their requirements increase, they can easily add more modules or upgrade to higher-tier plans.

Feature gating, tied to entitlement logic, is a powerful tool here. By offering advanced features in higher-priced tiers, you incentivize customers to upgrade as they seek more functionality and value. These upsell opportunities directly contribute to expansion revenue and a stronger NDR.

3. Reduce churn through billing clarity

Reducing churn is just as important as driving expansion for improving your net dollar retention. A significant factor in churn can be unclear or unexpected billing. By prioritizing billing clarity, you can build trust and reduce customer dissatisfaction.

Transparent invoices that clearly detail charges, usage, and any applicable taxes or discounts are essential. Implementing fair and auditable usage metering ensures that customers understand exactly how they are being charged and can verify the accuracy.

Eliminating billing disputes and surprises goes a long way in fostering positive user relationships and reducing involuntary churn. When customers trust your billing practices, they are less likely to cancel their subscriptions, directly impacting your retention rates and overall NDR.

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Mistakes to avoid when calculating or tracking NDR

To safeguard the integrity of your net dollar retention metric, it's vital to be precise in your calculations and consistent in your tracking methodologies. Here are some common errors to steer clear of:

• Misclassifying expansion revenue vs. renewals: It's important to distinguish between true expansion revenue and revenue from simple renewals at the same price. Expansion reflects added value, while renewals represent continued business. Including the full value of a renewal as "expansion" will inflate your NDR artificially.
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• Comparing NDR across inconsistent timeframes: Confirm you are always comparing your net dollar retention over the same length of periods (e.g., month-over-month or year-over-year). Comparing monthly NDR with annual NDR, for instance, will provide a misleading picture of your performance.
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• Including non-customer revenue: Your NDR calculation should solely focus on the recurring revenue from your existing customer base. Including any other forms of revenue, such as interest income or one-time service fees, will distort the true measure of your customer retention and expansion.
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• Using NDR to mask high churn: A high net dollar retention rate can hide a significant churn problem if expansion revenue from a subset of customers is substantial. It's crucial to look at NDR in conjunction with your churn rate. High NDR driven solely by a few large expansions despite significant customer attrition is not a healthy sign.
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• Overlooking contraction in small accounts: While large upgrades can significantly boost NDR, consistently overlooking small downgrades or cancellations in smaller accounts can lead to an overly optimistic view. The cumulative effect of contraction across numerous small accounts should not be ignored in your NDR tracking.

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How Orb helps SaaS teams increase NDR

You understand the critical importance of net dollar retention for sustainable growth in your SaaS business. You know that expanding revenue from your existing customer base is often more efficient and indicative of long-term health than solely focusing on new acquisitions.

Now, empower your team to actively increase your NDR with Orb, the done-for-you billing platform with an infrastructure designed to unlock the full potential of your usage data. With Orb, you can:

• Implement usage-based pricing for organic expansion: Move beyond static subscription tiers. Orb's flexible platform, powered by Orb RevGraph, enables your business teams to define and launch sophisticated usage-based models — charging customers based on the value they receive.
  
  This directly fuels your expansion revenue, a core driver of NDR. As your customers' usage grows, so does your revenue from those accounts, demonstrating the value they find in your product and naturally increasing your NDR.
• Create adaptive plans that grow with your customers: Stop limiting growth with rigid structures. Orb allows you to design modular pricing and offer upgrade paths, including leveraging feature gating strategies.
  
  By providing flexible plans, you incentivize customers to expand their usage and move to higher-value tiers over time, directly boosting your NDR. Orb provides accurate billing as customers scale, fostering a positive growth journey.
• Minimize churn with transparent billing: Eliminate billing disputes and surprises that erode customer trust. Orb's raw event architecture ensures accurate tracking and billing on any metric.
  
  Clear and auditable billing reduces involuntary churn and boosts customer satisfaction, both critical for a healthy NDR. When customers understand their charges and trust your billing, they are more likely to remain loyal and even expand their usage.
• Test pricing strategies to maximize expansion: Don't let uncertainty hinder your growth initiatives. Orb Simulations allows you to model and test new pricing strategies using your real usage data, predicting the impact on key metrics like expansion revenue and churn before going live.
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• Gain granular insights into expansion and retention performance: Understand which customer segments and pricing models contribute most to your NDR. Orb's built-in revenue analytics and customer usage dashboards provide deep visibility into expansion patterns and churn indicators.

Ready to transform your billing from a necessity to a powerful engine for NDR? Explore Orb's capabilities and flexible pricing options for your business.