ARR is one of the most commonly cited metrics in Startupland.
Annual Recurring Revenue (the OG meaning of ARR) is often calculated by multiplying Monthly Recurring Revenue by 12. The logic is to give an extrapolation of the latest numbers, as fast-growing companies will have much higher ARR than “last 12 months” revenue.
Originally it was mainly B2B startups who spoke about ARR. It was a way to strip out the noise of one-off income streams like implementation fees and professional services, and get to the nub of the core, high margin, recurring software income. With business customers typically less fickle than consumers, the middle R - “recurring” - was a relatively good bet as you could reasonably expect long term contracts, often with high renewal rates.
Recently...
ARR is one of the most commonly cited metrics in Startupland.
Annual Recurring Revenue (the OG meaning of ARR) is often calculated by multiplying Monthly Recurring Revenue by 12. The logic is to give an extrapolation of the latest numbers, as fast-growing companies will have much higher ARR than “last 12 months” revenue.
Originally it was mainly B2B startups who spoke about ARR. It was a way to strip out the noise of one-off income streams like implementation fees and professional services, and get to the nub of the core, high margin, recurring software income. With business customers typically less fickle than consumers, the middle R - “recurring” - was a relatively good bet as you could reasonably expect long term contracts, often with high renewal rates.
Recently, though, in the fight to “build in public” with impressive ARR charts showing up-and-to-the-right growth on LinkedIn posts, I am seeing the acronym increasingly misused in a few different ways.
First, I would question whether it’s right to call a lot of this revenue “recurring” - particularly in a pro/consumer content with minimal contractual commitment. Is it “recurring” annual revenue if churn is 10% each month? What about if you sell 1-year contracts and haven’t yet had a churn “event” (i.e. you’re less than 12 months post-launch) to understand long-term behaviour? Is your recurring revenue actually just experimental transactions that have no hope of sticking around?
Second, I think we need to dust off our understanding of “revenue”. Revenue is recognised over the period the product or service is delivered. If someone buys an annual subscription for £120 and pays up front in January, your cash income in January may be £120, but your revenue is only £120 / 12 = £10. This may seem like accounting semantics but it really matters if you’re then annualising from monthly numbers. What we often see is the full £120 being include in a monthly “revenue” figure that then gets multiplied by 12 to proxy for an annualised number. So that customer signing up in January all of a sudden shows up as £120 x 12 = £1,440 of ARR, which is obviously wrong - by a mile.
Third, and linked to the above, is the trick of leaning into the ambiguity of acronyms to replace “annual recurring revenue” with “annualised runrate revenue”, or some similar jiggerypokery. It’s important to point out, this is a completely different metric that is entirely incomparable to true ARR! The problem gets even worse when applying the calculation blindly. A few different variations lead to big errors and nonsensical numbers.
- The case we covered above - confusing cash income with revenue.
- Companies with seasonal purchasing patterns. For example, annualising a runrate revenue number from November for a gift wrapping service is obviously stupid as there is massive seasonality in the revenue profile.
- Companies with transactional, rather than recurring, purchasing behaviour. Back in the day all the D2C mattress companies got excited about run-rate revenues, until they realised people only buy a mattress once every ten years…
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