All you need to know about Tech Metrics

TLDR

• Software metrics are confusing, but most try to paint a picture of the potential revenue trajectory.

• Bookings show the health of the pipeline, billings represent the cash flow that the company expects to eventually receive.

• The difference between ARR and DBNR for SaaS companies represent the ARR from a new customer for any given quarter

• Like the CAPM model, inputs in churn and CLTV (customer lifetime value) can drastically take you out of reality when analyzing marketing spend for a firm.

When most of us are trying to assess the strength of a software company, we are often bombarded by a bunch of software jargon by the management team to help describe the health of their business. In some way or form, most of these software metrics try to paint a picture of the revenue trajectory, but often with slight subtleties between them. This post will aim to provide a more defined definition across the board to help new investors into the space to better understand these metrics.

Revenue

Ah, revenue, the most basic of all. As most are aware, revenue is not the same as cash collected by the firm. Revenue is an accounting measure (score-keeping) to account for services/products that the firm has delivered to the customers. For software firms, revenue will be accounted throughout the life of the contract after the customer activates/sign-up for the product. And because of this "record as you use" accounting method, this might or might not paint the most accurate picture for a software firm growing at an accelerated pace.

Bookings

Bookings are just one of the many momentum metrics to represent the business' ability to acquire new contacts/customers. Bookings essentially represent all the contracts value that is signed, whether from existing or new customers for a specified period. Depending on the duration of the contract, bookings can be stated either on a Total Contract Value (TCV) or on an Annual Contract Value basis (ACV). One thing we need to be aware of is that, Bookings might or might not directly affect the financial performance of the company. They are just an indicator of the health of the sales pipeline. On top of that, contracts can be terminated at any time before the customers are fully committed to the services/products.

Billings

As the name suggests, billings represent the total invoice value (billings) that you as a company have “billed” your customers. Basically, the health of the billings value shows the approximate cash that the company expects to collect in a certain timeframe. But obviously, fluctuations with billings could also be affected by changes in billing cycles or collection policies shift. The rate of collections for billings will also directly influence working capital (deferred revenue, A/R), P&L, and of course, cash flow.

ARR (Annual Recurring Revenue)

ARR is effectively the “annualized” portion of the MRR (Monthly Recurring Revenue). This is extremely important for SaaS/ Subscription-based companies that have high recurring revenues. ARR is usually presented on a net basis, so investors need to be aware of where the growth is coming from. A good way to do this is to take the difference between ARR growth rate and DBNR (discussed below), to figure out the ARR that is coming from new clients for the quarter.

• Formula: New ARR Growth = (1-DBNRR) - ARR Growth

DBNRR (Dollar-based Net Retention Revenue)

DBNR is measured in % terms, and it measures the amount of revenue generated for the same client over two comparable periods (Period 2 Revenue / Period 1 Revenue). If that amount is above 100%, that means there is a net expansion/ upsell of the existing clients. While DBNRR is a good indicator of revenue upsell or slow-down of existing customers, it ignores customer churn. There is no DBNRR for customer XYZ if they just decide to terminate the contract in period 2.

Customer Churn Rate

Customer churn rate is essentially the % of customers that leaves you at any given period. While this might seem like a simple concept, the actual calculation and adjustments can be quite complex. Factors that could change your calculations would be:

• How do we define customers cohorts and segments

• Do we include seasonal/promotion customers into the churn rate?

• Do we exclude episodic customers?

• What is the time horizon for a customer to be considered “churned”?

As we can see, many different factors could completely change the way you think about churn rates. At its core, churn rate is defined as: Churned Customers/ Total Customers. But defining the denominator and numerator is the hardest part of the job and having a consistent framework or methodology is even harder. It is the same concept as knowing the right EBITDA definition (adjustment) when you are thinking about stock multiples. You would likely raise lots of eyebrows if someone gives you a community-adjusted EBITDA with tons of unreasonable add-back (sorry WeWork!).

Customer Life Time Value (CLTV)

CLTV is an attempt to quantify the net present value of the profit stream of a customer. CLTV is typically used by tech firms to benchmark against customer acquisition costs (CAC), with the expectation that the sum of the future cash flow should offset the current acquisition cost. As long as this holds, then firms will continue to burn capital through marketing. Borrowed from Mr. Gurley’s CLTV formula:

The key statistics are as follows:

• ARPU (average revenue per user)

• Avg. Customer Lifetime, n (This is the inverse of the churn, n=1/[annual churn])

• WACC (weighted average cost of capital)

• Costs (annual costs to support the user in a given period)

• SAC (subscriber acquisition costs (aka. customer acquisition cost)

However, just because an LTV is positive doesn't mean that you can take marketing spend to the moon. One of the most important issues about LTV is that all the variables work against each other. If you raised ARPU (the price of your products), your churn goes up. Then you have to increase your marketing to capture more customers, but then as you scale, your SAC grows exponentially. The formula is a simplified version of reality, so do be mindful when tech companies tell you that all metrics can improve across the board.

By now, hopefully you have a better understanding of some of the most common tech metrics that are used by management. And if you find the content helpful, feel free to share it with your buddies.

Cheers!