We are routinely asked about Net Dollar Retention (NDR) which is a somewhat little-known metric that is incredibly important to measuring the strength of a company’s recurring revenue and customer churn rates. It is also an indicator of operating and employee performance in the areas of product management, support, sales and overall management.
Very simply put, it shows what percentage of revenue from the start of year one (1) was retained by the end of that year or the start of year two (2). NDR looks for shifts and swings in the recurring or existing customer base. Here is how it works.
NDR considers growth within the customer base over the last twelve months. Let’s look at a software vendor with clients that are acquiring more licenses or adding more options from the current year to the next one. If this software vendor had $100 in sales at the start of year one, and $110 in sales at the end of year one (or the start of year two), the software vendor would have a net increase of $10. To calculate NDR we use the following formula.
Start of Year One ARR + (new licenses/options — reduced licenses/options — customer churn)/ Start of Year One ARR = NDR. The values in the equation are expressed in dollar amounts but the result is a percentage.
This metric considers both existing customer up-sell and down-sell and factors in customer churn over this period as well. What this calculation does not include is net-new business and the reason for this is that NDR is used to evaluate the “stickiness” of a customer base and, in a way, the strength of the existing customers’ commitment to the software vendor’s products and or services. Seeing how much revenue you are creating year over year from the same customer base is an indication of strong Annual Recurring Revenue or ARR. When NDR is over 100% it indicates an increase in revenue that has resulted from existing customers. When NDR is less than 100% it indicates a contraction in recurring revenue from the existing customer revenue. Even when firms have growing ARR, they may have churn or contraction in the customer base and this, of course, requires further analysis.
A couple of final points. Keep in mind that it is far less costly to keep a customer then to find a new one. Also, loyal customers tend to increase their purchases over time (if you have the right, product management, support and sales efforts…which is where some of the further investor or buyer analysis may go if NDR is poor!). All of this to say that the NDR metric and related analysis are standard order in today’s evaluation of companies with recurring revenue models. It is a very important metric!
Mark Gaeto is a Managing Director and Stephen Wasylenko is an Associate with Falcon Capital Partners, a leading mergers and acquisitions firm. Mark leads Falcon’s commercial technology practice.
Mark can be reached at 610-989-8903 or firstname.lastname@example.org.