ARR=Monthly Recurring Revenue (MRR)×12 Net ARR=Start+New+Expansion−Churn−Contraction
Net ARR vs Net Revenue Retention (NRR)
Net ARR: Year-over-year change in total Annual Recurring Revenue. Focuses on overall growth of the recurring revenue base.NRR: Measures how much recurring revenue you keep from the same cohort of customers over a period, including expansion and downgrades. Focuses on retention quality and customer value over time.
The 4 Levers of ARR
A. New ARR (Acquisition)
Revenue from brand-new customers acquired during a period.
Growth focus: Optimize top of funnel, improve conversion from free trial to paid, and lower Customer Acquisition Cost (CAC).
B. Expansion ARR (Upsell / Cross-sell)
Additional revenue from existing customers who upgrade plans or add more seats/users.
Growth focus: Product-led growth (PLG), in-app prompts, tiered pricing, and "land and expand" campaigns. Often the most profitable growth.
C. Contraction ARR (Downgrades)
Revenue lost when customers downgrade their subscription but do not fully churn.
Growth focus: Understand why users downgrade. Does the higher tier fail to deliver value? Are key features under-used or broken?
D. Churned ARR (Attrition)
Revenue lost when customers cancel their subscription entirely.
Growth focus: Strengthen retention loops, improve onboarding, and use re-engagement campaigns so that "time to value" happens quickly.
Reporting on ARR: Common Mistakes to Avoid
Confusing bookings with ARR: A 3-year contract for $30,000 paid upfront equals $10,000 ARR, not $30,000.Including one-offs: Do not include implementation or setup fees in ARR. They inflate the metric and break predictability.Ignoring discounts: If you give a 50% discount for the first year, ARR for that year should reflect the actual billable amount, not the undiscounted list price.
Why ARR Matters
ARR is one of the most critical metrics for subscription-based businesses such as SaaS.
A useful companion metric is the Magic Number:
Magic Number=Sales and Marketing Spend (Previous Quarter)Net New ARR (Current Quarter) How to interpret it:
< 0.75: Something is broken. You spend $1 to generate only $0.75 of recurring revenue. Focus on fixing product–market fit and retention before scaling.> 1.0: You are efficient. You spend $1 to generate $1+ of recurring revenue. This is often a signal to scale more aggressively.