With so many metrics, it’s hard to determine the ones that are actually helpful for your subscription-based business. Our advice is to focus on the ones that give you a better understanding of your active users and the value they bring to the table. ARPU, which stands for average revenue per user, is one of them.
In this piece, we’ll discuss what your ARPU is, why it matters in the context of a subscription business model and how to calculate it properly. Keep reading if you want to plan your budget effectively, gain a better understanding of your company’s revenue, develop a better strategy to combat customer churn, and have a good grip on how your business is doing.
What is ARPU?
ARPU, is a non-GAAP metric used to identify the total revenue generated by one paying user per a specific period. Put simply, it’s the revenue a customer brings your company over X days.
Customer behavior defines the financial performance of any subscription business, so knowing as much information as possible about your existing customers and their purchasing habits is critical. ARPU isone of the metrics and KPIs that allow subscription businesses to track their performance and get insights into their target audiences – provided it’s calculated correctly, of course.
The formula for calculating ARPU is intuitive: take the total revenue you get over a particular period (usually, a month) and divide that by the number of active subscribers that have paid for your services/products during this time.
X (total revenue from all subscribers) / Y (total number of subscribers) = ARPU (average revenue per user)
Here’s an example. During the last 30 days, your company was able to generate revenue of $15,000 and had 300 clients who purchased your services. If you put those numbers in the formula, you’ll see that your ARPU during that last month was $50.
Now is the time to clarify two things about this suspiciously easy formula:
One: It doesn’t mean that each of your paying users contributed $50. Because you’re a subscription business, you have various tiers, segments, and variously priced products. Your more valuable customers may have paid $115 while other, low revenue customers, may have paid only $30.
Two: It doesn’t mean the purchase was made by a single person. Some subscription businesses like Netflix allow multiple users, but they all are billed from one account. The account that is being billed is considered one user in the ARPU formula.
These two points aren’t here to confuse you. Instead, we’ll use them to specify the limitations of the ARPU metrics.
Limitations to ARPU calculations
Some businesses are skeptical about even including ARPU in their metrics toolkit because it’s a “vain metric.” We disagree.
While it’s not the most profound or precise metric, your ARPU calculation empowers you with knowledge about the trends in specific customer groups. Plus, a solid grasp of how much revenue your average customers are pulling in is a must-have to fully understand whether or not your pricing is effective, what options subscribers choose more often, and where your company has room for growth. However, there’s also a flipside.
One of the most criticized aspects of ARPU is that it can’t provide you with detailed information about your user base because it works on the macro level. For instance, you may have created a Facebook account, but you’re only using it from time to time. Does that make you an active user? Not really. But does your account matter for Facebook stats? It sure does, though it doesn’t illustrate the frequency of your activity. The same goes for ARPU.
Despite this, there are several strong reasons why your business should control ARPU regularly and care about the insights it shows.
Why subscription businesses should care about ARPU
Since ARPU shows the average amount of money one user brings into your company, it’s an essential metric for tracking changes in your monthly recurring revenue (MRR),another hugely important metric for subscription businesses. The other reasons are no less valuable:
ARPU indicates how your business is doing financially
ARPU can be used for tracking how and if your subscription business is growing. For example, if your monthly ARPU remains stagnant month after month while the client base is growing, this should prompt you to revise your segmentation and pricing. It might also be a sign that you should diversify your product range, optimize how you convert free users finishing their trials, or upsell more effectively to turn low-tier paying customers into higher paying customers.
ARPU shows the product value for a certain market or audience
The thing is, you may be underpricing your product without even knowing it, and running an ARPU analysis can show that. If your product is in demand, it has value for the clients, and you can plan a strategy for upselling or cross-selling to increase value and justify a price increase. More value means a bigger customer base and a higher average revenue.
ARPU helps to see if your marketing is effective
This metric can also illustrate whether your marketing budget is proving its worth and generating the expected revenue. For example, say you’ve calculated that your customer acquisition cost (CAC) is $60, while you ARPU is $50. As you’re spending more than you’re making to acquire customers, this could indicate that your marketing techniques need to be adjusted ASAP – perhaps you’re spending too much on social media companies or your targeted ads aren’t bringing in enough advertising revenue.
ARPU allows for competitive analysis
One of the most widespread use cases of the ARPU metric is to compare your business to your competitors and forecast your profitability. With all other factors equal, the business with a higher ARPU is considered more profitable. Apart from market competition, ARPU numbers may be of interest to your potential investors or acquirers.
ARPU highlights optimization opportunities
If your subscription business is tier-based and you offer, let’s say, four plans (freemium, starter, medium, and pro), running an ARPU analysis may show you which of your revenue streams consumes more resources without bringing proper value, or where your most valuable customers are.
It’s often said that free plans require just as many resources for maintenance as any other plan but never return the investment. ARPU will reveal this “subsidized” group so you can think of the strategies for optimizing the spending-income flow and boosting your average margin.
ARPU tracks the impact of changes
The average revenue per user changes as a result of adding new features, teaming up with partners, or implementing other structural changes.Facebook has a case in point. The ARPU of its family of apps (WhatsApp, Instagram, Messenger, and Facebook) turned out to be lower than Facebook’s ARPU alone. What does this show? ThatFacebook is still the largest revenue generator out of the entire “family,” and it’s probably time to make the other ones work their investment as well.
ARPU helps to plan for the future
Every startup wants to mature into a solid company, maybe even an international corporation. But it won’t happen without measuring, managing, and setting goals. What does ARPU have to do with it? Well, it can show you the current dynamics you’ll later use for budget estimates, quarter planning, and analyzing if your situation is close to the desired one.
Let’s say, your goal is to reach $500,000 in revenue by the end of the year. You have 1,000 active clients monthly. With all else unchanged (or as they say, ceteris paribus), you will have to generate around $42k each month, so your expected ARPU should be at least $42 to reach that goal. Sure, nothing stays the same for 365 days in business, but this indicator will serve as the bare minimum the ARPU reports should show monthly.
As you see, there are plenty of ways in which this metric can come in handy for the subscription business. The question is, how do you calculate ARPU correctly, and what other metrics do you need to consider at the same time?
Calculating ARPU: do's and dont's
You already know that the general ARPU formula is the revenue for a specific period divided by the number of active consumers. However, there are additional important metrics to keep in mind while measuring ARPU:
MRR (monthly recurring revenue). The total amount of money a business has gained during a month.
Upgrade/Downgrade MRR. The revenue obtained/lost due to users’ upgrading or downgrading.
Churned MRR. The lost revenue from the customers who didn’t purchase as usual or canceled their subscription during the set period. You can getway deeper into churn, but for understanding average revenue, it’s critical to identify what clients cancel on your business.
On the other hand, unlike these indicators, which you may also want to include while measuring the ARPU to get more accurate results, there are some others that shouldn’t be considered.
Don’t include these in the calculation
Goods/services you didn’t get money for. Even if you give away your services/products for free to compliment your loyal clients, don’t include their cost in the revenue. The reason? They didn’t generate any direct income.
Inactive accounts/free plans/freemiums. The same logic applies here: if these accounts didn’t make any purchase, they didn’t contribute to the revenue and should be excluded. In a sense, they’re still only ‘potential customers’. However, you should include them when calculating the cost spent on their support, marketing, and management.
Tips to take your ARPU to the top
Now that you know why ARPU is important for your subscription business, here are a few tips on how to improve it.
Measure it. The initial step to improving your ARPU game is knowing what’s going on. Tracking and comparing the monthly and quarterly indicators will help you identify the areas that need troubleshooting.
Add value. Better products/services allow you to charge your clients more and revise your pricing policy, which leads to increased ARPU. Analyze the ARPU metrics and your clients’ personas to see where you may add a tier or upsell features.
Resegment. Offering the right products to the right people is what helps your business thrive, andsegmentation makes it possible. ARPU analytics will tell if you pay enough attention and provide enough value to the audience that brings in the most money.
Improve the retention rate. Churring clients decrease the ARPU and, consequently, LTV (lifetime value), so make sure your retention program is working.
Knowing your clients and analyzing their behavior can help make subscription businesses more successful. The ARPU metric allows you to see a bigger financial picture, adjust your customers’ personas, and set realistic goals and budgets to take your subscription business to a new level.
The good news? There are tools like Subbly that can provide you with analytics while helping manage and grow your subscription business. Try ourfree full-featured plan with 100+ subscription-first features for 14 days and get ready to unlock growth and revenue… ARPU is just the start!