Annual Recurring Revenue — What It Is, Why It Matters and 3 Simple Tips for Increasing Yours

In today's business environment, companies often rely on subscriptions as a key driver of revenue. Whether in the form of consumer-facing subscription boxes or SaaS platforms, many companies have recognized the value of setting up systems that deliver consistent, recurring revenue from their customers. In fact, the subscription economy is expected to reach $1.5 trillion in 2025.

Of course, just like any other business, subscription-driven companies must be able to effectively track their revenue to identify growth opportunities and challenges — and one of the best ways to do that is by looking at their annual recurring revenue (ARR).

Related: 5 Essentials for Building a Subscription Business Customers Won't Quit

What is ARR, and why does it matter?

Annual recurring revenue is a key metric in the subscription economy that measures the recurring revenue that the business gets from its subscriptions during a single calendar year. ARR is based solely on subscription revenue and doesn't account for one-time purchases or fees.

ARR is often calculated on a per-customer basis — dividing the total value of a subscription contract by the number of years in the subscription contract. Adding up the yearly subscription value of each customer provides the total ARR.

As the Corporate Finance Institute explains, ARR is a valuable metric for subscription-driven companies because it helps them quantify growth, evaluate the success of the subscription model and forecast future revenue. With ARR, organizations are able to gauge the overall health of their business and whether current subscription revenue (and subscription growth) is in line with the organization's goals.

1. Introduce multiple pricing options

For organizations trying to increase their number of customers so they can subsequently grow their total ARR, introducing multiple pricing options can be a savvy strategic practice. This has become especially prevalent in streaming, where practically every streamer has introduced multiple subscription tiers, largely divided by ad-supported and ad-free content.

For example, after introducing its ad-supported tier a little over 18 months ago, Netflix's ad-supported tier now allegedly accounts for over 45% of new signups — a clear indicator that offering a lower-priced plan made its offerings more appealing to budget-minded consumers.

Offering multiple tiers or pricing options certainly isn't limited to streaming. Many SaaS businesses also successfully use this model, with pricing tiers based on factors like the number of users who have access to an account, the amount of available storage or bandwidth and other factors.

Quite often, many of the most desirable features are locked behind a higher-priced tier, which encourages subscribers to opt for the more expensive option. However, by giving your audience multiple price points to choose from, you can grow ARR by becoming more desirable to both budget-minded and feature-focused audiences. Price scaling can also make your core service tier more attractive, further fueling subscription and revenue growth.

Related: 5 Tips for Growing Your Subscription Business

2. Be strategic with price promotions

One common technique used by subscription-driven businesses is to offer a price promotion, typically getting users to sign up at a steeply discounted price for the first year before reverting to the standard price in future years. Though discounts are effective at driving signups, they can be even more powerful when backed by a strategic campaign.

Penned by co-founder, Iman Gadzhi, a case study from Flozy demonstrates how effective promotions can be driven by much more than an attractive price point. In the buildup to the company's first Black Friday, their team created a significant amount of educational content to go alongside the Black Friday campaign.

As a result, when the Black Friday campaign launched with a significant discount on the company's yearly plan, it was further supplemented by free educational content and live events with the founding team. This strategic approach that went beyond a simple price promotion resulted in a 1,000% increase in revenue — and helped demonstrate the subscription's underlying value right from the start.

3. Ensure you have the necessary systems and support in place

As valuable as growth-oriented strategies are, retention cannot be ignored. If you have high levels of subscriber churn, then you don't truly have annual recurring revenue. Instead, your subscription-based business will be operating more like a traditional business model, in which you must repeatedly pursue sales with new customers.

Because of this, businesses that have ARR as a key performance metric must invest heavily in customer satisfaction and retention efforts. In the Flozy case study cited earlier, after the company's initial growth, implementing 24/7 support and daily customer service sessions that offered real-time assistance played a key role in helping satisfy existing customers while also spurring new monthly growth increases when the company reintroduced marketing.

Businesses must regularly evaluate pain points that are causing customers to cancel their subscriptions and focus on the processes and practices that affect these areas. Correcting deficiencies and finding ways to increase the value you offer to your existing subscribers is key to keeping them around in the long run. Such actions can also make potential price increases more palatable, as long as subscribers still feel like they are getting good value.

Related: How to Improve Your Subscription Business Churn Rate

For subscription-driven business models, few metrics are ultimately more important than ARR. By prioritizing this metric as part of your acquisition and retention process, you can identify initiatives and processes that will help you build a loyal customer base that drives dependable revenue for years to come.