Don’t Make These Common Revenue Mistakes
Calculating Annual Recurring Revenue (ARR) and applying it to strategic business decisions can get ridiculously complicated when a sales organization is juggling hundreds of customers and thousands of prospects. Proper discipline and awareness of the following pitfalls can make a sales operations manager the beacon of reason in the otherwise messy process of calculating subscription revenue.
Companies run into trouble when they are so reluctant to admit to churn that they fiddle with their ARR calculations to hide it. No one wants churn on the books, but some companies will wait up to six months after a customer has reduced their contract or terminated it entirely before they chalk it up to churn. This is an expensive, dangerous game. You’re likely to end up servicing an account for months without ever getting paid for it. It also doesn’t play to your team’s strengths. If months of negotiations were unable to renew the customer, the skills required to get them back will be more suited to those of your Account Executives than your Account Managers.
Another way companies frequently run into trouble with their ARR calculations is when they miscategorize their revenue. Services like training and deployment assistance often come at an additional one-time cost to a basic software subscription. But because this income is inherently non-renewable, including this in an ARR calculation guarantees an equal amount of churn in the future.
Contracts that don’t last a full year can also be a pain to include in ARR reports. A customer may sign a $10k deal for one quarter, testing out your product to see if it’s a fit for their workflow. When included in an ARR calculation, a deal like this looks like $40k in ARR. But say the customer didn’t feel your product was a fit, and doesn’t renew. This $10k deal now appears in the books as $40k of ARR churn.
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This is where the distinction between ACV (Annual Contract Value) and TCV (Total Contract Value) comes in handy.
If your business deals in both annual and sub-annual contracts, you’ll want to measure sub-annual contracts separately from your ARR calculations, as they are by definition not annually recurring. This will reduce the instances where your churn rates look higher than your actual income, and give your organization a more granular look at where your revenue is coming from.
Misaligned contract expirations:
Sometimes a customer will like your product so much they’ll want to make a drastic expansion of their deployment halfway through their contract, or renew the contract early. This is great for business, but can be tricky from a contracting standpoint. Let’s say you secure a customer with a $50k ARR initial deployment. Seven months into their contract, they decide they want to go wall-to-wall, for an increase of $250k ARR. They want to make it an annually recurring contract, starting immediately. In the excitement of the massive increase, it can be tempting to go right ahead and sign the deal without a second thought. But what happens when your primary contract expires in five months? All of the sudden, they’re only paying for the expansion, and you either need to need to turn off service to $50k worth of their users or push for a last-minute contract. This is a painful process for both you and the customer.