Net Dollar Retention (NDR) is a metric companies use to evaluate the fluctuations within their customer base. It measures the changes in recurring revenue with respect to upgrades, downgrades and churn.
How to Calculate Net Dollar Retention
Net Dollar Retention (NDR) is calculated based on the formula:
In the formula, upgrades and downgrades refer to the revenue gained or lost from users' action of upgrading or downgrading their subscription. Churn, another word for cancellation, refers to the revenue lost caused by user cancellation.
As an example, let's say company A has a revenue at the start of $100M, revenue generated by upgrades of $20M, revenue reduced by downgrades of $5M and revenue reduced by cancellations of $5M. Based on the formula, we get
Generally speaking, a NDR of more than 100% represents that a company is in a healthy growth state.
It means that the company's revenue can continue to grow without acquiring new customers. A NDR below 100% means that a lot of existing users of a company are downgrading or cancelling their subscriptions.
In the example above, we can tell that company A is in a healthy growing state and that company A can grow solely based on maintaining its current customers without the need to acquire new customers.
SaaS industry leaders usually maintain a NDR around 120%.
Why is Net Dollar Retention Important in SaaS
Net Dollar Retention (NDR) is often used to analyze Saas (Software as a Service) companies, because SaaS companies heavily rely on recurring subscription revenues.
A high NDR in the SaaS space represents the company’s ability to retain or increase its existing customers while attracting these customers to upgrade their services. In this case, most customers are willing to continuously pay for the subscription or to upgrade.
Net Dollar Retention in Valuation
Net Dollar Retention (NDR) is also an important metric when it comes to valuation. Because NDR represents companies' ability to grow without acquiring new customers, it could be a great indicator to predict future growth.
A high NDR indicates that the company brings values and solves painpoints for its customers. Because of the values and benefits a company brings to its customers, customers will have strong stickiness and loyalty.
Therefore, in valuation method such as discounted free cash flow, which values a company based on predictions of the future, a company with high NDR will most likely result in a high valuation. This, in turn, will appear attractive to potential investors such as acquirers and venture capitals.
The Bottom Line
Net Dollar Retention (NDR) is an important metric when evaluating SaaS companies. It measures the fluctuations within their customer base with respect to upgrades, downgrades and churn. NDR is also useful in determining a company's ability to grow without acquiring new customers. Combining with other fundamental analysis, NDR can help investors to screen for SaaS stocks more efficiently and make decision on what SaaS stocks to purchase.