Healthy SaaS businesses show a consistent ability to upsell their current customers every year, increasing the value of each customer cohort over time. ZScaler, a SaaS business which recently went public, shows a wonderful example of this in their public filing. Their cohort chart below shows the initial value of each annual cohort of customers as well as the value of that cohort in subsequent years. For instance, the 2015 cohort was worth about $50mm of ARR in 2015, $60mm of ARR in 2016, and $70mm of ARR in 2017. The chart is up and to the right, which is exactly what you want your cohorts to look like, and a cohort analysis like this is the most detailed way of looking at the health of your customer base.
A similar metric we like is dollar net retention, which doesn’t view each cohort but rather looks at the customer base as a whole. Like the cohort analysis, dollar net retention factors upgrades, downgrades, and churn into the calculation. The specific formula is beginning ARR + upgrades – downgrades – churn all divided by beginning ARR. Therefore if you’re over 100%, that means upgrades are outpacing churn and downgrades over the entire customer base while if you’re under 100%, you’ve got an unhealthy situation whereby churn and downgrades or eating away at your current customer base. Dollar net retention at the time of going public for some of the best SaaS companies is below. As you can see, the median is well over 100% which is where you want to be.
Whether you do a cohort analysis which divides the customer base or simply rely on dollar net retention, both measures are fantastic at understanding the health of your SaaS business.