How to Calculate Net Dollar Retention Rate (the right way)

The Science

Net Retention is a measure of how much your existing customers expand in a given period, net of any churn or down sell. It basically throws all of your existing customer dynamics into a pot, mixes them up, and spits back out how much your business will grow or decline by, absent any net new business activity.

Think of customers as a “cohort” or group representing those who existed at the start of the period you are measuring. You shouldn’t include expansion for new customers who started after the measurement start date, as this will overstate your NDR.

Net Retention is a measure of how much your existing customers expand in a given period, net of any churn or shrink.
Ways to impact Net Retention are to:
- Churn less
- Sell more of the same product to customers
- Sell new products to customers
- Increase existing customer usage
Generally, anything over 110% is good and anything over 130% is great
Enterprise customers usually have better net retention than smaller customers
Usage Based monetization models have an easier time increasing Net Retention compared to Subscription

How Do You Change Net Retention?

There are three levers you can pull to impact Net Retention.

You sell more of the same product (more licenses to more people, or more usage)
You sell more of a new product (product upsell)
You decrease churn (don’t lose them)

How Do Other Companies Calculate It?

This is how well known tech companies calculate NDR:

Book a benchmarking call with Virtua

Common Mistakes

Some of the biggest red flags I see when people / companies calculate NDR:

1) The Net Dollar Retention Rope-a-Dope

Net Dollar Retention is typically measured on a trailing twelve month basis. But you shouldn’t include expansion dollars from customers who were not already onboard at the start of the measurement period. But many companies do what I call the “NDRRD: Net Dollar Retention Rope a Dope”.

This is where you shuffle in expansion dollars from customers less than 12 months old into the numerator. But since the customer isn’t actually in the annual cohort (they showed up later), their starting ARR value is not in the denominator. This artificially inflates net dollar retention.

To avoid this, build a sales export from your CRM with every customer listed down the left side with a unique ID, and months listed across the top columns. Find the month you’d like to start your measurement at, and filter for all values greater than zero. These are the only accounts eligible for inclusion in your net retention calculation.

Then create a new column on the far right to calculate the expansion (or contraction) in revenue by account from the start to the finish of the measurement period, subtracting from right to left.

Keeping the filter on, at the bottom of the sheet you can now sum the starting, ending, and expansion (or contraction) dollars for your aggregate inputs into your calculation. This safeguards against bleeding in an “early” expansion dollars

2) Hiding behind segments

Treating all customers equally in the NDR calculation can mask problems in specific segments. For instance, a few large accounts might be growing, inflating NDR, while a significant number of smaller accounts are churning. Segmenting customers by size, industry, or product usage can provide a more nuanced view.

3) Overreliance on headcount increases

We are seeing this now, as hiring slows. There’s been a 10% to 15% reduction across the board, as expansion dollars via license increases have all but dried up.

4) Complacency with a high NDR

If you have an astronomical NDR, you may actually be leaving money on the table.

In fact, Metrics Guru and VC Alex Clayton of Meritech Capital spoke to this on the RTN podcast. He thinks companies with +140% Net Dollar Retention AND Less than 18 months of CAC Payback period should spend MORE on customer acquisition. Here’s why:

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“If you think about the value of a software business it’s the net present value of future cash flows. So let’s think about those future cash flows and what’s comprised there.

If you have a business that’s had 130% to 140% net retention per year and that’s consistent, that means your base is growing 30% to 40% per year. Every single dollar that you acquire over time will continue to grow and compound.

And let’s say your gross margin is relatively stable at 80%.

Software companies incur the cost to acquire a business up front. So we spend a lot of money to acquire them, the cost to upsell them / expand them over time is relatively less, and our gross margin is stable.

What does that mean? It means that base of revenue will become extremely profitable over time…

-Alex Clayton on the RTN Podcast

In other words, if you know your customer is going to stick around AND expand over time, it’s worth it to spend a little more now in order to let them compound year after year for minimal additional cost. Allowing the same customers to grow over time will drive shareholder value.