ARPU is a common metric that’s useful for all types of businesses, but it's most commonly used to analyze subscription based uses. It’s a simple, straightforward metric with a handful of use cases.

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Calculating ARPU is a great way for a business to continuously track their annual growth progress. For example, service and software businesses that offer different monthly subscription levels can use ARPU to monitor the monetary value of each new user. They can then compare the value of users for each subscription to determine which premium offers are the most influential in driving revenue.

In this post, we’ll dive into what ARPU is, how to calculate the metric for various businesses, and how you can use it to drive business results.

This is not a GAAP accounting term, so technically there’s no official ‘standard’ of how it’s calculated. However, the calculation is generally used in the same way across the board.

Average Revenue Per User vs. Average Revenue Per Unit

In the investing world, sometimes this formula is referred to as “Average Revenue Per Unit.” The calculation of the formula is essentially the same, but it’s meaning is a bit different.

ARPU Revenue Formula

The calculation of ARPU is quite straightforward. It simply involves taking the total revenue in a given time period by the number of users in that time period.

ARPU = Total Revenue / # of Users

What time-frame should you use?

By far, the most common time period is monthly. Any company that sells a monthly subscription probably uses monthly. In this case, to calculate your ARPU, you would take the total revenue for the month and divide by the total active customers in that month.

If your business isn’t a subscription, think of how often a user ‘should’ use your service. At LawnStarter, we expect people to get their lawns cut at least once per month, so we measure it on a monthly basis.

In some cases, a different time period might make sense -- it depends on how often your users are expected to use your product. Airbnb, for example, probably doesn’t expect their users to make a booking monthly since most people don’t travel monthly. Therefore, they might measure ARPU on a quarterly basis.

How to Calculate Total Revenue

To calculate the total revenue for your business, we first need to determine the number of goods or services sold during a specific time period. Companies that sell multiple products will want to look at each product’s total revenue individually, and then combine their totals together. This allows you to see which specific products are producing the most revenue.

If you’re selling a product that’s tangible, you’ll want to calculate the total number of units sold per each product. If you’re selling a service or software product, you can look at the total number of subscriptions that were purchased.

Once we know the total of goods sold, next we’ll have to calculate the price of these goods. This will be the number that the customer pays for one unit of the product or service.

Now that we have determined both the number of goods sold as well as the price of each good, we can multiply these values together to calculate total revenue. To help, here’s an example using HubSpot’s subscription model.

HubSpot offers our Marketing Hub Starter plan for $50 per month. Let’s say we sell 10 of those plans. If we multiply our quantity of goods sold (10) by our price ($50), then our total revenue for this product would be $500 (10 x $50 = $500).

How to Define a User

How do you define users?

There’s no clear-cut definition, but it depends on your business.

For a consumer-based monthly subscription company like Spotify or Netflix, you would generally define a user as one who had an active subscription that month.

The same goes for a subscription SaaS company like HubSpot. The only difference is when you have multiple seats per account, and the pricing scales with users. In that case, you might define a user as a seat or as an account, depending on your purpose (more on this later).

If you’re an ecommerce store like Amazon, or an as-needed service like Instacart,  you would probably define a user as one who purchased that time period because the transactions are one-off,.

For ad-based websites (non-subscription) like most news sources, you would probably use visitors. For a social network or consumer app, you might identify a key action or sequences within that app as ‘activity’.

There are a number of ways to calculate active users, so you'll want to align the definition with the frequency and manner in which you make money.

Key Differences between ARPU and LTV

Some confuse ARPU with customer lifetime value, or LTV.

While they are related, they are different metrics.

Lifetime value is a measure of what the value is, on average of a customer that signs up. Additionally, lifetime value accounts for variable costs such as support, transaction fees, and refunds.

It’s calculated using the following formula:

LTV = (Lifetime spend - lifetime variable costs) / # of customers acquired

Lifetime value is a measure of how profitable each customer is on a unit basis, whereas ARPU is a way to measure the overall health of the business on an ongoing basis.

How to Use ARPU

1. Comparison to Competitors

The best use for ARPU is in comparison to competitors and companies in other verticals. It’s an easy, high-level way to compare how much one company makes off its users compared to another. For decades, stock analysts have been using ARPU to analyze and compare subscription-based businesses, like telecom providers.

All else equal, the company with the higher ARPU is more profitable.

2. Choosing your Customer Acquisition Channels

When evaluating customer acquisition channels, you should use lifetime value as the ultimate indicator of whether a customer acquisition channel is profitable or not. However, ARPU can still be valuable.

As previously mentioned, ARPU is a great way to benchmark your business with other businesses, both competitors and companies in similar verticals. Therefore, this is a quick yet effective way to make a list of similar companies whose channels may also work for you.

3. Segmenting your Users for Profitability Analysis

Most businesses have some sort of segmentation. In SaaS, you typically will have different tiers of customers, ranging from freemium to entry level to enterprise.

Looking at ARPU by a segment can reveal interesting insights when paired with other metrics.

For example, it’s quite likely that your enterprise users with have a much higher ARPU than your entry level plan. But what about your support cost per user for each of these segments?

Many businesses find that the lower level users generate the same amount of support cost on a per user, but only a fraction of the ARPU. Hence why you see companies like Optimizely eliminating low-level plans.

Or, the balance may not be so out of whack that you lose your lower tier, but perhaps you could use this insight to adjust pricing.

4. Forecasting

Many financial models involve first forecasting your users based on acquisition, customer acquisition, and retention assumptions. By simply multiplying that number by your ARPU, you get a revenue forecast.

Of course, you might need to make adjustments if you think your ARPU will change over time.

If you use ARPU differently, I’d love to hear from you on Twitter.

To learn more, read about the differences between IaaS vs. PaaS vs. SaaS next.

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 Customer Service Metrics

Originally published Mar 14, 2019 4:27:00 PM, updated March 25 2019

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SaaS