ARPU is a common metric that’s useful for all sorts of businesses but is most commonly used to analyze subscription based uses. It’s a simple, straightforward metric with a handful of use cases.
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.
What does ARPU stand for?
The acronym ARPU stands for Average Revenue Per User.
In the investing world, some call it Average Revenue per Unit, but the definition is the same.
This is not a GAAP accounting term, so technically there’s no official ‘standard’ of how to it’s calculated. However, the calculation is generally used in the same way across the board.
How to Calculate ARPU
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 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, where the transactions are one-off, you would probably define a user as one who purchased that time period.
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, but generally speaking, you 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.
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.