What is expansion revenue?

Expansion revenue can be defined as additional revenue from an existing customer base beyond their initial purchase. It can either be a one-time purchase or a monthly subscription that increases recurring revenue.  It can be categorized as upsells, cross-sells, and any add-ons offered to the customer.

Upselling: It is the purchase of a more expensive product or upgrade than a customer’s current purchase.

Cross–selling: It is about selling products or services complementary to customers’ current purchase.

Add-ons are any additional products that increase customer experience for using a product or a service.

For instance, if you are a SaaS-based business, an upsell will be licensing a higher-tier version of your product. A cross-sell would be selling training or integration services to a company. The add-on will be an additional feature that can be used at a slightly increased monthly cost. Expansion revenue not only serves as additional earnings for your business but also shows the satisfaction level attained from your products by customers.

What is the formula for calculating expansion revenue?

Expansion revenue can be calculated by taking the total revenue from existing customers at the month’s end minus your total revenue from existing customers at the start of the month. The difference can be stated as expansion revenue.

For instance, if your MRR at the month start was $1000 and your MRR at the end of the month is $1200, your expansion revenue can be $200.

It is an interesting fact that the same customer base is used for this calculation. However, if there was a customer churn in the monthly cycle, they can be eliminated from the initial MRR figure.

Formula:

Expansion Revenue = (Revenue from Existing Customers at Month End) – (Revenue from Existing Customers at Month Start)

Symbolically:

Let:

• R end​ = Revenue from existing customers at the end of the month
• R start​ = Revenue from existing customers at the start of the month

Then, the expansion revenue (E) is:

E=R end​−R start​

Imagine a subscription-based online learning platform.

• R start​ (Revenue from existing customers at the start of the month): $50,000
  • This represents the total monthly recurring revenue they were already generating from their current subscribers at the beginning of the month.
• R end​ (Revenue from existing customers at the end of the month): $58,000
  • This is the total monthly recurring revenue from the same group of customers at the end of the month. The increase is due to upgrades, add-ons, and other expansion efforts.

Calculation:

E (Expansion Revenue): E = $58,000 – $50,000 = $8,000

What is the significance of expansion revenue for SaaS-based businesses?

For a SaaS-based business, expansion revenue has a direct correlation with long-term profitability and customer lifetime value. Thus, additional revenue from customers is more than just money, as it signifies your business performance in the long run. It aids in:

Protect Churn

When your existing customers stick with you and also sign up for any additional features of your services, it ensures negative churn. Negative churn means when existing customer revenues rise sufficiently to replace the lost revenue from cancelling or downgrading customers.

Scalability

It is much cheaper for a company to create new revenue growth from existing customers than it is to chase new customer leads. That is why monitoring expansion revenue illustrates how business leaders can expand sales without raising customer acquisition costs (CAC).

Certain software can observe how a well-cultivated relationship to expansion revenue can also enhance product development. Feedback from customers regarding extra features provides a two-way street to innovation, eventually increasing expansion revenue.

Teamwork

A healthy growth rate of expansion revenue indicates that your customer success teams and sales teams are in sync. This depicts a smooth customer experience that allows renewals and organic growth.

It is not merely meeting a sales quota; in fact, it is about providing real value to the customer, where each upsell or add-on is strategic.

What are some ways to improve your expansion revenue?

Expansion revenue has the potential to sharply cut or neutralize a SaaS company’s churn rate. The path to more revenue and less churn is lit by a customer success team’s emphasis on customization, teaching, and where customers are in their process. A good expansion revenue strategy does not push extra features and products without the above in mind. Some methods to increase expansion revenue are:

Strategic marketing campaigns

If you have a self-serve product, you can offer in-app notifications for upgrades or availing extra features. By using analytics, you can monitor your customer response and whether they click on your offer. By using that data, you can send emails to interested customers to learn more about the upgrades.

It is best to stick to customers who are apparently interested in your product, as excessive notifications about new deals can irritate the customer.

Utilize the power of CRM.

If your product is complicated or it targets large enterprises, your potential expansion revenue will rely on a decision maker. Strategically using customer retention management can offer a chance for growing expansion revenue. Account reps can gauge potential customers that are fit for an add-on or upsell. A follow-up person must have all information about the product, such as pricing details and what value the upgrade offers.

Connect product features to growth.

You can also make expansion revenue a natural extension of a customer’s growth. Expanding businesses, for instance, will require additional seats or more advanced features. This is particularly effective if your customers are able to connect their growth to your product somehow, such as through increased efficiency.

If your paid product has more than one tier, think about features your customers would require for every tier. With your product reaching maturity, take a lot of thought into consideration when introducing new features associated with each tier. The more alluring the feature, the bigger the chances customers will upgrade or pay for an add-on.

Customer Segmentation

Segmenting your customers based on their product usage patterns and knowing who will most likely be interested in an upsell, add-on, or upgrade can help. From a customer success standpoint, developing various buyer personas from known preferences can assist reps in seeing upsell opportunities and targeting their existing customers ahead of time. They already know how the customer would apply the product (similar customers already have it), so they can build a customized offer that addresses their issues.

Segmentation also makes teams aware of who will more likely upgrade and also those who will need additional education and support. Apart from maximizing expansion revenue, this also maximizes the productivity with which CS teams develop such accounts.

Bundling Products

Products offered as bundles attract customers who are price sensitive. It allows customers to buy several products as a package at the same time. Bundling can be considered a type of cross-selling that involves grouping up two or more products to attract the customer. It enhances the average deal size while staying profitable.

Bundled pricing is a great opportunity to sell two or more products to a customer who only might want to pay for one product. Bundles can be of great interest to customers if they involve many complementary items that fulfil customer needs.

Differential pricing strategy

Adjustments to prices based on customer usage patterns and later scaling discounts to customers with increased usage are a great idea. It engages customers with the product and increases the frequency of usage. Also, offering a discount on renewal may allow customer loyalty and a decreased churn rate. Through differential pricing you could gain a new customer who would subscribe to a low-fee package and may use your product in the long run as their needs increase for further features.

What are the advantages of expansion revenue?

There are several benefits associated with monitoring expansion revenue rate. It is a driver for business expansion and growth. Some of the advantages associated are:

Customer behavior

By keeping a check on how the spending patterns of your customers are, you can understand your potential customers for expansion revenue. This usage pattern can guide you to devise helpful innovation and growth strategies for your business.

Strategic Decision-Making

Expansion revenue rate allows you to guide business decisions and devise meaningful strategies. If the rate is high, it can be great to upsell or cross-sell, and this metric also assists in identifying growth opportunities.

Retention strategies

ERR helps to find customer retention strategies as it aids to highlight areas where customer loyalty is improving. An increased ERR showcases increasing customer satisfaction.

Financial planning

Understanding the purchasing power of your customer base can help in making reliable financial forecasts. Forecasting shows increased revenue; you can expect more revenue gains in the future. It also helps to ease budgeting and resource allocation in an actionable way.

What are some limitations of expansion revenue?

Even though it is crucial as a metric for growth, it is essential to note that expansion revenue rate has its downsides.

To begin with, it does not always give a comprehensive view of your business performance. Although it focuses on revenue growth from existing customers, other important metrics can be ignored. This might be new customer acquisition or churn rates.

Further, employing the expansion revenue rate by itself is not recommended. Like all financial measures, it is only part of the picture. For example, a high expansion revenue rate can conceal an underlying issue with retaining customers.

There are also situations wherein expansion revenue rate can provide erroneous outputs. For example, most of the expansion revenues could be contributed by a few specific customers. This would result in an exaggerated expansion revenue rate that hides the actual performance of the company.

How does ERR relate to other revenue metrics of the company?

Understanding the impact of ERR on other key factors for growth and success is critical for informed decision-making. It affects various metrics such as:

ARR/MRR

Revenue expansion increases ARR/MRR as it captures the incremental recurring revenue achieved through upsells, cross-sells, and service increases from your current customers.

Customer LTV

An increase in expansion revenue has a direct impact on customer LTV, as higher spend from current customers pushes their lifetime value to the business and indicates longer-term profitability.

Logo Retention

Successful expansion tactics can generate greater logo retention. Customers are not only sticking with your service; they are deepening their investment over time, which is the go-ahead for long-term reliance on your services.

Logo churn

With a minimized logo churn and customer attrition, you lay emphasis on increasing ERR. Keeping your customers on board provides numerous chances throughout the sales funnel to allow additional services and upgradation of plans.

What is contraction revenue?

Contraction revenue is a decreased revenue that a company may experience owing to a lost customer base and reduced product offers. Whereas growth revenue is usually regarded as an indicator of a thriving and prosperous business, contraction revenue is usually regarded as an indicator of a struggling business.

It is significant that firms should be able to track both measures in order to gauge the well-being and growth pattern of their business. Also worth mentioning is the fact that these indicators are not mutually exclusive and that, based on different factors like market conditions, competition, and its own strategy, a company might witness growth and shrinkage of revenue in the longer run.

Formula for calculating contraction revenue:

Contraction MRR (Monthly Recurring Revenue) = Downgrade MRR + Cancellation MRR (or Churn MRR).

In this formula, downgraded MRR is the amount of MRR lost when customers switch to lower-priced subscription plans.

Cancellation MRR is the lost MMR when customers cancel subscriptions.

Scenario:

Imagine a SaaS company that provides project management software with tiered subscription plans.

• Downgrade MRR:
  • Let’s say 50 customers downgraded from a “Professional” plan to a “Basic” plan.
  • The “Professional” plan costs $100 per month, and the “Basic” plan costs $60 per month.
  • The MRR lost per downgrade is $100 – $60 = $40.
  • Total Downgrade MRR = 50 customers * $40 = $2,000.
• Cancellation MRR (Churn MRR):
  • Let’s say 20 customers canceled their subscriptions entirely.
  • The average MRR per canceled subscription was $75.
  • Total Cancellation MRR = 20 customers * $75 = $1,500.

Calculation:

• Contraction MRR = Downgrade MRR + Cancellation MRR
• Contraction MRR = $2,000 + $1,500
• Contraction MRR = $3,500

It is important to know that this formula is relevant for recurring revenue-based businesses. Contraction revenue allows calculation of customer dissatisfaction and competitive pressures. It informs a business to improve its strategies in terms of business performance and pricing.