Revenue quality: ARR, MRR and unit economics
Not all revenue is equal. A pound of recurring subscription revenue is usually worth far more than a pound from a one-off sale, because it is predictable and tends to repeat. That's why subscription companies are measured with their own set of metrics.
The key metrics
| Metric | Meaning | Good sign |
|---|---|---|
| ARR / MRR | Annual / monthly recurring revenue from subscriptions | Steady growth, low concentration |
| Churn | Share of customers or revenue lost per period | Low and falling |
| Net revenue retention | Revenue from last year’s customers this year, after upgrades and churn | Above 100%: existing customers grow |
| CAC | Cost to acquire a customer | Paid back within 1-2 years |
| LTV | Gross profit a customer generates over their life | Several times CAC |
| Rule of 40 | Growth rate + profit margin | At or above 40% |
Recurring revenue
MRR is monthly recurring revenue. ARR is the annualised version, roughly MRR × 12. They show the run-rate of contracted subscription revenue, excluding one-off fees. Investors watch ARR growth and how it breaks down: new customers, expansion from existing ones, and churn.
Retention is everything
If net revenue retention is 120%, last year's customers pay 20% more this year even before any new sales. If churn is high, the company is constantly refilling a leaking bucket, spending heavily just to stand still.
Unit economics
Unit economics ask whether each customer is profitable. If it costs £1,000 to acquire a customer (CAC) who generates £4,000 of gross profit over their life (LTV), growth creates value. If LTV is below CAC, every new customer destroys it, and faster growth only means faster losses. The payback period (months to earn back CAC) shows how much cash growth consumes.
Growth vs profit
The rule of 40 is a simple balance test: revenue growth plus profit margin should be at least 40%. A company growing 30% with a 10% margin passes. One growing 50% while losing 30% doesn't.
Watch out for
- Changing definitions of ARR from quarter to quarter.
- Big customer concentration.
- Growth bought with steep discounts or heavy marketing that stops when spending stops.
- Adjusted profit that excludes large share-based pay (lesson 1.5).
Key takeaway
For subscription businesses, ask how sticky the revenue is and what each new customer costs. Revenue growth alone tells you very little.
Educational content only, not financial advice. Investing involves risk and you can lose money.