Annual Recurring Revenue (ARR) is a key metric for subscription-based businesses that measures the annual value of ongoing, predictable revenue from customers. ARR includes only recurring elements like subscription fees and excludes one-time revenues like implementation fees or consulting services.
ARR is particularly important for SaaS companies (Software as a Service) and other subscription-based business models where customer relationships are long-term and revenues come at regular intervals.
For sales organizations, ARR is often the primary metric used to measure salesperson performance and calculate commission. This is because ARR better reflects the long-term value of a sale than a one-time transaction.
ARR is one of the most important metrics for subscription businesses for several reasons:
ARR provides a clear picture of the company's expected annual revenue from existing customer relationships. This makes budgeting and forecasting more reliable.
By tracking ARR over time, companies can measure their growth rate and compare with industry benchmarks. A healthy SaaS company typically targets 20-50%+ annual ARR growth.
Investors often value SaaS companies as a multiple of ARR. The higher the ARR and growth rate, the higher the valuation.
ARR is typically used as the basis for calculating sales commissions because it captures the full value of a subscription sale rather than just the first month's payment.
ARR is calculated by annualizing Monthly Recurring Revenue (MRR):
ARR = MRR × 12
Alternatively, ARR can be calculated directly from annual subscription values:
ARR = Sum of all active annual subscription values
To understand ARR development, it's important to know the different components:
New ARR comes from completely new customers who haven't previously been paying. This is typically the primary focus for sales commissions.
Expansion ARR comes from existing customers who upgrade their subscription, buy more licenses, or add new products. Also called upsell or cross-sell ARR.
Churned ARR is the ARR lost when customers cancel their subscription. High churn reduces net ARR growth.
Contraction ARR occurs when existing customers downgrade their subscription or reduce the number of licenses.
Net New ARR is the total net change:
Net New ARR = New ARR + Expansion ARR - Churned ARR - Contraction ARR
In most SaaS companies, ARR is used as the basis for commission calculation. Here are typical models:
Salesperson quotas are often set in ARR. Here's an example quota structure:
It's important to understand the difference between ARR and other revenue metrics:
Here are typical ARR benchmarks for SaaS companies:
The Rule of 40 states that a healthy SaaS company's growth rate plus profit margin should equal or exceed 40%. For example, 30% ARR growth + 10% profit margin = 40%.
When designing commission plans based on ARR, consider:
Be clear about which products and deal types count toward ARR quota. Do you include discounts? Freemium conversions? Partner deals?
Decide whether commission is calculated on first-year ARR or TCV. Multi-year deals can either get a bonus or a lower rate.
Clarify whether account executives or customer success managers get credit for expansion ARR.
Consider clawback clauses where commission is repaid upon early customer cancellation.
Reward overperformance with higher commission rates above quota.
New hires may need ramped quotas while they build pipeline.
To work effectively with ARR, it's useful to know these terms:
Tracking ARR-based commissions manually is complex, especially when handling different products, customer segments, and contract types. Prowi automates the entire process.
With Prowi you get:
Book a demo today and see how Prowi can optimize your ARR-based commission calculation.