You know your customer well and offer them the best services, but are you aware of how much they are worth to your business? It is when Average Revenue Per User or ARPU comes to play as it gives the exact same information.
Average Revenue Per User, or ARPU, is the average amount of revenue generated by each active user over a given period of time. It is a useful metric that predicts how much the average users spend on your app. Once you know ARPU, you can optimize the support budget, pricing, and product positioning of your business.
Businesses put in the best customer-centric strategies and make efforts to uplift marketing and sales. Irrespective of how well you are offering, realizing whether the efforts are generating value for your business at an individual level or not is essential.
How is ARPU calculated?
ARPU quantifies the typical revenue generated from each user in a certain period. Before understanding how to calculate ARPU, it is essential to know who the user is and what time frame you should use for measuring.
Who is a user?
Usually, the definition of a user depends upon the type of business. For instance, the user of Spotify and Netflix, consumer-based monthly subscription companies, the one with an active subscription. However, when there are multiple seats per account, an account can be used to define a user.
What time frame should you use?
Usually, ARPU is calculated monthly, especially for companies that sell a monthly subscription. Here, ARPU can be calculated by taking the total revenue of a month and dividing that by the total active customers for that month.
However, when the business is not based on a monthly subscription, how often a user is using the company’s services can be taken into account.
Likewise, companies like Expedia and Airbnb, which don’t expect their users to make booking every month, may calculate ARPU on a quarterly basis.
Formula to calculate ARPU
ARPU is calculated as follows:
Average Revenue Per User (ARPU) = Total Revenue ÷ Total Number of Customers
It can be understood with the example:
If a company has generated revenue of $10 million with 10,000 customers, ARPU will be-
$10 million/10,000 = $100.
It means the contribution of an individual customer to the business is $100.
Variables to Consider when Calculating ARPU
Even though calculating ARPU seems easy, you need to keep a few key factors in mind. These are:
Paying vs. Free Users
Your app might be giving free sign-ups and trials to the users as a welcome token. Even though it is important from the business point of view, it should not be considered while calculating ARPU. It is mainly because free uses do not help generate any revenue until the users start exploring the paid services.
So, if you include such users, the results may be skewed.
Apart from this, here is a list of components that should be avoided in calculating ARPU:
- Inactive users
- Users who have unsubscribed
- Non paying users
- Gift subscribers
Excluding all these, while calculating ARPU will ensure you get a clear and accurate picture of the ARPU of the business.
Upgrades vs. Downgrades
If you keep on adding new paid plans and add-on features, the customers’ spend will not remain static. For some users, the new features might be alluring, but for others, they are a turnoff.
In this case, you need to keep an eye on customers’ moving tiers. It will give an insight into the features that helped generate more subscriptions and, therefore, more revenue. Also, it will help you know what add-ons reduce retention.
Churn Rate
The churn rate tells the number of lost customers over a given period of time. It also applies to the number of subscribers who don’t renew or cancel a subscription.
If your business is losing high-paying customers, it will drop the ARPU more steeply than the small-paying ones.
How to Use ARPU?
ARPU is an important metric that can help in a number of ways.
1. Enables you to compare competitors
Knowing your competitors inside out and learning their business strategies help immensely, and ARPU assists this in different verticals. Once you know the ARPU of competitors, you can compare how much a company is making off its users compared to another.
ARPU is a good measure to analyze and compare subscription-based businesses. Companies with higher ARPU are obviously more profitable.
2. Segment Users for Profit Analysis
Businesses typically have different tiers of customers- from entry-level and freemium to the enterprise. Here, ARPU can give a better insight into the customers based on these segments, especially when it is combined with other metrics.
For instance, it is quite likely that your entry-level plan will have a lower ARPU than your enterprise users. However, here it is important to learn about your support cost per user for these two segments.
Sometimes it is found that both these segments generate the same amount of support cost, but the revenue generated from the lower level is too less. It is the reason why many companies eliminate low-level plans.
3. Forecast the revenue
ARPU, when combined with other financial models like customer acquisition and retention assumptions, it helps forecast the revenue of the business.
Based on this data, you can decide if you need to make adjustments if you believe that your ARPU will change over time.
