ARPU gives marketing and customer service departments the ability to make their delivery more effective and efficient. By understanding the average contribution to revenue per user, businesses can identify opportunities to increase revenue and efficiency. By working out the ARPU for your business, managers understand how users interact with their company.
Why ARPU is Important
Service-based companies commonly use ARPU (Average Revenue per User) to understand how much revenue is generated per user of the service. This calculation allows managers to better understand the effect of their promotional activities during a specific time period. ARPU is beneficial for businesses with a recurring revenue model that is mostly service-based instead of product-focused. The calculation is similar to the Lifetime Value of a Customer but looks at a specific period with a start and end date.
How to Calculate ARPU
Calculating ARPU is a simple mathematical operation. The total revenue for a user base for a time period is divided by the total number of users for that period.
ARPU = Revenue ($) / Users (n)
The formula above specifies users instead of customers. The reason is that some business models don’t have users who are paying customers, such as social media platforms that have users who use their features for free. For example, ARPU is used by some social media companies such as Facebook. A platform such as Facebook can use ARPU to calculate operational costs and assess profitability based on the number of users who use its advertising features.
Choosing a Time Period
The period used in the calculation will be different for each business. The key when it comes to choosing the period for ARPU is relevance. By calculating the average revenue on a monthly basis, managers can identify times of the year when revenue per user is higher than others. By identifying periods of higher revenue per user, the business understands when and why demand is higher during these periods. However, monthly monitoring might not be useful if the company runs an annual subscription service and vice versa. ARPU analysis using the entire year as the time period will not give management enough information if their business model is based on monthly revenue.
Average Revenue Per Unit
A similar calculation is Average Revenue per Unit (also ARPU) used in businesses where a user is less relevant, and a product unit is more important. It is the same calculation; only users are replaced with the number of products in the market. The Average Revenue per Unit calculation is especially relevant for business models where revenue is linked to the use of a product in the market. Vending machines are an example of a product where per-unit revenue is relevant and measurable.
ARPU = Revenue ($) / Units (n)
How to Decide Between Unit and User
Deciding on whether to interpret revenue per user or unit is based on two questions: which one is measurable and which is linked to revenue. If your business is a service-based organization, then ARPU must be calculated per user. Some firms use both the number of units and users to calculate ARPU. For example, telecommunications companies have clients paying for phone contracts (users) as well as hardware parts such as phones and phone booths (units).
- Which is measurable?
There is no need to calculate average revenue per user if it’s impossible to measure the number of users . An eCommerce website can measure both since they can quantify both users and products, and that is where revenue comes into the decision.
- Which is linked to revenue?
The purpose of calculating average revenue by user or unit is to analyze and understand how to increase revenue and manage service capacity. In the case of eCommerce, the goal is to increase sales per user to get the most effective use of marketing.
How to Define a User
The definition of a user will vary depending on your business. Defining a user for your ARPU calculation comes back to its relevance for your business and how you would like to track your user base.
- A subscription service with free-to-use features (ex. MyFitnessPal) can identify a user as either a paid subscriber or a free account holder.
- A company can identify active users as those who have used or paid to use a service during a specific time period. By focusing on active users, the calculation doesn’t take into account user profiles that don’t generate revenue.
- Other Software as a Service (SaaS) companies can have numerous individual users linked to one account, such as the case with SaaS accounting firm Xero, a cloud-based accounting software platform. With Xero, users can be large accounts made of numerous people.
How to Interpret ARPU
Tracking and reporting performance metrics is useful for streamlining business operations. This is an opportunity for operations to reduce costs and for marketing to increase revenue during busy or quiet periods.
Let’s take a look at a simplified example. There are many ways for a company to generate a million dollars in revenue. Some businesses will achieve this with one big client, and other companies will find one million users to make one dollar from each. This varies from business to business, depending on customer acquisition costs and the business model.
One quick way to increase revenue is to increase the existing spend of your customer base. By doubling the ARPU, a business can earn higher revenue with little increase to the costs of doing business. There are a few ways to increase revenue:
- Rethinking the free aspects of the platform: If there are a lot of free users, introduce changes in the business model to increase the user’s level of subscription. The goal of offering free features is to provide value to non-paying users and turn them into paying customers.
- Offering additional features: Rather than having a subscription revenue model, your platform can start offering specific features for one-off use to generate additional revenue.
- Trial periods: Many businesses use trials to motivate users into upgrading their accounts. By offering the premium version for a limited time, users often go back to the base package and realize the product is worth their investment.
Track ARPU Over Time
Businesses’ service delivery and customer perceptions change over time. It is worth tracking ARPU over time to look for trends. By consistently tracking metrics and identifying changes to the business operations, management can understand what is or is not working well. Increases and decreases in customer spending can be tracked and linked to events over time. Tracking trends over time helps companies make well-informed decisions.
Criticisms of ARPU
Some managers might rely on ARPU without taking into account other important metrics. ARPU should be assessed in addition to changes in business operations such as new products launches or changes to business strategy. ARPU is also a high-level calculation made to examine the market and interpret major shifts and trends. The calculation of average revenue should be assessed in comparison to other metrics such as the total number of users for the period, prices of products or services, customer acquisition costs, and lifetime customer value.
For business managers, efficiency is key. When it comes to working out your Average Revenue Per User:
- Select a relevant time frame. Make sure that it is linked to your revenue model.
- Identify what the ‘U’ is. It can be a user or a unit. If it is a user, determine a clear definition of what constitutes a user.
- Track the ARPU over time, looking out for potential opportunities to improve marketing and operations.
- Be sure to consider other business metrics at the same time.
CustomersFirst Academy offers comprehensive customer service training designed to help you grow your skills and advance your career.
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