Why is a company's dollar-based net expansion rate, or DBNER, important?
Because it measures a company's ability to expand the level of revenue it generates from its customers. For a business to grow successfully, it needs to attract new customers and grow the revenue it receives from existing customers.
Understanding DBNER
The dollar-based net expansion rate is particularly relevant to software and technology companies that operate via a subscription model. These are referred to as software-as-a-service (SaaS) companies.
These companies look to onboard new customers and increase the revenue received from existing customers over time. This can occur by selling additional products or services to customers or increasing product and service usage within customer businesses.
DBNER tells us how well a company has expanded its business with existing customers by selling additional products or services over time. It is measured over time using customers who have remained with the business for that entire time. As such, DBNER is not concerned with customer churn but with the expansion of the business with retained customers.
A DBNER above 100% means the company is succeeding in selling additional products or services to existing customers over the period measured.
How do you calculate it?
A company's dollar-based net expansion rate is calculated by comparing revenue generated from customers at the start of a period with revenue generated by those same customers at the end of a period.
Importantly, the DBNER calculation does not include customers who do not remain customers of the business.
Let's look at an example:
| Customer | Revenue start of period | Revenue end of period (Scenario 1 ) | Revenue end of period (Scenario 2) |
| A | $2,000 | $2,000 | $3,000 |
| B | $3,000 | $3,000 | $3,500 |
| C | $4,000 | $0 (exited) | $0 (exited) |
| D | $5,000 | $5,500 | $5,500 |
At the start of the period, the company is generating $10,000 in revenue from customers A, B, and D. Customer C ceased being a customer during the calculation period, so is not counted when calculating DBNER.
In scenario 1, the company is generating revenue of $10,000 from customers A, B, and D at the end of the period. This means DBNER will be 100%. In scenario 2, the company is generating $12,000 from customers A, B, and D at the end of the period. This gives a DBNER of 120%.
In the above scenarios, customer churn is 25% because one in four customers ceased using the business. But customer churn is not captured in DBNER. This means it is important not to use DBNER in isolation. It should be considered alongside other metrics, such as customer churn and revenue growth rates.
The dollar-based net expansion rate indicates how effective a company is at selling additional services to its customers over time. It does not, however, consider the impact of customer losses on revenues.
When do you use the metric?
DBNER is particularly useful for technology companies operating on a SaaS model. They can grow revenue by adding new customers or by increasing sales to existing customers. Many SaaS companies aim to 'land and expand' — that is, land new customers and expand the offerings used by those customers over time.
Because it is generally more cost-efficient to increase sales to existing customers than win new ones, SaaS companies must expand sales to their existing customer base. If they can do so, it indicates that customers are happy with the service and are increasing their use of the company's products.
DBNER is a useful metric for assessing how much a company's existing customers increase their product and service usage over a given period.
What about DBNRR?
A company's dollar-based net expansion rate differs from its dollar-based net retention rate (DBNRR).
While DBNER looks at a certain segment of customers, DBNRR examines the entire customer cohort over time. Both provide helpful insights to measure how well a subscription business is doing and the level of customer engagement, but there are crucial differences. Where DBNRR measures the percentage revenue retained over a period, DBNER measures how well a company 'expands' the customers that it 'lands'.
When using these metrics, it is important to understand how individual companies calculate them to ensure you compare like with like. Some companies have been known to use the DBNRR and DBNER interchangeably, so you must review any disclosures in company filings to ensure you understand exactly what is being measured.
Why is DBNER so powerful for SaaS companies?
As existing customers expand their use of a company's products or services, the lifetime value of each customer grows. Because SaaS companies operate on a subscription model, a high DBNER should translate into growth in recurring revenue.
Recurring revenue is the portion of a company's revenue that it expects to continue in the future. Companies generate recurring revenues by providing ongoing access to their products or services in exchange for regular payments. Recurring revenues are more predictable and stable than one-off sales. Companies can expect recurring revenues to be received regularly with a high degree of certainty.
Higher valuations
SaaS companies seek to maximise their recurring revenues by expanding the level of products or services they provide to their customers. Recurring revenue, combined with fast rates of growth, are the reasons why many SaaS companies have relatively high valuations.
SaaS companies are frequently valued based on multiples of recurring revenue. This differs from methods used to value traditional companies, which include comparing past sales of similar companies or using the discounted cash flow (DCF) method to arrive at a present value.
Long-term customers
Because SaaS companies charge customers regular subscription or recurring fees, their earnings are more predictable. They can also generate significant revenues if they keep customers for a long time. Additionally, as the SaaS model becomes more widely accepted, many SaaS companies are recording high growth rates.
SaaS companies do not charge the hefty upfront fees of traditional software sales models. However, the lifetime value of SaaS customers is often greater and can increase if a company can expand the level of products or services it provides to its customers.
Stability and scale
Long-term contracts with happy customers reduce earnings volatility, leading to higher valuations. SaaS companies also benefit from their scalability. As the use of cloud-based applications grows, these companies can attract a bigger slice of an increasingly large market. Additionally, SaaS companies often offer proprietary technology and own unique intellectual property, increasing their valuations.
Company insights
The dollar-based net expansion rate can provide crucial insights into how well a company can grow the level of products and services it offers to its existing customers.
If the DBNER is above 100%, the remaining customers over the measured period are increasing their spending. This is a positive sign but certainly not the only measure to consider when assessing if a company is a worthy investment.
Combined with additional information, however, the dollar-based net expansion rate can provide valuable insights into a company's performance.
