For any software company, retaining and growing customers is a valuable way to drive growth. Existing customers are a great source of new revenue at a low cost of sales and marketing dollars. Measuring the success of these efforts can be tracked in a metric called dollar-based net expansion rate (DBNER). But investors should be aware that not all companies measure it the same way.
After checking out the fine print in Alteryx's (AYX 3.11%) earnings review, Motley Fool contributor Brian Stoffel explains the problem with this data analytics company's calculation on an episode of Fool Live that was recorded on Feb. 11.
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Brian Stoffel: Yeah. The next is the dollar-based net expansion rate. The best way to think about this is that if your dollar-based net expansion rate is 100 percent, that means you're basically holding on to all your customers. In fact you know what? Do you want to go to the next slide and we'll come back to this? What a dollar-based net expansion rate is is it takes your cohort of customers from, I'm going to start this by saying year 1. Like at December 31st, how much annual revenue are we collecting from all of our customers? Then at the end of year 2, we go back and we see how much annual revenue are we collecting from those same customers. The key is we don't include any new customers. Because what this does is digs under the hood a little bit and it says, "Okay, of the people we had on December 31 last year, how much revenue are we getting from that group?" That includes people that leave and then it also includes people that add more.
If it's $5,000 and you have one data scientists who is using this tool at your company, if you up it to three, then all of a sudden, that's a lot more revenue that Alteryx is getting. Now, here's the funny thing, and Brian circled this, is that the way that they do it here is that they calculate their dollar-based net expansion rate, and what they do is they take what it was at the end of every quarter, but then they average it out over the past four quarters.
If it was 130 percent in Q1, 125 percent at the end of Q2, 120 percent at the end of Q3, and it was a 115 percent at the end of Q4. What I want to know as an investor is I want to know it was a 115 percent at the end of Q4, that's what's interesting to me. But what they'll publish is that it was about 120 to 123 percent, because they average it out.
Let's go back to that previous one now. If you look at these, overall, for a SaaS or software-as-a-service-company, this is pretty good. If you can have your dollar-based net expansion rate above 120 percent, that's not bad. The thing is that if you can see between Q2 and Q3, it fell two percent, and then on the bottom, Brian wrote in what we had this quarter, which was a 122 percent. It's fallen by two percent every quarter going back to Q3 of 2019.
Brian Withers: You wonder why they didn't show the update on the slide for this quarter. [laughs]
Brian Stoffel: Yeah. Well, and what is interesting too is that if it falls two percent, what we can deduce is that whatever that dollar-based net expansion rate was for Q4 of 2020, it was about eight percentage points lower than it was in Q4 of 2019. I could get into the mathematics of all that. But basically, the bottom line is, we know Q1, Q2, and Q3 of 2020, they're all the same. They were included in both last quarter's calculation and this quarters. The only difference is we're X-ing out Q4, 2019 and we're adding Q4 2020. If it fell by two percentage points and you're multiplying that out across four quarters, that means it's eight percentage points lower. We've seen it fall about eight percentage points from the previous quarter for quite some time now.
Again, this isn't at the area of "Oh my goodness, crisis." But in general, I don't love that level of opacity. I like clarity. I like people being really forthcoming about what is going on in the business.