Revenue refers to all the money your company earns during a particular period. You can extract valuable information about it by calculating the average revenue formula.
In this article, we will discuss what average revenue is, why it matters, how it is affected by market structure, what the average revenue formula is, how to calculate it, and many more.
What is Average Revenue?
Average revenue is the mathematical average of your revenue earned per user or unit (ARPU). ARPU allows your company’s investors and management team to analyze revenue generation and forecast future growth.
ARPU is a useful macro-level measurement tool for analysts and managers. However, it does not provide much insight into the units or user base.
If your company sells only one product at one price, the average revenue is the product’s price. So, in many situations, ‘price’ and ‘average revenue’ are synonyms.
But if your company sells multiple products for more than one price, average revenue is one way to estimate the profit. In this situation, ARPU is basically the average price of units or users.
Average Revenue vs. Marginal Revenue vs. Total Revenue
Two other terms closely related to average revenue are marginal revenue and total revenue. It is good to know the difference between these three. Here are the definitions:
- Total Revenue: This is the total amount of money your company earns from your products/services. It is the price of a product/service multiplied by the quantity.
- Marginal Revenue: This refers to the change in total revenue from selling additional units of products/services. So, in short, it is the rate of change in total revenue.
- Average Revenue: This is the amount earned per individual user/unit. It is total revenue divided by the quantity.
Is There a Difference Between Average Revenue Per User and Customer Lifetime Value?
Average revenue per user (ARPU) is sometimes confused with lifetime customer value (LTV). Although the two indicators are closely related and equally important, they are very different.
LCV is a metric to measure the average revenue generated from a customer over a given period, such as a month or year. In other words, it calculates the average value of each customer during a given time.
So while LCV is used to measure the profitability of each customer, ARPU is used to measure the revenue generated from selling goods on a user basis.
LTV accounts for some variable costs, including refunds and transaction fees. And its formula is as follows:
Customer lifetime value = (Long-term spending – Variable costs)/Total customers acquired
What is the Average Revenue Formula?
You calculate the average revenue of a user/unit by taking the total and dividing it by the number of users/units over a specific period.
The number of users/units may vary during the specified period. So the estimated number of users/units, or a weighted average, is used instead to provide a more accurate calculation. We can express ARPU as a dollar amount, a table, or on a curve.
The average revenue formula is: AR = TR/N
- AR = Average revenue
- TR = Total revenue
- N = Number of units or users
If your company is active in new industries, such as blockchain and Web3, there is no rigid formula for you to calculate your company’s average revenue. However, you can use a crypto profit calculator instead.
Why is the Average Revenue Formula Important?
Numerous companies use the average revenue formula to analyze and predict their revenue.
Telecommunications companies, like mobile phone service providers, can use ARPU monthly. They use the average revenue formula to calculate and track the revenue generated per mobile phone user.
Cable companies also calculate the ARPU for their subscribed users and use the data to compare with other companies and forecast future revenue.
Social media platforms use the average revenue to explain gaps in valuations, track revenue sources, and report to investors.
Step-by-Step Guide on How to Calculate Average Revenue
Here are four steps to calculate average revenue:
#Step 1: Collect Your Data
Collect a set of data over a specific period. For example, suppose your company wants to calculate the average revenue per unit for the previous week. In that case, you will need the weekly totals for unit sales. If you sold four items in the last week, your sales data might look like this:
- Item 1 = $10,000
- Item 2 = $15,000
- Item 3 = $8,000
- Item 4 = $12,000
#Step 2: Add the Data Points
To find the total amount of revenue and incorporate it into the average revenue formula, you need to add four price amounts together: $10 000 + $15 000 + $8 000 + $12 000 = $45 000
#Step 3: Divide by the Number of Data Points
In this example, there are four data points, one for each unit. You can divide the total of $45,000 by four data points to get the average revenue:
- AR = TR / N
- AR = $45 000 / 4
- AR = $1 250
#Step 4: Analyze the Results
You now know the average revenue per unit (ARPU) last week was $11,250. You can use this information to further analyze sales or make revenue projections.
An Example of Utilizing the Average Revenue Formula
Below is an example of how to use the average revenue formula to calculate ARPU:
A software company offers several monthly subscriptions. Each one has a different price. The team wants to calculate the ARPU to determine the revenue value for each new user.
They can later use this information to compare the revenue value of each new subscription user and determine which of the plans has the most impact on driving gain. Also, the company can use the ARPU information to track its annual growth progress.
The software company’s total revenue for the previous quarter was $8.2 million. Subscriptions last quarter were volatile. But the weighted average was 110 500 users.
The team takes all of the above information into the average revenue formula to calculate the ARPU:
- AR = TR / N
- AR = $8.2 million / $110 500
- AR = $74.21 per user
Now, the company knows that each new subscription user brings in a revenue amount of $74.21. It can now use this information to track annual growth, estimate profits, and generate revenue forecasts.
How to Determine Your Market Structure Using Average Revenue Curve?
After calculating your average revenue for all the periods, you can represent the results on a curve to quickly know the relationship between the ARPU your company receives for its output and the quantity sold.
The relationship between quantity produced and average revenue is determined by one of the four market structures: perfect competition, monopoly, monopolistic competition, or oligopoly.
In a firm in perfect competition, average revenue equals price and marginal revenue. Therefore, the average revenue curve is a horizontal line.
In the other market structures, average revenue is more significant than price and marginal revenue. The larger the quantity produced, the lower the price and marginal revenue decrease, demonstrating the company’s ability to control the market. In this scenario, the average revenue curve is negatively sloping.
Since average revenue is essentially the price of a product, the average revenue curve is also sometimes considered the demand curve for your firm’s output.
How Can You Increase Your ARPU?
Many companies, especially telecommunications, try to increase their ARPU by selling their existing customers higher levels or service bundles. Others, like media companies, focus on boosting advertising revenue.
Both of them analyze their internal numbers to identify the demographic groups that are most valuable to them.
If Gen Y (the people born from 1981-1996) and families with children appear to be their most valuable customers in terms of their contribution to ARPU, the companies will aim at those groups to grow.
A Must-Have for Your Finances
Average revenue helps you provide a basis for comparison with your competitors and analyze how your business evolves over time. It is a tool that every financial advisor needs not only for calculation but also for analysis.
Therefore, we hope you have learned thoroughly about the average revenue formula in this article. If you have any questions, feel free to drop them down in the comments section below.