There is a growing acceptance of why recurring revenue is special. Founders now understand that not all revenue is created equal. The more predictable the revenue, the more valuable it becomes. In VC parlance, it is not a little bit better than non-recurring models, but 10x better. Many VC firms are adding weight to recurring models with high gross margins as evaluation criteria, along with market & team.
What makes this business model so valuable is that you can invest more of your time towards growing your business than trying to acquire new customers to reach the same revenue level that you hit last year. If you have 10million in sales and 80% of which is recurring, you can already count on receiving 8million next year as well. Add 2million to reach your last year’s sale and anything above is all growth. If you have 10m in sales in non-recurring revenue, next year you start at zero, which makes it difficult to sustain growth.
Here’s why the recurring revenue is so beautiful:
Predictable: As you can predict what you are going to earn, you face less risk (something that investors love). This predictability makes your forecasting process more accurate and you rarely have major fluctuations in your results.
Visibility: You get clear visibility around your numbers for the next few quarters. And if they are off, you’ll know it well in advance.
Real time expense management: You can ramp down expenses in a quarter in real time due to lower than anticipated revenue. Where as in non-recurring revenue models you are in a position to take action only after the quarter has closed, when you review your results. For today’s startups this can very well be the death blow.
Valuation: The going valuation multiple is 8 to 11x for recurring revenue model. This is more than twice as high as the non-recurring model.
These benefits have made recurring revenue the gold standard of business models.
Let us identify the types of this model so that you can integrate this in your own organization.
Repeat Customers: Grocery stores function on this model. With good customer service, you can have the customers walk in your store for years. However, there is almost no barriers to entry for competitors and no switching costs for customers. Businesses create membership programs like frequent flyers to make their clients stick. Even though your revenue remains risky, it is still better than not having repeat customers.
Recurring Revenue: This is the basic subscription service model where you agree to pay up certain amount every month. Gillette did this amazingly well by selling cheap razors to shaving consumers and then perpetually selling them expensive razor blades. Insurance companies also work on same principle. However there is no obligation to renew the policy with the same provider. You can shop around and port your policy if you find cheaper rates or better service.
Recurring Revenue with a contract: When the contract stipulates a switching cost, it make difficult for the customers to move to your competitor, which makes it a better business model.
Sequential Revenue: This model creates recurring revenue by encouraging customers to upgrade to new offerings. The carrot tempts you with fancy new features and the stick means no support for earlier versions.
Revenue with network effect- The more the number of users, the more each user gets out of the service, which creates a barrier for that customer to leave. For e.g., Facebook.
Now let’s have a look at some common ways of changing your sales into recurring model:
Rentals & leases
Consumables- buying luxury coffee maker once and then purchasing ingredients every month
Transaction fees- The charges paid to payment gateways on each credit card swipe
Subscriptions- Finite subscriptions, like for magazines.
Platforms- Subscription where you access a service via a platform. For e.g. Dropbox, Bloomberg Terminal--a proprietary platform you have to buy in order to subscribe to Bloomberg's financial publications
Membership services- streaming digital media etc
Now that you know that recurring revenue is the best model for your business, you should switch to it as soon as possible. However good may be the case, you’ll receive cold shoulder from some of your customers. You may consider dividing your customers into recurring model & traditional model. Explain in clear terms that you are going to discontinue the support of traditional products after a certain period of time.
Hope this helps you in devising a strategy to make the shift.