Neely Shachal, Marketing, Synthesis Systems
Are you Ready for Recurring Revenue Model?
“Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”
Heard that quote before? Now let us understand it in a business context. Giving someone a fish represents our traditional business practices, where we make a one-time sale and remain unsure of where the next fish (business) will come from. On the other hand, teaching a man to fish represents a subscription business: you’ve learned how to provide long-term, as you have your customers for a lifetime.
In a time when consumers would rather subscribe to a car service than purchase one, shifting to a recurring revenue model has become a necessity of sorts for organizations to remain relevant and in business. New patterns in consumer demands have the subscription economy growing, and multiple industries – from software to furniture to healthcare – are looking for new ways to earn revenue.
Recurring revenue models shift the focus from one-time sales to building long-term relationships with the customers. They also allow organizations to develop and maintain a steady cash flow for smooth operations. But is it really meant for all businesses? Let’s find out.
What is a Recurring Revenue?
Revenue can be generated either through one-off sales or via a consistent stream of scheduled periodic sales. Recurring revenue is the latter. It usually takes the form of monthly subscriptions and provides a steady, dependable income that is certain to be earned for a considerable period of time. When measured on a monthly basis, it is taken as monthly recurring revenue (MRR), or it can also be done yearly, as annual recurring revenue (ARR).
Apart from laying the foundation for sustained financial growth, recurring revenue helps maintain higher retention rates and profit margins. Acquiring new customers is indeed more expensive than retaining existing ones. Recurring revenue helps curb these costs substantially by moving the focus on to providing services as a solution, as opposed to merely selling a product to the customer.
Types of Recurring Revenues
Subscriptions: Depending on the organization’s payment cycle, users are required to pay a specific amount for a product. Today, everything from software (SaaS) to content (CaaS) is available in the form of subscriptions with the freedom to cancel at any time.
Auto-subscriptions: A modified subscription model, the service is renewed automatically at the end of every cycle until the user opts for cancellation. This guarantees a repeated income as well as greater consumer retention as users are not required to put in any additional efforts to maintain the monthly subscriptions.
Sunk-money subscription: The customer initially purchases a product or service which requires constant upgrades for continued use. Apple is a good example. A consumer ‘sinks’ their money into the platform when they purchase an iPhone and then need to buy other small accessories and products.
Sunk-money consumables: Similar to sunk-money subscriptions, here too the consumer makes an initial investment in a product but without the need to purchase proprietary products. For instance, a coffee maker is a platform that needs coffee beans for everyday use, but they don’t necessarily have to be from the same brand or company.
Simple consumables: A company may offer consumable goods such as beauty products, meal kits, grooming products, or even coffee (as in the case of Starbucks) for a certain monthly fee.
Contracts: A business enters into a contract with its client to provide a certain service for pre-decided rates for a specific period of time. Besides long-term revenue, this model also offers protection against unexpected cancellations and delays.
Types of Recurring Revenue Models
Every business has its own demands and objectives that cannot be met with a universal approach. It is important to keep this in mind before determining the base revenue mode, as they work differently for everyone. These models are:
- Usage-based Pricing
- User-based Pricing
- Flat Pricing
- Tiered Pricing
- The Freemium Model
- Hybrid Pricing
Recurring Vs Non-Recurring Models: The Difference
As evident from the terms itself, the basic difference between the two models lies in the frequency with which revenue is generated. Recurring revenue, which is vital for the growth of SaaS companies, is a cyclical income generated on a monthly basis. Non-recurring revenue, on the other hand, comprises of one-off payments that may or may not occur in the future.
For example, the Microsoft Office product line is available for use in two ways: Office 2019, a traditional software product, sold as a one-time purchase for a single and upfront cost, and Office 365 – a subscription service that gives users access to office tools such as like Word, PowerPoint, and Excel with the additional benefit of extra online storage and cloud-connected features for a monthly or yearly fee.
- Increased revenue predictability
- Steady in-flow of cash through small but monthly payments
- Reduction in cash in hand (at least initially)
- Market investments are recovered gradually
- Examples: Salesforce, Adobe, Amazon Web services
- Ability to maintain higher pricing rates and margins
- Cash is generated more rapidly as sales and marketing costs are regained quickly
- More opportunities for immediate investments
- Chances of growth are much faster (so are the chances of drop in revenues)
- Example: Airbnb
Important Recurring Revenue metrics
Recurring revenue makes it easier to plan and forecast the financial growth of any business, but to do so, it is necessary to understand how it works. Some important recurring revenue metrics are:
Monthly Recurring Revenue: MRR is a core benchmark of a business’ progress. It is the revenue an organization earns in a month through subscriptions and is likely to earn in the coming months as well. It is an important metric any SaaS business should be tracking, as its success depends on the ability to maintain a stable MRR.
Annual Recurring Revenue: Similar to MRR, annual recurring revenue also measures the income earned by a business, but it is calculated on a yearly basis.
Churn Rate: It measures the percentage of customers leaving a business at the end of every month (or year). A high churn rate denotes that something is wrong with the product, service, or offering. The key here is to have a high retention rate and a low churn rate, and fortunately, it is not very complex to track.
Cost per Acquisition: A business has to invest money before it can start earning it back through revenue. CPA is a metric that helps determine the total costs that went into developing the product/service— including R&D, advertising, marketing and so on. If more money is being spent than earned, there is obviously a problem which needs to be resolved.
Lifetime Value: As mentioned earlier, recurring revenue models are all about putting customers at the forefront of the business and retaining them. Customer Lifetime Value measures how well a business maintains those relationships. Its determining factors are the margins, CPA, churn rate and retention rate.
How Can Businesses Earn Recurring Revenues?
Whether an organization has been in business for a while or is just venturing into it for the first time, there are a few different strategies to earn recurring revenue such as:
Switch the Model: Swap the conventional one-time payment model with a recurring payment cycle. If a business is into selling a product or offering a service, it could opt for offering it on a membership/subscription basis instead. Spreading the payment model across a period of time is an effective of ensuring a constant income.
Supplementary Services: Another effective method is to supplement the existing product with an additional service. For instance, a company selling home appliances can offer maintenance plans that the customers can opt in to for a monthly or yearly fee. Such deals draw consumers in since they offer additional safety just in case something goes wrong with the product.
Cross-Selling & Up-Selling: Offering ancillary products or premium upgrades of the core products increases the appeal of the offering. It helps widen the scope of what a business can provide to its customers – making it a suitable opportunity to generate recurring income.
When adopted correctly, recurring revenue models have numerous benefits. They reflect the change that has over-taken today’s consumers who have become ‘subscribers’ rather than ‘buyers’. Once organizations are able to navigate through the initial challenges, an eventual supply of recurring income will ensure greater stability and growth.
The big question is whether to go for recurring revenues or not. But, that shouldn’t be the question. The question should more likely be “What do my customers want?” We are entering the age of “customer experience” and they demand to consume services at their convenience. In other words, the consumers are looking to subscribe to things and consistently consume (recurring revenues for you) rather than own (non-recurring revenues). This only leads to the conversation on subscription-based economy.
Talk to our experts to find out if you and your business is ready for recurring revenues.