Why Is Recurring Revenue So Important To You?
Recurring revenue is a disruptive trend that empowers companies to grow revenue, gain a competitive advantage, and increase market share across all industries, from healthcare to entertainment to retail. Some estimates place the total market value of the opportunity for recurring revenue business at $500 billion or more.
According to Ventana Research, “the increasing importance of the recurring revenue model reflects a shift in buying preferences for both businesses and consumers.” Businesses must consider this model if they want to mimic the success of forward-thinking and fast-growing companies such as Salesforce, Adobe, and Netflix who have already reaped the benefits with new consumption and distribution models built on recurring revenue.
So what is recurring revenue? It is an income model that describes regular payments over time for a service or subscription, as opposed to a one-off payment for an item. Examples of recurring revenue are monthly payments to for a landscape service, iCloud subscription or payments for household utilities.
It is the backbone of SaaS and subscription-based companies. At these companies, customers purchase a service on a consistent basis, giving the company the ability to project future revenue more accurately. Recurring revenue can be calculated with metrics like churn rate and user growth rate for a realistic view and predictability of a company’s future income.
Non-recurring revenue is made up of one-off payments that may or may not happen again. For instance, assume a printer company launches an event and gets 50 people to buy tickets. The revenue from this event is non-recurring because it’s hard to assume that attendees will return next year (if there is a next year). It’s much more likely they’ll continue paying for the printer cartridges that are essential for printing.
To John Warrillow, the founder of Value Builder™ author of the book Built to Sell as well as The Automatic Customer there are few things more important than recurring revenue for a business owner who sees the future as seeking the company or wanting to build more value into the company thereby making it more efficient.
To a potential acquirer, though, not all recurring revenue streams are created equal, and some types are far more valuable than others. John ranked the six different types of recurring revenue from most valuable to the least valuable.
1. Hard contracts. What’s the holy grail of recurring revenue? Look no further than your cell phone contract. “When the iPhone launched in the United States, AT&T insisted that you buy a three-year contract. Why? Because the stock value of AT&T mobile went up and down based on that contract revenue,” Warrillow says.
2. Auto-renewal subscriptions. Even better than these two subscription models are the kinds of subscriptions that go on forever, or at least until a customer tells it to stop. In the world of recurring revenue, this is known as an “evergreen.” Document storage subscriptions are good examples of evergreens.
3. Sunk money subscriptions. A sunk money subscription requires the initial purchase of a platform. A good example of this is the Bloomberg Terminal–a proprietary platform you have to buy in order to subscribe to Bloomberg’s financial publications
4. Straight-up subscriptions. These are finite subscriptions, like for magazines, that offer an optional renewal at the end of the contract.
5. Sunk money consumables. This is when a customer makes an initial investment in a platform. For example, what if instead of going to Caribou Coffee, you prefer to make your own coffee at home, and purchase a $500 titanium luxury coffee maker to prepare hundreds of perfect cups over the long haul. Now you need to buy the accessories to make it work. This means that as a consumer, you’ve bought a platform rather than just a product. In the world of recurring revenue, platforms trump products every day of the week.
6. Simple consumables. Do you want a sophisticated and complicated, three-pump cinnamon dolce, soy, no whip, no foam latte? Or maybe just a drip coffee? Either way, if you’re a loyal Caribou Coffee customer you’re coming back for more of the company’s products.