What is recurring revenue?
To grasp what Recurring revenue is, let’s use the Inversion technique and look at what Non-recurring revenue is – the one-off payment a company receives in exchange for a product or service. It may/may not happen again.
The Oxford English dictionary defines Recurring as something that occurs regularly. Recurring revenue in the business context, is a stable stream of income, earned by companies at regular intervals over an extended period.
Recurring revenue lies at the core of sustainable business models, revolving around key metrics that provide crucial insights into a company’s financial health and growth trajectory.
Understanding the concept of recurring revenue is crucial for companies aiming to establish stable and sustainable business models.
What is Recurring Revenue Business Model? Types, Benefits & Challenges
Dale S. Richards in his Excel Management Systems presentation, mentioned the importance of Recurring Revenue. At the time only about 20% of American companies had embraced this model in their business.
According to a 2019 CFO and Salesforce survey, recurring-revenue models have become well-established and are continuously growing. This business model presents a strong case as it revolves around building robust customer relationships, aligning customer success with business success, and creating new avenues for growth. Companies that adopt recurring-revenue models gain smoother and more predictable revenue streams, ultimately leading to higher valuations from investors. We’ll be looking at the different types, benefits and challenges of Recurring revenue business models in the following sections.
What are the Types of Recurring business models?
Hard Contracts: Customers commit to fixed-term agreements and regular payments, providing the company with a predictable revenue stream over a specified timeframe.24 Hour Fitness uses this model; they offer annual memberships with monthly payments for access to their facilities.
Sunk Money Consumables: This model involves products/services that require replenishments or renewals to create recurring revenue. Kuerig is an illustration of this model. They sell coffee makers and pods as consumables that customers need to purchase periodically to brew coffee with their Keurig machines.
Auto-Renewal Subscriptions: Auto-Renewal occurs at regular intervals, such as monthly or annually.Unless the customer cancels their subscription.Spotify and Netflix use this model, where subscribers pay a monthly fee for access to their streaming service, with automatic renewal each month.
Usage-Based Subscriptions: Customers here are charged based on their usage of the product or service. The more they use it, the higher their subscription cost. Amazon Web Services (AWS)adopts this model for their Cloud computing services. Customers pay for the computing resources they use, such as storage and data transfer, on a pay-as-you-go basis.
Tiered Billing: Pricing in the Tiered billing model is organized into distinct ‘tiers’, based on features and usage. Each tier is designed to cater to specific customer needs and is priced accordingly. As customers’ requirements expand, they can easily upgrade to a higher tier, gaining access to advanced features. A typical example is Grammarly, a writing assistant tool that offers Free, Premium, and Business tiers.
User-Based Billing: Organizations are billed according to the number of users accessing the product.Slack, a team collaboration platform, charges teams based on the users within their workspace.
Hybrid billing:The Hybrid model combines different parts of revenue models, for flexibility in pricing and features. Zoom uses a hybrid billing approach, offering both free and paid plans with varying features.
Freemium: Companies offer a basic version of their product for free, with premium upgrades available at an additional cost. Dropbox adopts this model, providing users with limited storage for free and premium plans for more storage.
Businesses that are best suited for the Recurring Revenue Model
The quote by Socrates – “Man knows thyself” can also be applied to business.
While the RRM seems juicy, it’s not suited for all kinds of business. There are particular businesses that it favors, they include:
Service-based
Service-based businesses, providing ongoing services or support, are a natural fit for recurring revenue models. They can charge regularly for continuous feature updates.
Adobe Creative Cloud is a good example, selling Photoshop and Illustrator on a subscription basis.
Content-based
Companies creating and distributing digital content such as online publications and streaming platforms.
Take Netflix for instance, providing a vast library of movies through monthly subscriptions, that attracts a wide and loyal customer base.
Product-based
Product-based businesses provide physical goods, giving customers a product they can touch and use. An example that embraces the recurring revenue model is StichFix – a personal styling service. Subscribers experience the thrill of receiving handpicked clothing and accessories tailored precisely to their preferences and style.
4 Recurring Revenue Metrics to start tracking
Tracking key metrics is vital for the success of any business. These metrics provide valuable insights into the health and performance of your RRM business.
Here are 4 Recurring Revenue metrics you should start tracking today:
Monthly Recurring Revenue (MRR)
Monthly Recurring Revenue (MRR) is a key indicator of your business’s growth trajectory, it helps you understand the income you can expect each month. Say your business operates on an Auto-renewal subscription model and customers are billed monthly. You can predict your cash flow by tracking the MRR.
Annual Recurring Revenue (ARR)
Annual Recurring Revenue (ARR) is the total revenue your business generates on an annual basis. It provides a broader view of your business’s financial stability and growth over a longer timeframe. For long-term planning and evaluating the overall performance of your RRM, ARR is particularly valuable.
Average Revenue Per User/Unit (ARPU)
ARPU determines the average amount of revenue generated by each customer. Calculating ARPU is straightforward – divide your company’s total revenue by the number of users (customers) within a specific period.
Customer Lifetime Value (LTV)
Customer Lifetime Value(LTV) estimates the total revenue a customer will generate during the time they patronize your business.
Tracking this metric helps you to identify potential high-value customers and implement strategies to retain them in the long-term.
What are the Benefits and Challenges of Recurring Revenue Model?
The Recurring Revenue model has several benefits that can propel businesses towards long-term success. Some include:
Steady Cash Flow: When the cash is flowing the business is growing. Having a predictable stream of income helps the company to plan for growth and economic uncertainties. Faster Customer Onboarding: RRM encourages customers to start using the product immediately after subscription. This leads to quicker product adoption and onboarding. Customer Retention and Stability: Customers that subscribe are more likely to stay engaged with the business, which fosters strong customer relationships.
To gain deeper insights into Churn360, we recommend setting up a demo with one of our experts for a detailed walkthrough
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Builds a strong Reputation – A well-structured RRM showcases a company’s ability to generate consistent income over time. This enhances a business’s reputation in the eyes of investors, making it attractive for funding and partnerships.
However, the RRM also has its own sets of challenges:
Initial Investment:
Implementing the Recurring revenue model may require upfront investment in technology, infrastructure, and marketing to attract customers. Customer Churn: Retaining customers becomes crucial for Recurring revenue success, as losing subscribers can directly impact revenue and growth.
Pricing Complexity:
Setting the right subscription price that balances customer value and business profitability can be complex and will require ongoing evaluation Market Saturation.
In a market like SaaS that is saturated with similar RRM, the competition to stand out and retain customers becomes high.
Wrapping Up
The Recurring Revenue Model gives businesses a powerful strategy to achieve financial stability, foster customer loyalty, and drive long-term growth. By tracking key metrics, and staying customer-centric, businesses can unlock the full potential of this model for long-term success.
