Usage-Based Billing

What Is Recurring Revenue?

January 06, 2021

Recurring revenue is scheduled payments a company expects to receive in the future in exchange for products or services – with payments made on a monthly or annual basis. Although a simple description, this revenue model has intricacies that are worth exploring. To begin, let’s take a look at a few examples of subscription-based revenue models, and the industries that have successfully implemented them.

Examples of Recurring Revenue Models

Standard subscriptions: Well known for magazine subscriptions, this is the most basic type of subscription model. Offered for varying periods of time, the customer can either cancel the subscription at the contract’s end or renew.

Long-term or hard contracts: Typically used by satellite and cable companies, as well as internet services providers and cell phone companies. The buyer enters into a contract for a period of 1+ years with payments due on a monthly basis.

Evergreen subscriptions: Also known as auto-renewing subscriptions, this type of subscription can go on indefinitely – or at least until the customer cancels the subscription. Widely used, some examples include organizations that sell software as a service (SaaS), streaming services, subscription boxes, and document storage. The subscription automatically renews for the same terms, unless the subscriber provides advance (usually 30 days) notice of cancellation.

Sunk money subscriptions: This model is a bit more convoluted than the previous subscription models, you can think of it as a brand loyalty model. Say a customer purchases a product that requires accessories (or in the case of consumables – replacements). Only the original company can provide them. For example, Brita water filter systems require Brita filters, and certain coffee makers require their brand of coffee pods.

While this isn’t an exhaustive list of models, it captures the essence of recurring revenue and its varying degrees of value.

How Subscription Business Models are Different

To Illustrate the inner workings of recurring revenue, we’ll compare two B2B companies. Company A uses the traditional purchasing model where software products are purchased as needed. Company B sells the same software, but sells it on a subscription basis.

Purchases made with company A require a large upfront perpetual license fee, in addition to fees for upgrades, support and maintenance. Customers of company B pay a nominal monthly subscription fee that provides them with access to the latest software versions. In addition, the subscription plan includes support and maintenance.

The convenience, cost efficiencies and services offered by recurring revenue models make it a popular choice for both consumers and businesses. From the company’s perspective, they are able to focus on providing the type of service that encourages customer retention. With a committed customer base, subscription-based companies have the opportunity to grow profitability through up-selling and cross-selling efforts.

The Advantages of Recurring Revenue

Recurring revenue models provide a predictable source of income and a higher customer lifetime value. This benefit is echoed by IDC who believes that by 2022, 53% of all software revenue will be via a subscription model. The advantages don’t end there.

Companies that embrace a subscription business model boast a higher valuation. Substantiated by John Warrillow, author of The Automatic Customer, the company value of organizations with a recurring business model can be up to eight times greater than that of their competitors that have no or very little recurring revenue. In yet another example, the recurring revenue model can be 10x better than non-recurring models.

Let’s examine a few additional benefits that a subscription business model provides.

  • Predictable revenue: Because revenue is recurring, the company is virtually guaranteed to receive a certain amount of revenue on a regular basis. With a positive cash flow, the business is better able to cover operational costs and growth investments.
  • Customer loyalty: With customer retention at the core of a successful recurring revenue business model, subscription-based companies focus much of their efforts on creating and maintaining customer loyalty. The importance of building solid, long-term customer relationships shouldn’t be taken lightly. The longer a customer stays with the company, the more difficult it becomes for them to move to a competitor.
  • Future revenue visibility: Due to its very nature, recurring revenue business models provide greater insights into the next quarter’s revenue.
  • Higher valuation: With revenue predictability, higher profitability and a stable customer base, the recurring revenue business model provides greater valuation than other revenue models.
  • Increased Customer Lifetime Value (CLV): By establishing long-term customer loyalty, subscription-based companies are able to maximize CLV through ongoing interactions with their customers.

Common Mistakes To Avoid

While a recurring revenue model delivers numerous advantages over other revenue models, it also has complexities that should be considered. The first being technology. Tracking subscription-based revenue can be more complicated than single purchase billing. This is especially true as your customer base increases. With customers on different subscription cycles, varying contract lengths, and purchasing diverse products at different prices, a flexible billing system that can easily handle a variety of pricing models and scale as the business grows is essential.

With any new business strategy, planning is essential to maximizing the benefits received from your subscription-based company. Then you can avoid the most prevalent missteps companies make when adopting a recurring revenue business model.

  • Customer loyalty is essential to the long-term viability of the business, so it’s important to focus on delivering customer value.
  • Initially providing products or services for free helps build a customer base. However, using a freemium pricing strategy needs to be used sparingly. It should be accompanied by charging for additional features, products and services that enhance the functionality of what was provided for free.
  • Be sure to track metrics such as customer churn rates and new customer acquisitions.
  • Avoid monthly recurring revenue (MRR) and annual recurring revenue (ARR) miscalculations.

Simplify Your Recurring Revenue Processes

Don’t all organizations want a loyal customer base, predictable revenue and higher profitability? As recurring revenue business models continue to gain momentum and (with good reason), they come with their own unique complexities.

To alleviate challenges caused by this more complex billing model, you need an agile billing system that allows you to tailor subscription billing. It must suit your individual needs and manage recurring payments for your products, services and bundles. BillingPlatform offers an agile system that was purpose-built to automate even the most complex recurring revenue processes. Reach out to our team today to learn more about how we can help.

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