The Recurring Revenue Business model, with its proven ability to continuously grow your customer base without losing current clientele, is here to stay. In theory, it allows your SME to provide your service (or product) continuously through the idea of licensing, so customers pay for repeat access to your software. But before you jump into developing your own recurring revenue businesses, there are a few decisions to make.
What is a recurring revenue model?
Businesses built with a recurring revenue model rely on regular and repeat payment intervals from their customers for access to their product and services. Think about your current subscriptions or memberships – those businesses collect recurring revenue from you.
This model allows companies to sell their product (or access to their product) over and over again to produce stable monthly income, i.e. generate recurring revenue. Where generating demand for one-off sales is costly and unsustainable, recurring revenue creates long term income. Plus, customers are retained automatically, meaning that the business is not so dependent on acquisition.
Finally, unlike traditional one-off sales model where the relationship between the business and a customer may end after a single sale event, the recurring model enables a deeper relationship that results in higher customer retention.
It is a very popular way to run a product or service business, since high recurring revenue is attractive to investors. In fact, in the SaaS industry, you’ll struggle to find a business that doesn’t run on this type of product subscription business model.
Growth of income is measured in changes to monthly recurring revenue (MRR) or annual recurring revenue (ARR). Startups and scale-ups should attempt to increase their MRR consistently in order to upgrade their passive income and working capital money.
Types of recurring revenue business models
There are a few different types of recurring revenue business models. The best-suited for your business will depend on a number of factors. For instance, whether your business caters towards individual users or teams, how quickly could your product’s usage grow, what is the size of your typical customer business.
Usage-based billing
In this type, customers are charged based on usage in scheduled, regular intervals. The advantage is that it allows the customer decide how many features they require. It offers a sliding scale of pricing, which can be attractive to customers using a low or medium proportion of your services. For example, payment software Stripe bills its customers on a metered approach depending on consumption levels. This is also great value for customers who use your services on an irregular basis, as they will benefit from savings.
The challenge with usage-based billing is that it could mean unpredictable costs for customers and unpredictable revenue for the business.
User-based billing
Contrary to the model above, user-based model means that your prices are determined by the number of “seats”, or users accessing the product in a month or year. It works well for team collaboration or CRM tools – the model scales well as your clients grow and provides flexibility if they need to reduce the number of seats, too.
However, the real benefit of a user-based revenue model is the predictable income for your business, as it is unlikely to fluctuate much from month to month. The one disadvantage could be that your customer may try to limit the number of users to control their costs.
Tiered billing
A tiered recurring revenue model targets different buyer personas with varying degrees of service. For example, software company SEMrush has several pricing options depending on the plan you require, with increased access as you hit the ceiling of your current tier. Once a business hits a maximum of a certain tier, they are upgraded to a higher one that offers maybe more usage or features. Membership to businesses using tiered-models appeals to a wide range of users with different needs, and is well-suited to sales or marketing products.
However, since the product and/or features base is broader, targeting specific customers could be more difficult.
Hybrid billing
This model combines two or more revenue models. For instance, Birchbox combines the recurring and one-time sale models – it offers a one-time subscription fee or one-time purchase of products offered.
Hybrid billing offers flexibility in pricing structure, but the business also needs to ensure that the structure is easy to understand for customers.
Freemium
Finally, the freemium business model provides a low barrier to entry since it offers a free account for life. It provides a good value for customers who can’t afford to spend a lot of money on products or services. But customers still have the option to upgrade for more features, which helps build recurring revenue.
While this is a great way to quickly acquire customers and scale your user base, the freemium model should be applied with a word of warning. The revenue stream could get reduced if a certain percentage of customers are not upgraded to the paid model, and even then, those paying customers may feel undervalued. There is also the possibility of customers moving over to some other solutions in this highly competitive SaaS market. So ensure you have good customer service practises and standard operating procedures to avoid this.
Benefits of recurring revenue business model
Recurring revenue models are heralded as one of the most stable ways to grow a business. Compared to direct sales or on-demand models, there are many benefits.
High degree of certainty
Entrepreneurship is a journey, which means that every business experiences ups and downs in its income. But a recurring revenue business model almost guarantees a consistent payment on a regular basis. Many businesses of this type will have long term contracts for customers to sign, such as your phone contract. It means that over the course of twelve or eighteen months, the mobile network can plan on collecting your $20 per month, for example.
High customer retention
Since recurring revenue ties the user into a contract with a monthly payment, there is usually very little change between monthly user numbers. This means that customers are retained between their payment cycles and your business can rely on stable revenue. With high customer retention comes increased security; which makes loan and funding applications that much easier.
Scale customer base
One of the biggest costs to a business is customer acquisition cost (CAC), which is one of your core values in the business’ unit economics. Expenses associated with converting new customers may include your content marketing, paid ads or sales department salaries. But businesses with recurring revenue models do not face the traditional struggles of a CAC since many of their customers are retained every month. In this way, it’s easier to scale your customer base with certainty as customers do not have to be replaced.
Challenges of recurring revenue models
As with any business model, there will be some common challenges with recurring revenue models that will require fresh ideas to overcome. Finding solutions to these problems is where the best SMEs will thrive and beat out competitors.
Subscription fatigue
We’ve reached the point as consumers where we’re being barraged with a load of “Subscribe!” messaging on every advertisement, social media and website. Frankly, it could get overwhelming. Known as subscription fatigue, data shows that customers are growing tired of this constant call-to-action and are more resistant to the monthly fee. Of course, this can damage both your cash flow and the predictable revenue benefits of this business model.
One way to tackle subscription fatigue is to always have a finger on the pulse of your customers’ reactions, feedback, and buying patterns. Businesses can then factor in these aspects to suit changing consumer needs and create greater value for their customers, old and new.
Churn management
Churn refers to the percentage at which current customers cancel their subscriptions or services with your business (again, this is measured monthly or annually). Auto renewal features are a large part of your billing and ensure that customers pay on a monthly basis. But it would be naive to think that customers wouldn’t quit their subscriptions if they’re not satisfied.
However, churn can be managed by identifying and evaluating the factors causing a high churn rate and taking appropriate measures to control it. One way to generate a low churn rate is by increasing customer satisfaction through maintaining an open feedback loop and showing they are valued. For involuntary causes of churn, such as technical issues or non-payment due to platform issues, ensure your business has the proper tools and software in place.
Recurring revenue business model is an attractive choice for businesses and customers alike, and the advantages often outweigh the challenges. Building a recurring revenue business is a fantastic way to create a passive income stream and manage customers on a monthly subscription. But it’s not quite as easy as one may think. Setting up a business to tackle a potential fast-growing customer population efficiently takes substantial working capital. To get started with gathering initial investment, take a look at our growth funding opportunities and make sure you hit the ground running!
