Business is inherently unpredictable. You’ll never be able to control whether the market will continue to desire your product or service. But, you can hedge against a few things, like a less lumpy cash flow. As long as you are making money, you can set up recurring revenue models to continue doing so.
Recurring revenue provides stability through dependable income that flows into a business on a consistent basis. Along with regular cash flow forecasting, like the kind offered by Smansha, recurring revenue helps you build long-term financial health and lay the groundwork for future growth.
What is recurring revenue?
Recurring revenue is very much what it sounds like — earned money that flows into your company at predictable intervals. Most businesses are set up to be one-off transactions — purchase the item you need, then go on your merry way.
But, one-off transactions aren’t enough to sustain most businesses, especially when cash flow issues are the number one reason small businesses fail. You can forecast your cash flow to predict inflows — but if that money doesn’t come in, you could experience a cash flow crisis. Recurring revenue streams help prevent this sort of misfortune.
Why recurring revenue is important
You’ll always be able to pull the strings on your company’s variable costs, but the same is not always true with your fixed expenses. At the end of the day, as much as you pare back your operating costs, running a business still takes money. Which means you have to make money to stay in business.
A recurring revenue stream lets you better estimate your cash flow on a regular basis. Will you be able to cover those minimum fixed costs? While there’s always the chance the unexpected can happen, the expected, via recurring revenue, is much better.
Other benefits of establishing and measuring recurring revenue:
Predictable income is perhaps the most obvious benefit to building recurring revenue. But, in generating and monitoring recurring revenue, there are other insights you can build upon including:
- Average revenue per customer (ARPU): By having a strong sense of what your customers will cost you each month, you’ll find intuitive ways to increase your profit margins. For instance, you may be able to produce consumer goods at a larger scale or lower your cost of goods (COGS). Or, offer upgrades, add-ons, and other modulations to earn more ARPU.
- Customer knowledge: You learn a lot about your customers’ likes and dislikes from your customer retention rate. The more you know about your customers, the stronger both your brand and business model become.
- Retention vs. acquisition: Customer acquisition cost (CAC) is a challenge for many businesses. You’ll still have to contend with getting your CAC as low as possible, but when consumers opt into a subscription, you won’t have to worry about getting them back for another purchase. Instead, you’ll focus on retention, which is inherently easier since they’ve already expressed a desire for what you offer.
5 types of recurring revenue business models
Different types of businesses require different types of business models. Luckily, no matter whether you’re a manufacturer or retailer, you should be able to find some way to establish recurring revenue streams. Diversifying to bring in a little extra money on a regular basis? Well, that’s just good business. Here are five ways to do just that:
1. Subscriptions or memberships
Subscriptions and membership-based programs, like the ones below, work well to create dependable recurring revenue. Businesses that use subscriptions and memberships rely on income from these fees as recurring revenue. There’s also a good likelihood that you participate in one yourself.
- Software as a Service (Saas): Companies including Atlassian (Trello, Confluence, JIRA, BitBucket, and more), Slack, ZenDesk, Shopify, DocuSign, and Gusto bill teams monthly.
- Subscription boxes: Subscription boxes are popular for consumer goods, including Rockets of Awesome for kids’ clothing, BullyMake for dog toys, BirchBox for beauty products, Sun Basket for healthy meal kits, and Dirty Lemon for detox drinks.
- Content as a Service (CaaS): Many B2C services you’re used to using in your everyday life employ a variant of the SaaS model, including Netflix, Hulu, and ESPN+. This also goes for apps, like Drops for learning language, ClassPass for fitness, or Spotify for music.
Subscription-based businesses are a high-potential area of recurring revenue. Over the last five years, the subscription-based e-commerce businesses have grown more than 100%. And, since 15% of online shoppers have signed up for some kind of recurring revenue-based product — with subscription boxes as the largest category — there’s lots of growth to come.
As a slight variant on subscription services, some e-commerce businesses choose to encourage customers to set up a recurring shipment at checkout. Many even incentivize longer-term purchases with a discount.
The most common auto-ship setup you might be familiar with — and may even use — is Amazon’s “Subscribe and Save” feature. With this feature, Amazon offers a fixed percentage, generally between a 5 to 20% discount, off certain products for setting up auto-ship. It’s a two-way win, both lauded as a consumer hack to save money, and a smart way to generate recurring revenue.
But you don’t have to be as big as Amazon to afford and implement auto-ship.
- Pet e-tailer Chewy lets its customers set up a custom Autoship package with 5% flat discounted essentials. They also let customers choose their shipping windows or ship on demand if they need the package sooner.
- Custom hair care company Function of Beauty offers customers the option to subscribe to their formula. It automatically ships every one, two, or three months as desired.
The famous example for this kind of recurring revenue stream is Gillette razors. (You might know it as razor-and-blade.) The premise is so simple but so effective.
A company sells a core, durable good once, then creates a recurring revenue stream with proprietary consumables that must be continually purchased to use them. The economics here are favorable for businesses, because the “blade,” so to speak, is often sold at a much higher margin.
In fact, many companies often sell away the “razor” at little-to-no markup. Many major companies — Procter & Gamble, owner of Gillette, included — often give “the razor” away to bring customers into the recurring revenue ecosystem immediately.
There are several other upsides to this model:
- Keurig Green Mountain, which makes the Keurig coffee brewers, earns the majority of their revenue on the recurring purchases of its single-serve K-Cups. Its market share has exploded: 29% as of January 2017. Such dominance has allowed the company to create an additional revenue stream. Keurig licenses its proprietary technology so other consumer packaged goods (CPG) companies can sell their beverages in K-Cups, too. (If only they’d offer their “razor” for free.)
- Startup toothbrush company Goby combines the consumable and auto-ship models. Goby sells an electric toothbrush kit once, then makes its recurring revenue on its brush heads — the only other product it sells. Customers receive $15 off the product itself when they opt into an auto-ship option at checkout. (Hello, hybrid solution.)
4. Contracts and retainers
Even if you create an infrastructure for recurring revenue, there’s still a fair bit of crossing your fingers and hoping your customers will continue to spend. Although consumers favor these less, contracts are a way to build in a little peace of mind and a lot of value.
There are many ways to build a contract or retainer into your business model. And many businesses do. They’re used at well-known tech and telecom companies and negotiated privately between restaurants and their suppliers, for instance. Even a rental agreement for a property is a form of contract wherein a landlord receives recurring revenue from a tenant monthly.
Retainer models are another common form for many professional service companies. With retainers, the professional and client agree on a set number of hours and scope of work for a project each week or month. Then, the agency, consultancy, or group of specialists bills a flat-fee. There’s a lot of flexibility in this approach, which can be tailored to work for something as creative as a copywriting agency or as traditional as a law office.
You can choose to structure a contract or retainer with a monthly fee, of course. Or, alternately, you might want to consider a yearly bill to create a larger lump sum of recurring revenue. Many subscription-based companies offer an alternative to monthly subscriptions with a small discount if companies pay a year up front. It’s a good deal for everyone, especially if your customer knows they rely on your service; and you, of course, get your cash.
If contracts and retainers sound like viable options for your business, there are benefits from the behavioral economics standpoint, too. Because humans are inherently loss-averse and hate to see our money go away, we experience the “pain of paying.” If you can get your customers to agree to pay you once when it works for them and be done, they’re more likely to view the investment as a good, and painless, one.
5. Loyalty and habit
The most desirable kind of recurring revenue is the one you don’t have to chase down at all. It just happens because your customers are that loyal. As you’d expect, it takes a while to get here — and many businesses never do.
Some of these might sound familiar:
- There are those who don’t start the day without a light-and-sweet iced coffee from Dunkin’ Donuts.
- Others who pack their workout clothes to go to SoulCycle, no matter the city.
- Brand evangelists who religiously buy Apple MacBooks and Apple-branded peripherals.
This phenomenon isn’t just for consumer brands. Think, for instance, of Atlassian, whom we mentioned in the first example. Many companies whose engineering teams loyally use JIRA decide to put the rest of their teams on Trello, since they’re fond of Atlassian’s products (and already in their ecosystem, anyway).
Recurring revenue from habitual behavior is tenuous — your customer could, say, move or encounter a product sample that changes her mind. Regardless, branding and brand loyalty is immensely powerful and could generate consistent returns if executed well.
How recurring revenue affects cash flow
If you’re able to establish a recurring revenue stream for your company, that’s a big win. Recurring income is a huge step in creating stable cash flow.
Because, yes — this all comes back to cash flow.
Use cash flow forecasting to build stronger recurring income
Recurring revenue makes sure your business can keep its lights on. As your customers pay a consistent fee every month (or year, or whatever you’ve established), you introduce a level of predictability into your company financials. You’re able to build out more accurate cash flow forecasts and drill down into whether or not you make certain choices with your business.
For instance, will you have enough money each month to apply for business funding to speed along your growth? Or, at the complete opposite end of the spectrum, are you at risk for still not making ends meet? If the latter is the case, you’ll be able to quickly make changes to your business model, whether that’s bringing down your COGS, or maybe attempting to lower your CAC.
4 ways to ensure your recurring revenue recurs
As much as a recurring income sets you up for success, you have to nurture it like any other kind of financial variable to keep it sustainable.
1. Keep customer payment information up to date. Credit cards expire or get replaced. PayPal and Venmo accounts get unlinked. In order for you to keep receiving recurring revenue, make sure your customer payments are valid and consistently coming through.
2. Stay in front of renewals. Don’t let subscriptions, auto-renewals, memberships, or contracts lapse. If a customer figures out they can live without your product or service for any amount of time, you’re far more likely to lose a customer. (Remember, the pain of payment is strong!) If your customers aren’t interested in renewing or don’t have the means to, work with them to provide incentives or custom payment packages. A little less revenue is better than none at all.
3. Watch your churn rate. Keep an eye on your subscription attrition, otherwise called your “churn rate.” If it’s high and climbing higher, and you’re not at minimum recouping your CAC, the alarm bells should be ringing. It’s time to change something. (Remember that your best sounding boards are your subscribers, both current and past.)
4. Monitor your cash flow diligently. Your cash flow is a window into the health of your business. Cash flow forecasting helps you monitor your recurring revenue. You’ll be able to predict whether you’re going to need to make changes and how you can improve your margins.
Having the best tools to understand your financials is paramount to getting the best information. Signing up for Smansha is easy. Just create your account then connect it to your QuickBooks Online account. Your near-real-time cash flow forecast will pull from your current financial data.
The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
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