In these challenging times of lockdown during the Covid-19 crisis, many companies are struggling due to lower sales volume. Some companies have been more resilient in retaining continuous revenue streams because they have established recurring revenue models. In this article, we highlight the advantages and some disadvantages of both types of revenue strategy.
Recurring revenues repeat periodically from a single sale as opposed to non-recurring revenue that occurs only once per sale.
Advantages of recurring revenue
Knowing future cash flow allows for better planning in terms of resource allocation and future investments, a cushion of predictable cash inflow allows a higher risk portfolio with the potential for higher future growth and returns. Predictable revenue improves credit worthiness in terms of loan applications and makes companies more attractive as an investment target.
Higher margin potential
Once fixed costs are covered the cost of servicing new users is often low relative to the additional revenue that they provide.
High return on investment
Many recurring revenue services are an incremental sale to an existing product or service sale. The financial and human capital resources required to execute this recurring revenue sale are far less than those required for the development and sale of a new, unrelated product. This boosts the ROI for this type of sale.
Dis-advantage of recurring revenue
The downside is that it often takes time and money to build up a fixed marketing, operating and service infrastructure in order to offer recurring sales.
You potentially need to budget to keep a recurring revenue customer for several months before reaching break-even point. Typically, in terms of software development, for example, this could be a 9-month breakeven timescale. You have most costs upfront with the software development costs to cover, then some lesser ongoing costs for the continued updates and service of the software.
Microsoft Office for example successfully migrated its software to the cloud-based Office 365. So rather than customers having to incur Capex by purchasing, owning, managing in house and running their own timed software updates, often leaving software out of date and prone to errors or virus attacks. Office 365 now automates updates and replaces Capex with subscription payments, overall, it took quite an investment in new software, but this strategy has been massively successful for MSFT.
Advantages of Non-recurring sales
Speed of growth
There is potential for explosive growth to meet supply and demand. (The flip side of this is that sales can also fall off a cliff edge)
Lower initial cost
Marketing and Sales costs can be recovered quicker and lead times can be lower
Size, value and type of product
Some sales are inherently infrequent or one-off in nature such as the sale of a house or motor vehicle
There is however in many product sales the potential to add an element of recurrence and there are undoubtedly stability motivating factors to keep revenues continuous in nature.
For example, when buying a house Estate Agents build up a reputation of quality and reliability in order to attract customers and suppliers, most Estate Agents don’t just deal in one off property sales, arguably one form of recurring revenue streams for property is the rental market. They can also offer add on services such as grounds maintenance, repairs and cleaning services.
In the motor trade vehicles are not just sold once, there is a thriving second-hand market, there is car leasing and rental and when vehicles are sold there is the potential to add recurring servicing options.
Markets are constantly evolving for example one way that car rental companies are creating new recurring revenue streams is to offer membership subscriptions to car clubs. Members pay either a monthly or annual fee in return for the ability to hire cars by the hour with easy pick up and drop off options. Especially in busy cities this can be an attractive alternative to car ownership.
Ways to encourage recurring revenue
Rather than restrict your offer to a narrow one-off product, encourage your clients to take a continuous on-going “solution”. Ways to do this include setting up preventative maintenance contracts, selling access to future updates and scheduled maintenance, offering subscriptions to access specialised information and advice associated with your product or provide “on-call” services.
Cloud computing technology companies have generally taken over the traditional in-house IT purchase of a computer server to process data and retain regular backups. Cloud computing services offer a vastly more flexible extension of traditional IT solutions, software updates are made in a more seamless manner and the amount of data storage and backup availability is easily expandable.
The following are ways that IT based companies can create recurring revenue: –
- Develop a Software as a Service (SaaS) products
- Become an affiliate for other SaaS products
- Create service or retainer plans
- Produce physical product subscriptions
- Build a membership program
- Combine online membership and physical product delivery
- Sell online courses
Tips for enhancing recurring revenue
- Bill your customers automatically and frequently
- Train your sales staff on recurring revenues
- Build trust through good policies – Have easy and transparent cancellation policies
From a customer perspective sourcing services by paying smaller regular amounts has the advantage of not having to pay large lump sums up front. Normally recurring payment plans are easy to set up and relatively easy to exit.
It’s a two-way partnership, if the services supplied aren’t kept up to date, informative, relevant, competitive, evolving and of a consistently high quality then the customer is free to source services elsewhere. A certain amount of trust is given to the provider and if the trust boundary is broken then they will potentially lose business so it’s in the supplier’s interest to stay competitive.
Examples of this are online streaming services such as Netflix and Amazon Prime who receive recurring revenue subscriptions, they have gained popularity over traditional terrestrial television services and other broadcasters such as Sky.
Disney+ just entered the UK market as a new rival offering services from 24th March 2020 at the same opening monthly price point as Netflix. If Netflix doesn’t keep their streaming services attractive, they could potentially lose customers to Disney.
There is nothing wrong with one-off sales per se. Some products are just that way in nature and many retail outlets such as supermarkets are very successful at selling individual products, however, they also increasingly encourage repeat sales whenever possible using several strategies including club cards, marketing image, price offers etc.
The adage is that; revenue is vanity, profit is sanity, but cash is king.
There is no doubt that in terms of keeping a business afloat, having a predictable inflow of cash derived from recurring revenue streams has a lot of positive advantages especially in times of economic uncertainty.