Recurring Revenue Model Businesses: A Primer
Businesses have started tapping into recurring revenue streams, as renewable subscriptions are becoming increasingly popular for both consumers and businesses alike. Subscription businesses benefit from more predictable revenues and cash flow. Similarly, customers have started to invest in products as a service that come with an ability to invest month-to-month rather than locking into a long-term contract or paying a high upfront cost. Many sectors are picking up this business model, from cars to software, and customers often prefer the freedom these pay-as-you-go payment plans allow.
Companies like Adobe, Microsoft, Dropbox, Dollar Shave Club, and Netflix have all tapped into this market, paving the way for subscription models across different business landscapes. Whether it's along the lines of SaaS business, service providers, physical product subscription boxes, or streaming services, recurring revenue has become a staple business model that has proven wildly successful. Recurring revenue business models are here to stay, but what exactly does this model entail?
What is a recurring revenue business model?
Recurring revenue business models charge customers on a scheduled basis for their goods or services, often in monthly or yearly regular intervals. Also known as subscription business models, these companies provide access to services or goods for as long as buyers stay subscribed. Having yearly or monthly fees means predictability for both the company's forecasting and the customer's budget. Metrics within recurring revenue models usually measure things such as acquisition costs, average revenue per user (ARPU), monthly recurring revenue (MRR), annual recurring revenue (ARR), and customer churn rate.
Why Recurring Revenue Beats One-Off Sales
Customer retention is easier to maintain than repeat purchases, making recurring revenue extremely appealing to companies. Focusing on retaining customers and cultivating long-term relationships means developing loyal fans who will also be more likely to spread the word about your products. Recurring revenue is also an upgrade in terms of predictability. One-off sales often lead to wildly different sales figures month-to-month with hard-to-track trends. Subscriptions, especially auto-renew ones, lead to a higher degree of certainty on your cash flow as long as you account for new customer acquisitions and customer churn.
What are the types of recurring revenue business models?
You can approach the recurring revenue business model with different types of pricing structures and models. While some of these architectures are seen in D2C subscriptions and services, some cater to B2B products.
Here are some examples of recurring revenue models:
A combination of the words "Free" and "Premium," freemium models provide a service for free with basic functionality, and a host of better add-ins or functions are available once the customer upgrades to a premium paid plan. For example, Spotify offers a free service that has ads to bring in revenue. However, Spotify also has a premium subscription option with no ads for listeners, so their music is uninterrupted.
The usage-based subscription model works off of a "pay-as-you-use" basis. Often, telecommuting companies take advantage of this model, allowing companies or users to pay by call length, SMS message count, or data usage depending on the services provided. Allowing for usage-based subscriptions can allow smaller companies or individual users to save money when they need a service but know they won't use it consistently or excessively.
Used most often by SaaS companies, user-based billing charges a recurring fee based on how many users have licenses to the program. User-based plans can be sold in discount packages and are common in B2B contexts. SaaS companies often have multiple tiers to their user-based plans, giving different features at different price points and capping off the max number of users for each level.
Also known as evergreen subscriptions, these payment models collect money automatically through a recurring fee until the customer cancels their service. These cancellations are free, meaning the customer has easy agency over whether or not they want to continue to use the service. Most often, auto-renewal subscriptions are associated with services such as music and video streaming services.
Similar to user-based billing, many SaaS companies use tiers to separate their different product packages or features. Often these packages have limits such as a max number of individual licenses or storage capacity. Providing tiered subscription billing makes your product more accessible as you get to give a swath of different offerings at flexible price points. Allowing for other financial options means smaller and larger businesses can invest in your product while keeping to their appropriate needs and budgets.
The hybrid billing model combines multiple models to gain revenue. For example, a retailer with a recurring billing option such as a membership subscription will probably have one-time sales. Subscription boxes are a great example of hybrid billing, as many have both a monthly or quarterly box and an online store for individual items.
Like some other recurring revenue models, rigid contracts give services to a customer over time for agreed-upon charges. The biggest differentiator between hard contract models and the other structures is that the customer gets locked in until the end of the contract.
Canceling a contract can result in an early cancellation fee. While this model means more security for the company, it also takes away the freedom that makes recurring models so attractive to paying customers.
Sunk money consumables
When a customer purchases an item, then has to buy recurring compatible items from that same company, it is considered a sunk money consumable. Great examples of this are air or water purifiers with proprietary filters or coffee machines such as Keurig machines with compatible coffee cups. These recurring fees can genuinely add up to a sizable profit over time, depending on the product and price.
Best Business Types for the Recurring Revenue Model
While many different businesses can succeed with a recurring revenue model, a few sectors seem to grow best under a subscription model. Some of the proven best business types for recurring revenue include:
Product-based companies offer either physical items or software products on a subscription model. Great examples of successful product-based companies include SaaS companies that market their software through recurring revenue models or subscription boxes that send curated items out for a fee on a monthly or quarterly basis. Most recently, subscriptions that send grocery items and meal kits have become increasingly popular.
Any services that you purchase through a recurring fee are service-based. For example, job boards with premium options or freelancers who charge a regular static fee for their services fall under service-based recurring revenue models. Service-based recurring revenue models don't work for all services due to their per-deliverable structures, but they can provide substantial predictability for service providers!
Content such as movies, music, podcasts, or blogs received in a subscription format is excellent for recurring revenue models. Services such as Patreon have even allowed content creators to post their content for a regular fee, making content-based models one of the most accessible. Larger companies such as Netflix and Spotify have also profited significantly from recurring revenue.
Practical Challenges of the Recurring Revenue Model
While there are many benefits when moving to a recurring revenue model, there are some unique challenges you will have to address. From preventing customer churn to sticking out in a bloated subscription landscape, here are some difficulties you will need to consider:
As recurring revenue models have become more and more popular, customers often are barraged with subscription options. Prices for subscriptions add up, and it can be frustrating for consumers who want to watch a film to realize that while they pay significant fees for HBO, Netflix, and Hulu, the movie they were hoping to watch is on a whole different subscription platform! As customers sign up for increasing numbers of recurring revenue services, it is essential to ensure that your service fulfills a core need of the customer so that they feel like they are getting a complete experience. Focus on a great customer experience to aid customer retention and make your business stand out.
Churn is a scary occurrence for recurring revenue business models. The best way to combat churn is to focus on your customer experience and build loyalty among your customers. By focusing on retaining customers rather than consistently worrying about gaining new ones, you can begin to combat churn. Along with customer retention, make onboarding easy to start new users' experiences on the right foot!
Managing customer data, bulk products, and technical support can be daunting if you don't prepare for growth before gaining subscriber momentum. Part of the appeal of recurring revenue businesses is that you pay and receive a service with no hassle, meaning you have to be prepared to scale smoothly! An excellent tech stack or CRM is essential to handle an influx of new customers and to ensure that you prevent churn due to inadequate or delayed service.
Recurring revenue business models can be highly profitable depending on your sector and business offerings. As you consider moving to a subscription architecture, remember that implementing software to support your team is vital to prevent excessive churn, provide a better customer experience, and allow for extensive scaling. By preparing for your move into recurring revenue, you can come out on top and gain a reliable and predictable cash flow that will only grow over time.
Boost Your Business With Portal
Are you looking for the perfect software to help you move to a subscription model? Portal can support a seamless user experience from your website to your client portal. Portal is a multi-functional client management program that gives you the tools to run your recurring revenue business. Easily create a custom domain name, add your branding, and create automated emails to keep in touch with customers. Portal provides everything essential to improve the client experience and allows for smooth scaling, such as billing and invoicing, eSignature collection, file sharing, messaging, intake form collection, and access to your knowledge base. These features are packaged into one intuitive experience, empowering your team to create elevated experiences for your customers.