The Hierarchy of Recurring Revenue
One of the biggest factors in determining the value of your company is the extent to which an acquirer can see where your sales will come from in the future. If you’re in a business that must start from scratch each month, the value of your company will be lower than if you can pinpoint the source of your future revenue.
A recurring revenue stream acts like a powerful pair of binoculars for you to see months, even years, into the future, so creating an annuity stream is the best way to increase the value of your business.
Think of the list below like a ladder. For each rung you climb on the way toward number one, the more valuable your business will be.
No. 1: Contracts
e.g. wireless phones
The only thing more valuable than an automatic-renewal subscription is a hard contract for a defined term. As much as we may despise being tied to them, wireless companies have mastered the art of recurring revenue. Many give customers free phones as long as the customer locks into a two or three-year full-service contract.
No. 2: Automatic-renewal subscriptions
e.g. document storage
When you store documents with Iron Mountain, for example, you are charged a fee each month until you decide to pick up your documents. Unlike a magazine subscription, where you have to make the conscious decision to re-up Iron Mountain bills until you tell it to stop.
No. 3: Sunk-money renewable subscriptions
e.g. the Bloomberg Terminal
Traders and money managers swear by their Bloomberg Terminal. Bloomberg customers have to first buy or lease the terminal and then subscribe to Bloomberg’s financial information. Having sticky customers loyal to a proprietary platform allowed Michael Bloomberg to build a valuable company.
No. 4: Renewable subscriptions
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future in the form of a subscription. Typically, subscriptions are paid for in advance, making them an excellent way to create a positive cashflow cycle and wean your business off a reliance on bank financing.
No. 5: Sunk-money consumables
e.g. razor blades
More valuable than a straightforward consumables business is one centered around “sunk-money consumables”. The customer first makes an investment in a “platform”. For example, once you buy a razor, you have sunk money into a platform and have a vested interest in buying the compatible blades going forward.
No. 6: Consumables
Consumables are disposable items like shampoo and toothpaste that customers purchase regularly but have no solid motivation to repurchase or to be brand-loyal to.
Whether subscription revenue is your entire business model or adds a small annuity stream adjacent to your main business, a subscription offering can:
- Drive up the value of your company
- Increase the lifetime value of your customers
- Smooth out demand
- Cut the cost of market research
- Automate the collection of receivables
- Lock in your most promiscuous customers (those who are always looking for a deal and who will switch for a small price advantage)
- Trigger customers to buy a broader selection of your products and services
- Inoculate your business from recessions
Recurring Revenue is one of eight drivers of your company’s value. Get your score on all eight by completing your Value Builder questionnaire.