Source: Tom Dibble, President and CEO of Aria Systems, a provider of cloud billing and subscription management solutions.
The Software-as-a-Service delivery model has rapidly matured in the past few years, evolving from an experimental delivery method for niche audiences to a widely-practiced business approach. Investors are clearly enamored with it, in part, because it’s helped lower the barrier of entry for filing for an IPO.
That’s certainly been the case with the recent wave of IPOs and S1 filings from the likes of Eloqua, Cornerstone, and Bazaarvoice, all of whom had annual revenues well under $100 million at the time of their respective filings.
While accessibility, cost, and ease-of-use are some of the most commonly cited factors when discussing how the “as-a-service” approach has gained mainstream traction so quickly, there’s another major factor at play: recurring revenue offerings. Unlike traditional financial models, which are built around one-time transactions or upfront fees, recurring revenue business models focus on a series of smaller, ongoing, subscription-based transactions. Users can consume a service or product as much as they like in an on-demand manner, as opposed to having to buy the entire offering up-front.
While the value per transaction in a recurring revenue system can be lower than traditional business models, a recent study by the Incyte Group, an independent research group, found that of more than 1,000 U.S. businesses, nearly 50% had either adopted or were planning to adopt recurring revenue models.
With that in mind, here are five reasons you should be consider a recurring revenue model for your own business.
1. It’s Not Just Tech Startups Profiting From This Model
If you’re assuming that it’s just newer, SaaS-based technology companies that are employing recurring revenue models, think again! Ingersoll Rand, which has been in business since 1877, is a particularly compelling example. Long known for their traditional lock and key services (remember those combination locks from middle school?), Ingersoll Rand has now introduced digital security systems for homes and offices that can be controlled remotely via mobile devices, which users subscribe to on a monthly basis.
2. It Lowers the Barrier of Entry for IPO
SaaS companies with recurring revenue models have been filing for IPOs at a higher rate lately, and it’s no coincidence. Doug Pepper, a well-respected venture capitalist from InterWest Partners examined this trend in some detail in a recent op-ed. Financial analysts have also expressed confidence in recurring revenue models and their ability to not only generate but sustain long-term profits. For this reason, companies that demonstrate solid, predictable growth are in some cases finding a lower barrier to entry than the traditional $100 million run rate. Recurring revenue models give greater foresight into annuity cash flows as opposed to lump sum sales, which in turn makes it easier to model and predict future revenue growth and profit margins.
3. It Minimizes Customer Churn and Builds Brand Loyalty
Recurring revenue models provide a way to reach out to customers more frequently and build a more loyal customer base. Look at the innovation cycle for a SaaS company like Salesforce versus that of more traditional software companies. Salesforce and other leading SaaS providers generally push out four to six major upgrades per year, while product cycles for large, traditional vendors generally take 12 to 18 months. Companies with recurring revenue models can also capture data sets that track consumer trends and preferences on a much more granular level than is possible with traditional models, which in turn leads to optimization of pricing and packaging, and consequently the uptake from and retention of targeted buyers. The ability to fine tune your offerings based on this data has enabled the consumerization of many B2B offerings. In other words, they are tailored to individual preferences instead of being a fixed, one-size-fits all package and price.
4. It’s Built to Scale
To expand on the above point, recurring revenue models are also built to scale as you grow out your customer base. A classic — and very current — example is Netflix. They succeeded in disrupting the video rental industry in a remarkably short period of time by offering a recurring service for a reasonable price as opposed to Blockbuster’s model of one-off video transactions. Netflix was able to effectively scale out its operations as consumer preferences were shifting from physical to digital offerings in the early 2000s. Their monthly growth figures provided a greater degree of transparency than Blockbuster’s model, which in turn inspired a great deal of confidence from investors and paved the way for the company’s successful IPO in 2002.
5. It Increases the Potential for Collaboration and Shared Revenue Models
Partnering models have proliferated as businesses with recurring revenue models have increasingly joined the mainstream. These models introduce a greater degree of transparency than those offered by one-time transaction models. This has in turn created a more collaborative environment between businesses. One recent example is the partnership between Microsoft and Comcast that allows monthly Xbox Live subscribers to access the HBO Go and Comcast On-Demand applications. Another example can be witnessed in the form of Box, the highly successful web-based file sharing/storage service. Their subscription business has spawned a massive ecosystem of partners – and a waterfall of revenue sharing tiers. It’s incredibly easy, for example, to discover and download a useful application via Box in five seconds, and greatly improve productivity in the process. The same can be said of DropBox, the SalesForce AppExchange, the Apple App Store, and a host of others.
It’s increasingly clear that we’re in the midst of a major shift in the way companies do business. Recurring revenue models have gained enormous traction with the convergence of two major trends: businesses recognizing the financial benefits of recurring revenue, and their buyers demanding the flexibility and personalization these models provide.
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices throughout the southeast including Charlotte, Raleigh/Durham, Greensboro, Wilmington, Washington D.C. and South Florida with a team of more than 30 professionals serving more than 100 companies throughout the region.
