I dropped out of college when I was eighteen. I left because of the concept of recurring revenue.
That’s today’s topic. Buckle up.
Recurring Revenue wasn’t the only reason I dropped out of college. I’ll tell you more about those details in my next blog piece.
If the concept of recurring revenue is something you’ve never heard of before, let me quickly unpack it for you.
There are two ways that service based businesses get paid. The first is called project based revenue. The second is called recurring revenue.
Think of project-based revenue as getting a bill for a service that you pay only one time. Project-based revenue is things like a website that your business pays for, a singular consultation fee, or a plumbing/HVAC bill, or car repair. That’s project-based revenue.
The second way a business gets paid is by billing monthly, or on a recurring basis. This is recurring revenue. Think of your Netflix subscription, cell-phone bill, home security system, your marketing automation software, etc. Anything that bills you, automatically, every month is defined as recurring revenue.
No matter what line of industry you’re in, if you want to make your business last, you need to consider recurring revenue
One of the common reasons service or project based businesses face instability is they live and die by the projects they have come in. Sometimes these projects might be a six-month project or a one-year project. The trouble with this type of business model is it’s tough to scale or grow a business if you don’t know what income you’ll have coming in next month, or at the end of the project.
For example, under a project-based revenue model, what happens when you have a client, and they suddenly leave? Whether after a six month period or twelve month period, when they leave you and that project stops, it can negatively affect your company’s revenue stream. If you don’t have another project lined up in the sales pipeline, you’re losing money as a business. And you need to pay your staff whether you have a project or not.
You might be a cash cow one day, but you really can’t spend your money because you might have to weather a storm, and have no projects for a few months. Not only does it leave your future unclear, financially speaking, but even the money you do make can’t be capitalized on because you have to save it.
With the uncertain future, you’re afraid to spend your income to grow, since you don’t know what’s going to happen if you don’t get another big project in the coming months.
A company without recurring revenue is in a less-than-ideal-state
I’ve got friends that have built fantastic businesses. The problem they run into is their business is essentially made of glass because they don’t have some sort of consistent income.
The future is full of a lot of unpredictably with project-based work.
Sometimes things go south, something you did wrong as an owner, maybe you have a client one month and then they cancel, and all of a sudden you might have to let a bunch of people go.
Then you let them go, and three months later you get a project, now you can hire them back.
Do they really want to come back to a place that they’re unsure of if they have a job next month?
I never wanted to have to do that to someone, or to their family. Letting a good employee go, because of a failed business plan, or something the employee didn’t do would really stink. I feel it’s my responsibility to make sure our business plan reduces the chances of something like this from ever happening.
It’s really tough to manage and to grow in those environments. Not that project revenue is bad, it’s just not a long term stabilizing source of income. We use project revenue as more capital to focus on our recurring revenue services.
Having the assurance around the certainty of recurring cash flow means you can afford to make mistakes, and not suffer, like in a project-based environment. You can afford to lose deals every once in a while without hurting the company or costing jobs. Recurring cash flow allows a business to be flexible, and take some necessary risks to keep growing.
An unstable source of income is bad for your clients
When you don’t have an income coming in every month, it quickly becomes a domino effect of bad events.
I’ve seen this sequence happen before:
- You lose a project
- You’re not making money
- You let people go in order to continue to be profitable
- Clients become less about how you can help them and more about when the cash will come in
What also happens in these scenarios is that people start talking.
Your peers, customers, and prospects hear that your business has been laying off employee’s and it creates a sense of doubt. Your potential customers begin hearing that you’re struggling, as well, and this negative effect becomes a bad form of word of mouth advertising about your company. All of a sudden you’re losing deals and it just starts to compound with the other business problems.
Even though you take two steps forward and one step back, people don’t want to see at any point in time that you went backwards, by having to lay off team members. Even though you’re still a good sized company and making money, seeing you lose employees and projects starts to impact your credibility.
From a client or customer perspective, it’s better for your clients to have a flat monthly fee (Saas/recurring billing model) and a support plan, then to bill them by the hour.
Having solid recurring revenue makes it easier for your clients to buy from you, and easier for you to sell your solution to them.
Recurring revenue is also better for customer service. Your clients or customers are more likely to reach out to you, when an issue arises, and easily remedy said issue in five minute. Happy clients and customers, because they feel comfortable to contact you, means they don’t leave you and you do a better job at preventing problems.
If you’re charging them per hour, most customers are likely to let little issues become massive ones, and end up hating your services or technology.
Plus, recurring revenue is easier to budget, as they know exactly what they’re getting each month.
Recurring revenue gives you an exit door
Let’s’ transition from why recurring revenue is great, and away from why it’s good for your clients, to selling your business.
Someday, if you ever want to exit your business, financial health is almost the only thing that has value. There’s typically very limited value in a name or a logo unless your company is a national chain, or franchise.
That said, without recurring revenue, it doesn’t matter how successful you were, because someone’s not going to buy what you did in the past. It doesn’t matter if you did $10 million dollars in revenue last year; someone who’s potentially buying your business wants to know the future worth of what they’re buying.
I’ve seen business owners that have been in the business for twenty and thirty years and their businesses are worth almost nothing because their revenue isn’t consistent. These people do a great job running a small company, but on paper their business is worth very little.
Having recurring revenue gives your company two big advantages
There’s two huge benefits to recurring revenue.
- It allows you to grow
- It allows you to take risks
Any business I look at, I ask the question “How big can we grow this?” Because of recurring revenue, most every line of work we go into has no ceiling. Meaning, we will never cap 100% of the potential. When considering investing in a business that is built on a recurring revenue model, I look at the best case and worst case scenario, if the worst case isn’t that bad, we’ll invest in it.
When you’re collecting recurring revenue, it gives you a consistent income that allows you to adjust with trends. Having a permanent source of money gives you the ability to see how much you can put into an investment, then mathematically calculate the time to make your investment back, and profit going forward.
A lot of people that have met me think that I’m a crazy risk taker. I’m not. When really I just understand our business and how our numbers work. That’s being strategic. Strategic because of recurring revenue.
What seems risky to others is typically a no brainer decision for us. Plus, I know that we just need to win more than we lose, and if there is uncertainty and we need to make a bet, I make sure it’s something we can afford to lose. Knowledge is power, especially when mitigating risk.
Again, recurring revenue allows us to be super competitive and invest in our future. Because we know what’s going to be coming in, we can scale and then we can offer more for our customers for less, because it’s a long-term plan.
Making sure our business is relevant in the future is very important. It not only helps with planning so you can grow, but also removes stress, and creates an atmosphere of stability for your customers and employees. It helps you know who you can afford to hire and gives you an eventual exit plan so your business is worth something when you retire and sell it.
You’ll also receive a profit, when you sell, because your business is worth something. You can say to a potential buyer, “without you doing anything, if you buy this business from me, you’re going to make this much money next year.” You can sell it for three, four, five times and possibly even more of that value. That’s the difference between selling a job and selling a business.
The greatest point of recurring revenue is security
In the last couple of years businesses have started to think about recurring revenue. Lots of people made a lot of money in something upfront, but they have nothing lasting. It’s terrifying because I’ve had friends that have sold businesses, made a bunch of money, but they have no lasting revenue.
The true benefit in recurring revenue is it gives you a peace of mind. Just like the peace of mind it is for employees saying, “Hey, I have a job and I’ve got a paycheck coming in,” that security in a known paycheck is what gives employees stability. As a business owner, you can get that same security on recurring revenue.
You can scale, you can build, you can grow, you can weather a storm when things don’t go well for a quarter or even a year.
Not sure how you can collect consistent revenue? Here’s some examples to adapt it for your industry
- Gym Memberships: Not just per session or training, but monthly membership.
- IT/Tech companies: Moving from break fix to managed services. Are you getting paid when your clients have problems and you fix it, or are you getting paid to stop their stuff from breaking? Are you offering residual value in being proactive?
- Snow Removal: Do you charge only when or if it snows or do your clients pay a flat monthly fee for all snow removal?
- Phone Plans: Are your charging customers by the minute or a flat monthly fee for unlimited. You know the revenue you get each month.
- Rental Income: A more well known source of recurring revenue. Auto draft the rent from their bank account or credit card if need be. Don’t wait for checks. Provide a discount for auto-pay.
- Marketing services: Are you creating value by charging a fixed monthly fee, with pre-established deliverable’s that you’ll “do” for the client, or are you billing by the hour?
Skeptical? Check it out in practice
When discussing how your business can create security for you, specifically in a situation where you’re looking to sell, the best means to measure a company’s growth and future worth is by measuring the average selling price per customer.
Meaning, when a company sells, how much revenue will your buyer make in the future from these customers.
The above chart identifies two similar companies. The two businesses in this example are software companies that manufacturer CRM software.
As you can see, Netsuite is much healthier because they developed a recurring model that makes their customers very valuable, in terms of future growth per customer. Salesforce is a bit different, and because of this they have a much smaller future revenue opportunity. In this example, NetSuite is able to grow their software sales through the SMB market and also offer their software to an Enterprise level, which adds to their average selling price per customer.
Build your business on a recurring revenue model = ability to sell your services to other markets and increase average selling price per customer.
According to TechCrunch, with a Saas or recurring model, many businesses continue to grow their annual revenues in the double digits. Recurring revenue also allows these same businesses to grow market share. (blog.intercom)
Now, here’s the disclaimer: These are just examples. But they’re good ones. Even though the examples we shared are larger companies, the same thought process applies to smaller examples, as well.
Bottom line: The more recurring revenue you have in your business, the more your business is worth to you and to anyone else.