The subscription model is in vogue, and this is no fleeting craze. Global research and advisory firm Gartner estimates that three in four organizations selling direct to consumers will offer subscription services by 2023. And it’s not just B2C —B2B companies are also driving the change.
For customers, subscriptions typically represent lower costs, convenience and/or highly personalized services — think of HelloFresh meal kits, or Netflix video streaming as examples. For companies, recurring revenue offers the prospect of a more stable business model and the opportunity to invest strongly in growth.
Because software companies were among the first adopters of this model, they have also been among the first to reap its rewards. Adobe, Workday and Zendesk are leading examples of companies that have at least doubled their valuations thanks to recurring revenue. But any business across any industry can take the same route and derive a similar outcome, and this is where the trend (as the statistics suggest) is so evidently headed.
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“The key [for businesses] is to find some way to create recurring revenue because that’s going to improve the value of their company, whether they want to sell or not. Improving the value of your largest asset is important – as well as making your business a whole lot easier and more enjoyable to run,” explains John Warillow, author of The Automatic Customer.
Here’s a look at how recurring revenue can increase your business’s value in more detail.
Professional investors like the predictability of recurring revenue
Professional investors like the predictability of the recurring revenue model compared to the traditional transactional model, and here’s an example that explains why.
A $US10 million-dollar company with 70% recurring revenue can rely on US$7 million dollars at the start of every year. Because this figure is relatively stable, management can plan and invest accordingly. The same is not the case for a US$10 million-dollar business with no recurring revenue. This company will have to start its year at zero. It will be able to make forecasts based on its past performance, but it doesn’t have the subscribers’ contracts and associated revenue in place to optimize labor and supplies, lower costs and base expansion plans around.
“When you have a recurring revenue business model, you rarely miss your monthly or quarterly numbers by more than 10-20%. Your forecasting process is much more accurate. At the beginning of the quarter, you start with a base to grow from rather than begin at zero.” explains Venture Capitalist, Jeff Bussgang
And of course, the more guaranteed revenue you can demonstrate, the more valuable your business is going to be for potential acquirers. “Because a high percentage of the revenue of a subscription-based business is recurring, its value will be up to eight times that of a comparable business with very little recurring revenue,” claims Warillow.
An agile business model that supports scale
Recurring revenue systems are built to support higher scale operations and allow businesses to meet customer demands with different online deals and packages that are easily flexed and adjusted. Amazon is a familiar example of how technology can be used to capitalize on streamlining the sale of both one-time buys and subscriptions. The customer journey is managed automatically from product discovery to billing, and offers are carefully targeted with the help of customer data. Amazon staff are no-where to be seen.
This automated management of the customer life-cycle accelerates time to revenue and frees up people and resources that the business can use to invest more heavily in responding and adapting to market changes and customer preferences — an agility that gets rewarded with exponential growth, then premium valuations and competitive advantage.
Enhancing customer life-time value
The ability to adapt and respond to customer preferences also increases customer life-time value (CLTV), which is the total net profit that a company makes from each customer. The happier customers are, the longer they are likely to stay and the more receptive they will be to new offers. Recurring revenue systems allow businesses to maximize CLTV through an established lifetime of regular customer touchpoints that provide an opportunity to win or lose revenue and loyalty. This includes reaching out to subscribers to upsell products and services.
The CLTV to customer acquisition value (CAC) is the most important metric for subscriptions businesses, states Warillow. This ratio delivers the report on whether a business has done well or not. For example, if your customer lifetime value is US$3,000 and your expenses for acquiring a customer are US$1,000, your LTV:CAC ratio would be 3:1. Warillow explains that this 3:1 ratio is the yardstick professional investors use to define whether a subscription company is “attractive and viable.”
A company that has been extremely successful at maximizing CLTV is flower subscription service, H.Bloom. On average, it costs about US$30 to buy a bunch of flowers, and— other than Valentine’s Day and Mother’s Day— flower-buying tends to be an impulse purchase. But, by inviting hotels, restaurants, professional offices, spas and regular customers to sign up for its flower delivery service, H.Bloom was able to, not only create a regular inflow of capital, but also increase the average customer life-time value to US$4,000, an impressive jump from US$30, and a clear illustration of how subscriptions can transform traditional business.
Managing your subscriptions with the right system
It’s important to note that adopting a recurring revenue model does require a digital transformation, but it doesn’t necessarily have to mean a complete swap-out of your current systems.
Take the time to research the best recurring revenue solution for your business strategy. By implementing the right processes and technology you can ultimately lower your overhead costs, promote efficiency, maximize CLTV and increase your bottom line.
In the process you can also create better relationships, not just with customers, but with potential investors too.
Karen Turtle, Editor and Content Manager at Cloudmore (opens in new tab)
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