Four Myths Of Recurring Revenue And What To Focus On Instead

Written by Addam Stone, Director

With the rise and success of software as a service (SaaS) business models, recurring revenue or subscription revenue has become the business model de jour. From banking to streaming services to co-working, businesses across the spectrum have sought ways to generate a stable source of revenue that can translate easily into new funding, higher multiples and faster growth. For certain businesses, recurring revenue makes sense, but for many, the push for subscriptions or membership-oriented revenue models is misguided and more likely detrimental. For those businesses considering a move toward subscriptions, I’d like to dispel a few commonly held myths.

Myth One: A recurring revenue biz model is the fast track to a high valuation multiple.

SaaS businesses have grown rapidly over the past 20 years. Investors have flocked to them because the delivery of the services was simplified via the internet and users quickly multiplied. Investor interest increased the multiples SaaS companies were seeing, and the high margin, fast growth nature of the sector supported those multiples. However, if you look at the thesis of why investors give higher multiples to recurring revenue, it is because there is an assumption of a lifetime value of a customer that greatly outstrips the cost to acquire. There is a lot that goes into that assumption, which for many companies isn’t true. Remember MoviePass? This was a case where consumers loved the movie theater subscription option. It was just a terrible business model for the company. Or how about Blue Apron, the subscription meal plan? There were only so many free meals and discounts Blue Apron could give to bring in new customers. Subscriptions certainly interest consumers, but it may not translate into a valuable business.

Instead of focusing on what gives you the highest multiple, stay focused on your mission. Investors will be attracted to the value your company is bringing to the marketplace and the long-term opportunity. Deliver on your mission and vision and the market will assign the value applicable to it.

Myth Two: They are easier to operate and scale.

The operation and scalability of a business isn’t going to be based on just the revenue but the kind of business you’re choosing to develop. Digital businesses like software and streaming may be easier to operate and scale as a subscription, but they are also surprisingly capital intensive (developers are not cheap and neither is updating your software to stay competitive). If you look at other subscription services such as telecoms and traditional media companies, they are certainly neither easy to operate or scale.

Instead, try to operate your business as efficiently as possible. Grow using the tools at your disposal including sales teams, marketing, referrals or word of mouth, to name a few. Avoid getting over your skis by trying to scale too quickly and negatively impacting your ability to deliver.

Myth Three: Every business should have a recurring revenue angle.

To address this myth, I would ask—why? What every business needs is a clear understanding of their customers’ needs and wants and to fully meet those needs and wants. If your customer uses and pays for your service without a subscription, then a subscription plan isn’t needed. Your underlying quality of revenue is what you should be focused on more so than if it recurs monthly. Low quality revenue is essentially customers paying for things they don’t use. Eventually those customers will stop paying you—regardless of when they pay.

Instead, put your customer first. Deliver what you say you’re going to deliver and charge a fair price for the value you deliver. That fair price should also be one that delivers a reasonable profit for your business, initially losing money with the hope of making it up later because it’s a “subscription” is a certain road to business failure. If you run a professional services firm, for example, your customers may prefer to purchase programs that are driven by the value they create, not a monthly retainer.

Myth Four: Subscriptions are sticky. Just set it and forget it.

No one wants a one-time customer. To attract and retain paying customers, every business needs to continually deliver on the brand promise it makes to the customer. “We make it difficult to switch” isn’t a brand promise. So constantly innovating and coming up with new offerings for your customers to delight and please them is what makes them stick around. Again, that has nothing to do with when or how frequently they pay. If a customer loves your product or services, they will gladly continue to pay for it.

Instead, find ways to make your business as necessary and valuable as possible for your customers. That can include new offerings, improvements on existing offerings, partnerships, loyalty programs and many others. Your customers will stick around because they value your products, services and partnership.

Recurring revenue business models work for some businesses, but not every one of them. Too many entrepreneurs make the mistake of thinking they can shoehorn a subscription-based platform into their business. If you keep your attention on generating high-quality revenue from the right clients and then work hard to keep them as clients or customers, you’re going to have a successful business with stable revenue.

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