In order for a business to pay the rent, make payroll, and cover all of their expenses, they need to make a certain number of sales each month.
Of course, they may be able to continue collecting receivables for a time to help keep the lights on; but eventually, that money will run out. What happens when businesses are faced with a significant loss in customers, a slow season, or an economic downturn?
Today, I want to share what I believe are the two most important words in business:
Recurring revenue.
Why is recurring revenue so important for your business’s financial health?
Simply put, generating recurring revenue offers the following benefits for your business:
- Recurring revenue keeps coming in when new sales are hard to come by.
- Recurring revenue provides you with a larger cushion during an economic downturn.
- Recurring revenue brings in payments for work already performed.
- Recurring revenue gives you the cash flow certainty needed to make new hires.
- Recurring revenue makes it easier to budget each month.
- Recurring revenue makes your business more valuable to lenders and investors.
- Recurring revenue saves time that you might spend marketing and selling to new customers.
Recurring revenue is so valuable that even many software companies are now using “software as a service” models to generate monthly income in lieu of one-time purchases.
Need more convincing? Consider the fate of Blockbuster once Netflix came along. One company became obsolete because of an outdated model that relied heavily on new customers. The other one thrived because they found a way to bring in recurring revenue from their customer base each month.
The 5 Levels of Recurring Revenue
Now that you see the importance of recurring revenue, here are five models that businesses use to generate it:
Level 1: Repeat Customers
The easiest way for businesses to generate recurring revenue is to sell products and services that need to be renewed. At my firm, for example, we sell tax preparation services. Because these services are needed each year, many of our customers are repeat customers.
The main problem with this model is that there is nothing stopping customers from choosing your competitors instead.
Level 2: Automatic Charges
When repeat customers accept automatic charges, you don’t have to wait for them to renew your products or services. This makes it easier to count on their recurring payment each month.
Of course, you may encounter the same problem as that of level one—your customers can cancel at any time.
Level 3: Contracts
While an automatic charge only allows you to count on recurring revenue on a month-to-month basis, a contract allows you to count on revenue for the entire term of the agreement.
While customers may be able to cancel the service, there is usually a cost associated with terminating the contract.
Level 4: Sequential Revenue
Many companies will sell a low-cost entry product that requires an upgrade to increase users, storage, or other benefits. This is an especially popular model among business-to-business companies.
By doing this, you are able to not only secure recurring revenue but also increase the amount of that revenue over time.
Level 5: The Network Effect
One of the easiest ways to maintain and even increase your business’s recurring revenue is to create a product or service that increases in value as more customers join.
Amazon, PayPal, and eBay are just two examples of the network effect in action.
Best Practices to Generate Recurring Revenue
If you’re unsure of the best way to implement a recurring revenue model for your business, here are several important tips to help you get started:
- Keep your prices low. While I don’t always follow this rule, it’s often easier for customers to commit to paying a manageable amount each month.
- Stress the benefits of your products and services. When following up with customers, list at least three benefits so that they are reminded of their value.
- Make payments easy. Today, most customers are used to automatic charges. The more payment methods you can offer, the better. This will save you time, too!
Determine whether a contract is the right option for you. While a contract will guarantee a longer period of recurring revenue, it may deter customers—depending on your products, services, and industry.