Recurring revenue (or rebilling, monthly billing, periodic billing, repeat billing, whatever you want to call it) is a business model based on charging monthly fees for a service. This term is most often applied to software as a service applications, but also applies to brick-and-mortar businesses such as insurance agencies and bank fees. Recurring revenue allows a company to grow revenues exponentially quicker than single-sale based products such as app-store purchases or trips to Whole Foods.
One of the most exhilarating parts of running a business with a recurring revenue model is watching the number of customers grow month to month and the seeing the corresponding growth in projected monthly revenue. A business that brings in just $500/month, but adds about $300/month will be seeing over $4000 in revenue monthly inside of a year. This kind of growth is entirely possible (and common). Imagine where that business can be in 3-4 years. This may not raise the eyebrows of too many venture capitalists, but it’s a bootstrapper’s dream scenario.
The Recurring Revenue Growth Model
Running a recurring revenue business lends itself nicely to financial modeling and forecasting. Understanding a few variables will let you accurately forecast where your company will be in X months.
Churn rate – The percentage of customers that cancel their recurring accounts each month
Growth rate – Two possibilities here; either the number of users that your company grows by monthly or the percentage of growth, whichever is the most consistent month-to-month.
There’s a big difference between growing by a consistent percentage each month and a static number of accounts. Growing by a percentage, assuming your growth rate is higher than your churn rate, will yield long-term growth to your company. Conversely, if you grow by a static amount, e.g. 100 accounts per month, then your churn rate will eventually neutralize your growth. It may take 3-4 years for the churn rate to catch your growth, but it will happen.
Recurring vs Non-Recurring Sales Comparison
It’s pretty easy to see why recurring revenue is better than non-recurring revenue. For illustration purposes lets assume that company A sells a service for $5/month and company B sells a similar product for $15 single use. Here are a few observations that result from comparing the two companies.
- Company A will need to have customers hang around for at least 3 months to match the revenue generated by company B, per customer.
- Company A only has to make a sale once per customer. Company B has to make the sale every time a customer wants to use the product. Advertising costs clearly fall on the side of Company A.
- All things being equal, company A’s total monthly revenue will quickly surpass that of company B, assuming that company A’s churn rate isn’t overly poor.