By Dennis Zink
You open your doors for business and you wait until a customer arrives. Wouldn’t it be wonderful if you started your month with a large contract base that covered your rent or overhead? What if that revenue was there every month, like an annuity?
Recurring revenue streams consist of predictable revenue sources that are expected to continue into the future. Annual recurring revenue or ARR is a beautiful thing. Rather than beginning your month or year at zero dollars, you have a starting base.
If a business can monetize its existing customer base by establishing long-term relationships, it will be way ahead as compared to selling onesies. When you decide to sell your business, recurring revenue takes center stage.
“When you have a recurring revenue business model, you rarely miss your monthly or quarterly numbers by more than 10 to 20 percent,” Jeff Bussgang writes in his book, “Venture Capitalist.”
“Your forecasting process is much more accurate,” he continues. “At the beginning of the quarter, you start with a base to grow from rather than begin at zero. In a SaaS (software as a service) or subscription software business, you can predict your churn rate and new business closings to determine your growth rate. The management team and the investors are thus rarely surprised by major fluctuations in your results.”
Consumers are demanding new consumption models. There are various types of recurring revenue models:
Annual Contracts – Both phone providers and cable tv contracts provide good examples of ARR. Penalties for early termination lessen premature cancellations.
Evergreen contracts – Contracts that continue “forever,” such as document storage.Example: Ross Perot’s successful company, Electronic Data Systems, created a revenue model named Business Process Outsourcing. This model placed IT employees in contracted positions and reaped a healthy profit percentage from those contracts. The contracted employees became so valuable to those companies that they could barely do without them. These contracts renewed perpetually.
Product purchases and consumables – Buy a Nespresso coffee machine and forever buy the coffee capsules from them. Keurig beverage pods are widely distributed and available from many sources other than Green Mountain, which happens to own Keurig. Think about the toner for your Dell or HP printer.
Subscriptions – Magazine subscriptions are generally available for one-, two- or three-year terms. Although magazine subscriptions are paid in advance, revenue cannot be recognized until each issue is delivered. Subscription revenue must be carried as a liability until earned.
Long-term contracts – Term insurance policies lasting 10, 15 or 20 years provide a steady revenue stream. Sales commissions can provide a trailing annuity to the insurance agent.
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