The Power Behind Recurring Revenues – Nick Gaskell
Just about everyone has heard the old adage ‘cash is king’. A company that is illiquid (short of cash) is in far more trouble than a company that is liquid but unprofitable. What is less understood is the importance of a recurring revenue model for modern businesses. Many venture capital and private equity investors look for new business models that utilise recurring revenue opportunities because they provide businesses with consistent cash flow on a monthly or quarterly. Even more appealing when the business has a low churn rate, which is the percentage of customers that stop consuming the service or product. To an investor, recurring revenues is a validation of a sustainable business model. Recurring revenues are also not only associated to venture capitalists and start-ups but are extremely relevant at all sizes and types of business. Advancement in technology, supply chain sophistication and payment services over the last two decades have transformed subscription-based business models across multiple industries. In some cases, companies that have failed to adapt have ultimately gone bust.
The subscription business model, by which customers pay on a recurring basis makes sense for the SaaS industries but it has seeped its way into many more industries beyond software. Amazon Prime is an obvious example but the brick-and-mortar equivalent, Costco is a fierce competitor of Amazon and also operates a subscription model. However with a twist, to shop at Costco unlike Amazon it is mandatory to be a member, $60 a year or $120 for the executive members. That fee provides Costco with about 75% of its annual revenue, with 90% of customers renewing their membership each year — a very healthy churn rate. Despite similarities on the surface Costco is operating in a completely different paradigm to retailers like that of Sears, JCPenny and Radioshack. Costco has developed a subscription model that enables it to add value to the customer experience with the comfort of recurring revenues.
Streaming is a typical marketplace to find subscription models. For example, streaming services for films and series via Netflix, Amazon Prime and Hulu or music streaming platforms such as Spotify and Apple Music. The model also applies to news media such as Bloomberg or WIRED and to sports brands too, UFC Fight Pass is a shift away from the traditional TV box office model that DAZN is now integrating into boxing. The model is even prominent in grooming companies like the shaving product bundles from Harry’s. Even the hybrid product and SaaS company, Whoop, offer ‘free’ sports straps that monitor sports performance and sleep metrics however access to those metrics is a subscription of $30 a month. Since 2012 the company has raised $49.8 million across five funding rounds.
Recurring revenues are the consummation of the old adage ‘cash is king’. Businesses must continuously evolve to their changing market environments. Subscriptions create brand loyalty and stickiness, the model allows the business to financially model for a fairly accurate and smooth rate of cash inflows and focus efforts on pleasing the customer once they are subscribed. Costco does this by limiting the margin at which it prices goods, ensuring they remain price competitive and maintain brand loyalty. Along with a generous return policy and free samples. Spotify and Apple Music battle it out for exclusivity for the latest music releases and podcast series to satisfy customers while Netflix and Apple TV are pouring billions of dollars into original content. Albeit a subscription model does not necessarily develop a sustainable competitive advantage, as the subscription itself is not a barrier to entry. In fact, many of the subscription model industries are replicable. However, understanding how a subscription model will shake up a respective industry is imperative to success. You only have to look as far as the dinosaur retailers and the iTunes store to realise how disruptive the model can be and how powerful recurring revenues are.
Keeping churn low and customers happy, means recurring revenues are sustainable. As long as businesses can ensure a certain level of recurring revenues and manage associated operating expenses, they can rely on a cushion of financial security in the short-term at least. Cash is king.