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Learn the basics of recurring revenue models, their types, and benefits. Discover why they're attractive to investors and a smart choice for business acquisitions.
Businesses with recurring revenue models are attractive to investors because they generate a stable and constant cash flow, where customers are, in reality, loyal users willing to pay for a product or service consistently.
In this guide, you'll learn the differences between the types of recurring revenue business models, the pros and cons of each, and why they work in specific industries or for particular products.
You'll also see why buying a company with a recurring revenue model is a good idea. Keep on reading!
Recurring revenue business models are commonly used in the software and media industry, where customers pay to access the product or service for a certain period that could span from a month to a year.
The benefits for business owners are that they have a stable and reliable source of income and, overall, a predictable revenue stream. It allows for better financial forecasting and planning and the potential for higher customer lifetime value (LTV).
Although recurring revenue business models can work similarly, they have some differences. Here's a list of the main types, pros and cons, and the industries where you can find them.
The subscription-based business model is among the software and media industry's most popular recurring revenue models. However, it is also widely used in telecommunications, health and wellness, financial services, and subscription boxes. Think of companies that provide digital content or services like Spotify or Netflix.
Businesses that offer continuous improvements or updates to their service can succeed with this revenue model by increasing customer satisfaction and reducing churn.
The subscription model offers a steady income, allows to work on customer retention strategies and enables the creation of different subscription levels and various prices. The downside is that acquiring new customers can mean investing significant resources in marketing, and if the customers' needs aren't met, they can easily cancel their subscriptions.
However, if the company successfully retains existing customers, it can lower customer acquisition costs (CAC) over time. The potential for scalability and long-term customer relationships often outweigh the initial high acquisition costs.
Under this recurring revenue model, customers are billed according to use. Zapier uses this strategy since it charges its clients depending on how much they use the platform. By implementing this model, customers can pay less when not heavily using the service.
Although revenue is variable, companies can still predict revenue based on customary usage patterns and trends. Additionally, companies can often benefit from this model when they have a broad customer base, as it can smooth out revenue fluctuations.
This business model is a good fit for companies that can track customers' use through emails, messages, APIs, or several triggers activated.
With this recurring revenue model, companies pay for the number of users they have on the platform. Atlassian is an example of this strategy. It charges depending on the employees using the service, allowing for scalability and flexibility.
User-based billing also offers predictable revenue based on the number of users, but companies still have to monitor interaction to optimize services, reduce churn, and identify potential upselling opportunities.
A user-based billing model works well for companies offering customer service or team collaboration tools.
The central concept of this recurring revenue model is that it has built-in tiers. Each one is designed for a specific audience and has a price limit. When users surpass the functionalities of their tier, they'll get the option of moving up to the next tier to access more features.
Companies that offer sales or marketing services commonly use a tiered billing revenue model. Hubspot uses this business model, offering plans for professionals and enterprises.
By using this revenue model in your business, you can access a wider audience since it appeals to the needs of different user personas.
Companies using tiered billing models often have robust systems to track and manage customer needs across different tiers.
With a freemium model, customers can access the service without a fee. This access can be for an indefinite time, with a limit on the duration of the free use or with a restriction on the number of features available.
Customers can upgrade their plans to access more features or extend their usage. This recurring revenue model allows users to try the service for free and then convert them into paying customers.
The company needs a good strategy to offer enough value to free users to convince them to upgrade their plan. There must be a balance between providing sufficient value in the free tier and encouraging upgrades.
A significant challenge with the freemium model is the cost of supporting a large base of free users, who may consume resources without generating revenue. Additionally, users may have little incentive to upgrade if the free version is too generous.
A freemium model is suited for companies that can keep their accessible product or services at a low cost.
A hybrid billing model combines two or more different recurring revenue models, such as subscription and usage-based billing. It allows businesses to charge a base subscription fee to access their core services while capturing additional revenue based on how much customers actually use the product.
For users, a hybrid billing model offers greater flexibility, allowing them to have more control over their spending based on use and the value the service gives their organization. It also enables businesses to offer customized plans that can better meet the needs of diverse customers.
The downside is that combining multiple revenue models can increase complexity for both businesses and customers. The challenge is for companies to keep their plans simple and clearly explain to customers their pricing structure. Maintaining transparency and avoiding unexpected charges is key to preventing customer dissatisfaction.
Hybrid billing models as recurring revenue models are particularly well-suited for SaaS businesses.
In a license revenue model, customers pay a recurring fee to use a service, typically software). Microsoft Office or Adobe are good examples of this type of business. Usually, the monthly payment includes regular updates, new features, and customer support.
The license model provides a predictable revenue stream and helps build a long-lasting relationship with customers, which translates to higher customer retention over time. However, users might feel dissatisfied with the product and 'trapped' in the agreement, with limited flexibility to switch to another provider.
To thrive with a license model, businesses must continually develop and introduce new features for existing customers to keep providing value, enhance the customer experience and reduce churn.
Through a retainer recurring revenue model, customers pay a fixed rate to an agency or a consultant. This payment covers business services for a specific period. The retainer model is commonly used by legal firms or marketing agencies, which offer their services over a set period in exchange for ongoing support and availability.
One potential issue with the retainer model is the difficulty in tracking and justifying resources allocation. Organizations may struggle to monitor how time and efforts are managed, while clients may lack clarity or control over how their payments are utilized.
In a membership model, users pay a recurring fee to access a product, service, or exclusive benefits. This revenue model is ideal for businesses that emphasize an "exclusivity" aspect, creating a sense of belonging or special access for members. A prime example is Costco, where customers pay an annual membership fee to shop at the retailer's stores and take advantage of member-only discounts and offers.
Recurring revenue models allow businesses to predict revenue streams, making budgeting and financial forecasting more reliable. With a clearer understanding of future revenue, companies can design more accurate strategies and plan better, ensuring resources are allocated effectively.
The stability of recurring revenue reduces the risk of sudden income fluctuations and gives them room for innovation and development of new features that add value to their existing customer base.
A recurring revenue model naturally supports higher customer retention by fostering long-term relationships. As businesses continually improve their services, users are more likely to remain subscribed, recognizing the ongoing value provided.
The predictable pricing structure and regular updates reduce the likelihood of cancellations, as customers feel that they are consistently receiving benefits that justify their subscription. Moreover, a commitment to improving customer experience directly contributes to lower churn rates, creating a stable and loyal customer base.
Businesses with a traditional pricing structure rely on constantly acquiring new customers and different strategies for customer retention. This can be costly over time.
In contrast, recurring revenue models enable companies to nurture a core group of loyal customers who are likely to continue using the service for a long time.
This focus on customer retention over constant acquisition leads to a reduction in customer acquisition costs (CAC) over time. As a result, businesses can redirect resources towards enhancing customer satisfaction, driving long-term growth, and increasing customer lifetime value.
Boopos lists businesses for sale with recurring revenue models like SaaS and subscription-based businesses. Find a recurring revenue business and become an owner!
