Thursday, December 12, 2013

Recurring Revenue

For businesses, recurring revenue, or re-occurring revenue, is the opposite of ‘one-time’ revenue.

Simplistically defined, recurring revenue should be continuous and/or predictable.

People sometimes regard regular one-time revenue as being recurring.  A business may do different work for (or sell different products to) the same client, every month, for varying fees (based on work effort or product)... kinda like me shopping at Costco ($COST) every month.

The example above demonstrates regular business with a loyal client, which is obviously good, but ≠ recurring revenue.  To be viewed as recurring, revenue should be pre-determined and predictable, like a contracted, monthly support fee.

When helping to create a business plan to secure a round of financing, or valuing a business for sale, we first inquire about current, predictable, recurring revenue streams... ideally generated under contract arrangements with clients.

Recurring revenue streams allow for the use of sophisticated accounting valuation methodologies, like Discounted Cash Flow (or DCF).  However, DCF can be as vague as one would like it to be.  No different to asking your CPA “What is 1 + 1?” and having her respond with “What would you like it to be?”

Let’s explore a few different types of recurring revenue, some more predictable and/or preferred than others.

(1) Recurring revenue on consumable products

An example of this may be a client purchasing a very expensive coffee machine.  An investment in expensive equipment - which some valuation experts informally refer to as sunk money - usually indicates that clients would also likely be willing to buy the consumable product (in this case coffee packets, or brewing cups), on a recurring basis.

The manufacturer of the coffee machine has therefore created an after-market recurring revenue stream that is somewhat predictable (barring market conditions, competitor entry, etc.).  This example illustrates a business-to-consumer model.  Valuations for business-to-business sales models are often valued higher (described below).

(2) Subscription revenue

At its most basic, examples include a subscription to a magazine, professional association, membership of an organization, etc.  A publisher of a magazine may be able to share subscription numbers with would-be advertisers, thereby creating an opportunity to generate greater one-time revenue from advertising clients.  Client subscriptions, on the other hand, would generate recurring revenue for the magazine's publisher.

(3) “Sunk money” subscriptions

This indicates - unlike the magazine subscription example above - that a subscriber has had to make some kind of an investment, in order to subscribe to the service.

An example of a ‘sunk money” subscription would be a stock trader (or financial advisor) who had made an investment in (or sunk money into) a Bloomberg Terminal, providing up-to-the-minute information about stock market activity, as required for his or her business.  It’s unlikely that the trader would stop payment for the ongoing subscription, when they had invested in the underlying terminal required to support their business.  Today, a Bloomberg Terminal is a software solution, rather than a physical terminal.

A financial advisor paying a recurring Bloomberg Terminal subscription would likely be a more reliable revenue source, than a coffee-by-the-cup retail client, buying consumables for their Nespresso coffee machine!  However, Nespresso also offers club membership… hmmm, good coffee + recurring revenue!

(4) Evergreen recurring revenue

This arrangement is common for companies that provide services that can be cancelled at any time.  Companies like Iron Mountain ($IRM) or Cintas ($CTAS) have predictable revenue streams.  They deliver services to clients on a regular basis, over a regular and predictable billing cycle period.

(5) Contracted recurring revenue

Arguably a Best Practice business strategy:  Contracted clients pay monthly or annual fees for a certain period, e.g. 2-5 years.

Today, this type of recurring revenue is often referred to as a user license subscription fee business model.  It is almost standard business practice for SaaS - Software as a Service - technology companies, e.g. SuccessFactors (An $SAP Company), or SalesForce ($CRM).  A common consumer example would be a 2-year Verizon ($VZ) mobile phone contract.

Several overlaps exist in the descriptions above.

One could say that subscription = evergreen = contracted recurring revenue.  But, subtle (and/or not so subtle) differences can also be observed in the examples offered.

Consider evergreen ≠ contracted, based on a termination clause.  A client may be able to cancel an evergreen agreement within 30 days at no cost, whereas a contracted client canceling an agreement may be subject to the entire remaining and/or outstanding fees, as per the agreement.

I trust that the information will be beneficial to entrepreneurs, especially the start-up technology geeks who ask questions related to pricing their products and services, on a regular basis!

Wednesday, December 11, 2013


"The trouble with quotes on the Internet is that you can never know if they are genuine" 
- Abraham Lincoln
First, some technical stuff:

Bitcoin is digital currency.

Bitcoin is an open source payment network.  Open source is a model that promotes universal access via free user licenses to the product's design or blueprint, and allows universal redistribution of that design or blueprint.

Bitcoin is a peer-to-peer payment network, meaning that tasks (e.g. searching for files or streaming audio/video) are shared amongst multiple interconnected peers, who each make a portion of their resources (like processing power, storage, bandwidth, etc.) available to other network participants, without the need for centralized coordination by servers.

Transactions transfer bitcoins, the individual units of currency, between Bitcoin addresses derived from public keys.  To spend the funds associated with an address, a user must broadcast a payment message that was digitally signed, with the associated private key. 

Transactions are verified by a decentralized network of computers globally.  These computers use a unique system to prevent people from copying and spending the same bitcoin multiple times.   Operators of these computers are called miners, and they are rewarded with transaction fees, and newly minted bitcoins.

Now, the fun stuff:

Bitcoin was supposedly created in 2009 by Satoshi Nakamoto.  However, the name "Satoshi Nakamoto" is a pseudonym for the unknown person or people who designed the original Bitcoin protocol in 2008 and launched the network in 2009.

Investigations into the real identity of Satoshi Nakamoto have been attempted by The New Yorker and Fast Company, but unsuccessfully, to date anyway.

And now, even more fun stuff:

Last year The Economist reasoned that Bitcoin has been popular because of "its role in dodgy online markets."   And earlier this year, the FBI shut down Silk Road, a service specializing in illegal drugs (after which the FBI took control of about 1.5% of all bitcoins in circulation).

However, bitcoins are increasingly being offered and used as payment for legitimate products and/or services.  Incentives for merchants include lower transaction fees, e.g. 2-3% less than typical credit card processing fees.

Speculators have been attracted to Bitcoin, fueling volatility and price swings. As of November 2013, the use of Bitcoin in the retail and commercial marketplace is relatively small.  On the other hand, the use of bitcoins by speculators is relatively huge!

These speculators expect the currency to increase in value as its popularity widens.  But, bitcoins really lack any intrinsic value (underlying fundamental value as an investment vehicle), because the value of bitcoins depend only on the willingness of users to accept them.

Some investment funds have shown interest in Bitcoin.  Recently Peter Thiel's Founders Fund invested $3 million.  The Winklevoss twins – of Facebook fame – are said to have made a $1.5 million personal investment.

As for BesterInvestor… no position, while I watch the drama unfolding, with my sense of humor still intact!

Tuesday, December 10, 2013

Fire Your Client

That’s right… I said “Fire Your Client”

Many business leaders will tell you that their business, like many other businesses, abide by the 80/20 rule.  As in, for example, 20% of the clients contribute 80% of the revenue.

Simplistically, one could automatically argue that the business should immediate fire the 80% of clients that contribute the lesser portion of revenue… and focus on better serving the 20% of clients that are actually paying the bills.

Why then, do we try to retain an unprofitable portion of our client portfolio?  Well, the answer to this is no different to why we – at a more personal level for example – would elect to stay in a home we cannot afford, drive a car not reflective of our needs, and so on. 

Appearance!  As in, “we have the most clients”, “we’re the largest vendor of XYZ”, “we generate the highest revenue” (probably also the most unprofitable, but who’s counting?).

A while ago I spoke with a client of mine (representing a major financial institution) and asked a couple of questions during our normal business chit-chat:
Q:  How many clients are you currently serving via your business unit?  A: 330
Q:  On how many of these are you actually making money (aka profit)?  A: less than 100
Q:  Why don’t you fire the other 200?  A: Because then they’ll go to my largest competitor!


Just let them go!  At best, your competitor will then lose money instead of you.  Ah… but it’s not that simple, right?  If a flood of clients exit your current client portfolio to go to a competitor, it may appear (to the marketplace) as if clients had e.g. lost faith in your ability to service them, causing others (like the 20% you wish to retain), to also depart.  And that’s not at all desirable!

What’s the answer then?  There are a couple of methodologies one can employ that may prove to be less disruptive to a business overall, when firing clients.

(1)  First communicate your intent to the 20% (the keepers).  Meaning, if you tell a few larger clients that you plan to cull some smaller, unprofitable clients from your client portfolio in order to serve them, the keepers, better… they’ll likely be happy, rather than feel at risk.  No?

(2)  Also communicate your plans to a smaller sub-section of the 80% (non-keepers), who could perhaps potentially be viewed as keepers.  Why?  To ensure they understand that a business needs to be profitable, in order to support a good, sustainable and mutually rewarding business relationship. 

Then increase your fees commensurately, so that you can make a profit!  If they balk, fire them.  Heck, you’re losing money on those clients already.

(3)  Simultaneously instruct your sales team to focus only on net, new, profitable revenue.  This may require a strategic shift in sales strategy, including moving away from a commoditized type of sales offering (and related sales compensation plan), and cookie-cutter sales processes/pitches.

The recommendation above is likely to be a more than scary proposition for many business leaders… especially many that shouldn’t have been in business leadership positions to begin with.  And even more so, those leaders more accustomed to wielding a proverbial big stick, preferring to micro-manage salespeople, while lacking the ability to grasp sales as a business profession, conceptually!

Instead of culling the bottom few performers every year (I know Jack Welch, and you’re no Jack Welch), rather hire or train salespeople who have the ability to take your products and services up-market, into higher-paying, profitable client relationships.

Have you noticed that, when you disrupt your organization by hiring the wrong people, top performers leave and your company actually often ends up retaining only the bottom-feeders?  After making senior management changes, always ask yourself the question:  “Are we better or worse off than (e.g.) last year?”

On a more individual or personal level, you are currently selling your services to your employer.  I have to assume that this is a mutually beneficial relationship?  If not, why are you still there?

Your client(s) may be, and usually are, your employer(s).  This rings true whether you are an individual employee, a consultant, or a business providing services/products to clients.  As in, the employer is buying your services for a consideration (paid in money), which in turn makes you wealthier over time. Oh yeah, that’s called capitalism.

If a chasm in strategic direction developed between you and your client, respectively, then you should end the relationship… as in… fire your client!  If you’re delivering services to a client at a financial loss or burden to your organization (or yourself), then fire the client!

A chasm may relate to revenue/fees (as illustrated earlier), future strategic direction, leadership changes, service level commitments/expectations, business risk, etc.; or even combinations of any/all of these.

If you cannot find common ground to resolve these, then you’d be well served… to simply fire your client!  Otherwise, don’t bite the hand that feeds you, and serve your clients to the best of your ability, exceeding their expectations, at every interaction they have with you!