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!
