The highs and lows of a recurring revenue business model
Things always seem to go in cycles: recurring revenue - pioneered by milkmen and newspapers - is now one of the trendiest models for a new generation of CFOs and FDs.
In AccountingWEB’s recurring series My Key KPI, it’s been notable how many finance professionals have referred to - either directly or indirectly - to recurring revenue models: monthly recurring revenue (MRR), churn, customer lifetime value (CLV).
Recurring revenue is desirable for numerous, obvious reasons. It’s easy to forecast future cash flows and budgets, it’s easy to scale, it keeps customers engaged by necessitating high touch service.
“We’re a highly recurring business,” said Elona Mortimer-Zhika, the CFO of IRIS. “So customer retention is huge for us. We hope every customer will stay with IRIS for a very long time.”
Similarly, for MarketInvoice’s Neha Mittal, customer retention is a key part of the story that the company tells investors. “So hypothetically, if I acquire 20 customers at the beginning of last year. I would look at the data to see how many of those customers continue to trade with at the beginning of this year.
“So if 15 of that 20 continues to trade with me, that’s a 75% retention rate. I’m happy with that.”
The industry you’re in also adds a layer to the metrics you use. Market Invoice is an intermediary service helping businesses to sell their unpaid invoices to provide working capital.
So one of Mittal’s favourite measures is the volume MarketInvoice is funding. “Because that overall number is showing us how companies we’re helping and how quickly we’re growing.”
What are the challenges of a recurring model?
“Our model depends on every customer staying with IRIS for a very long time,” said Zhika-Mortimer. One of the chief risks of a recurring model like this are customers cancelling their subscriptions.
AOL famously teetered on the edge of oblivion a few years back when over 100% of its revenue came from 2.3m people forgetting to cancel their $20 dialup subscriptions. AOL let their subs model go stagnant, and it nearly destroyed the business.
It’s highly competitive, admitted Zhika-Mortimer. “We spend millions of pounds in engineering to keep us compliant and add value-added tools to our customers.” These investments are crucial in maintaining consumers.
But some churn is inevitable - and it’s here where having low revenue concentration becomes important. “IRIS is different to my previous business where 80% of my business came from my top 20 customers. IRIS is a very resilient business: the top 20 customers are less than 5% of the business.”
Losing a customer is never good, said Mortimer-Zhika, but a low revenue concentration means it’s not a death knell. The diversified customer base does make it difficult to profile and know your customers, though.
For Duncan French, the CFO of the startup energy and gas supplier People’s Energy, the monthly revenue model produces numerous headaches. “Over the winter months, your energy usage is higher - but your Direct Debit will remain flat over the all year,” he said.
“It places a huge cash stress on the business.” If a customer is acquired in Winter, People’s Energy is effectively subsidising them and the difference will be made up in the summer when energy use is lower.
But with people switching so quickly, it can become a big problem. “We’d rather get money up front at the start of winter,” French said. And some suppliers do apply a winter weighting to their prices, but this is often highly unpopular.
The unit economics of a recurring model
Netflix - which now has over a 100m subscribers worldwide - started as an online DVD rental store. This model ate up the competition and built a healthy network of customers. It then took this momentum and launched its online streaming service to keep up with customer demand.
It’s a truism that it’s easier to sell new products to existing customers, rather than new ones. And a successful recurring model is built on this. Lowering your cost per acquisition for new customers, while increasing the lifetime value of existing customers is how recurring businesses break even.
“We have regular time set aside to focus on MarketInvoice’s finances - but I also make sure I work with the other leaders in the company on the product side,” said Mittal. “What new markets should we going into, what new products should we be launching?”
MarketInvoice recently launched two new products: unsecured business loans, and confidential invoice discounting product. “I was heavily involved in both cases thinking about profitability, unit economics, and building a business case.”
It’s not only acquisition of new customers, but extending the lifetime value of existing clients. The finance function is central to achieving this, said Mittal. “As the CFO or FD, increasingly your remit isn’t just controlling the finances. It’s the strategy. What are we investing in, what should we be doing to be more competitive?
“These conversations can’t happen without the finance function. The finance team creates the reports around how the business is performing monthly, weekly, yearly. We as finance directors have a unique perspective on what profit there is to be made and how can we enable the company to grow while serving our customers.”