Recurring Revenue

One of the biggest factors in determining value is the extent an acquirer can see where sales will come from. The existence of recurring revenue provides evidence of future revenue and so increases the chances of receiving a good offer for your business.

A recurring revenue stream acts like a lens into the future. Where you can see months or indeed years into the future, an annuity stream is created. It is one of the best ways to increase the desirability and value of your business.

From the buyer’s perspective there is a hierarchy of recurring revenue. The more certain the future revenue stream will be the greater the attraction of your business to the buyer. These types of recurring revenue streams are, in order of certainty.

1. Contracts (e.g. wireless phones)

Like you, I do not like being tied to contracts. However, sometimes there is little choice and the telecoms companies are very adept at the art of generating recurring revenue. Many give customers free phones if they lock into a two or three-year contract.

2. Automatic-renewal subscriptions (e.g. storage)

Whether it is document storage or furniture there are several storage companies operating in the Stevenage area. Access Self-storage, safestore to name but two. In these arrangements you are charged a fee each month as long as you continue to use the service.

3. Sunk-money renewable subscriptions (e.g. Bloomberg)

Some individuals are addicted to their online terminal for accessing financial data. First, you have to buy or lease the terminal in order to subscribe to Bloomberg’s financial information.

4. Renewable subscriptions (e.g. magazines)

It is normal for the subscriptions to be paid for in advance. This creates not only a positive cash-flow in advance of costs but may also be effective in locking-in subscribers.

5. Sunk-money consumables (e.g. razor blades)

This is where the customer first makes an investment in a platform. It is rather like Bloomberg but with more competition and choice. So, once you buy a razor you have a vested interest in buying compatible blades and this will lock you in for a period of time.

6. Consumables (e.g. shampoo, toothpaste)

Similar to razor blades but no platform. Again, they are disposal items that we need regularly. However, there is no motivation to repurchase from one seller or brand loyalty.

I am not pretending it is easy to create recurring revenue. A good example of this was a company I helped to sell. Their products lasted 10-20 years. They had examined this idea by considering site visits after 5 years or so. These only worked to a small extent.

Here is an example, Amazon. They have demonstrated with their Prime Service the spend per year of a prime subscriber is over double that of a non-prime subscriber.

Implication on value

It is not all plain sailing, here. Consider the costs of acquiring a customer; their life-time value and your margin on the revenue. Where the life-time value of the customer barely covers the cost to acquire, the value is not much. Where it is five or even ten times the cost to acquire, then that income stream will have value to a buyer.

So, let’s look at a couple of examples:

Example 1

• Cost to acquire an average customer: £2,000
• Marginal Revenue per customer: £500
• Churn rate*: 10%
• Gross profit: 75%
• Lifetime Value of the Customer**: £3,750
• Lifetime Value to Cost to acquire: 1.875:1

So, that is not viable in the long term.

*Customer churn, or customer turnover, refers to the number of customers you are losing in a predetermined time period. Churn rate is important to know. If you are unaware of how many customers are leaving the business, then you will not be able to assess how it’s impacting your revenue. When the buyer carries out their due diligence, they will not be able to verify your improvement plans to reduce the churn rate.

** Calculated as follows: 100/10% = 10 years. Contribution £500 * 75% = £375.

    Lifetime value = 10 * £375 = £3,750.

Example 2

• Cost to acquire an average customer: £300
• Marginal Revenue per customer: £3,000
• Churn rate*: 10%
• Gross profit: 80%
• Lifetime Value of the Customer**: £2,400
• Lifetime Value to Cost to acquire: 8:1

This is more viable.

Loyal customers who value the service given to them provide more scope to increase prices.

So, bear in mind when you put your business up for sale, it is the future you are selling not just the present. As difficult as it is to generate, consider how best to create a recurring revenue stream. given your type of business. It will increase the predictability of your revenue, the value of your business, and the interest of potential acquirers as they look to the future.

Here is an example I came across in the IT support sector:

A monthly program was designed offering business clients ongoing protection from technology problems. It was in the form of ongoing remote monitoring of their networks, pre-emptive virus protection and staff on call if there was ever a problem.

Each client was approached showing a calculation of what they had spent with the business over the most recent 12-month period. These numbers also included an estimate of the cost of the customer’s downtime. So, a case was made by signing up for the monthly programme, the customers would save money when taking into consideration both the hard costs of the support and the soft costs associated with downtime.

Over 75% of the customers switched from hourly billing to the monthly program.

Next the personal consulting rates were doubled. So, when one of the customers who decided not to opt into the monthly programme called the business, they were quoted one rate for a technician’s time or twice the price to have the personal consultation. As a result, more customers opted for the cheaper option and others chose to reconsider their decision not to sign up for the monthly programme

Finally, there was “survivor clause” in the monthly contracts. It stipulated that the obligations of the agreement would “survive” a change of ownership in the business.

The business was successfully sold at a price that was more than four times the original valuation just two years prior to launching the monthly programme.

Could a Recurring Revenue stream work for your business?

There are many recurring revenue models and recurring revenue is just one of the ways you can add value to your business.There are other ways to do this and to find out more go to “How do I maximise the value of a business” here on the website.

There is also a page What makes a business more sellable which you may also find of interest.