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Learn moreWith the consistency of a steady income stream, your company can effectively manage expenses, plan for growth, and invest in the future.
By Mike Aaron
Senior Director, Salesforce Revenue Cloud
October 11, 2024
Few things are more satisfying than seeing the numbers go up as money drops into your account — on repeat. A recurring revenue model means reliable income coming in at the same time, month after month, quarter after quarter, year after year. If you're operating under a usage model, with customers paying only for what they use, you might consider a switch.
But will your clients pay for an ongoing subscription? Can your website and payment systems accommodate that? And will you be offering your customers an ongoing value they can't easily find elsewhere? Read on to learn if a recurring revenue model fits in with your revenue lifecycle management software and the ways it can drive revenue growth for you.
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Recurring revenue refers to the predictable and recurring revenue derived from a company's products and services. It is a sales model that brings in consistent, reliable income streams by charging customers for ongoing services. With the dependable cash flow that recurring revenue provides, companies are in a position to make better financial decisions for their businesses.
It also projects a company's stability to potential investors.
Recurring revenue is a good indicator of the health of a subscription business. It's revenue that a company expects to repeat, so it can measure progress and predict future growth. It is useful to measure the momentum of new sales, renewals, and upgrades. Recurring revenue can also reveal lost momentum, downgrades, and customer churn.
A recurring revenue strategy has one obvious benefit: a predictable and stable cash flow. Unlike traditional sales models that rely on one-time purchases, recurring revenue ensures a steady income stream. This kind of consistency makes it easier for companies to effectively manage their expenses, plan for growth, and make investments to their business.
Other benefits include:
There are almost as many recurring revenue models as there are types of businesses. Companies have become increasingly creative in adapting their businesses to a recurring revenue model to take advantage of its many benefits. Some of these models include:
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A recurring revenue model is a great way to build a reliable revenue stream and build long-term relationships with your customers. But before you commit, be sure to go over every aspect of your business to make sure it's compatible with a recurring revenue model.
First things first — do your customers want a subscription business model for your products or services? Conduct surveys or focus groups with your current customers to gauge interest.
Do your competitors offer a subscription model? See if it's working for them — and how you can improve on their service.
Other considerations include:
Monthly recurring revenue (MRR) is a metric that most teams should closely monitor each month. MRR breaks the revenue into monthly increments, offering a more immediate view of trends. It's useful for spotting short-term fluctuations and making quick adjustments. It gives you a peek at how well your sales team and marketing efforts are performing, whether your business is effective at customer retention, and if any recent product launches, updates, or pricing changes impacted customers.
Generally, companies look forward to month-over-month increases in MRR to compound their growth and progressively scale their business and revenue operations. To do so, companies focus on nurturing loyalty among customers to minimize churn and increase average client billings. Customer acquisition is an important factor, too, but retention is a higher priority, since high turnover can quickly undermine even the most successful acquisition campaigns.
For long-term planning, most companies look at annual recurring revenue (ARR) to help them project cash flow, determine budgets and investment decisions, and build their roadmap. ARR is the total revenue a business expects to earn from its subscribers in a year. It helps companies make strategic decisions and forecast long-term growth. This gives them a baseline expectation of how much revenue they'll generate over the next 12 months. However, it's more important that they consistently improve MRR to outperform any earlier annual revenue forecasts.
As more organizations adopt subscription sales models, it's important to understand how to calculate recurring revenue. The easiest way to determine monthly recurring revenue is with the following formula:
New customer subscription revenue
+
Existing customer subscription revenue
+
Add-on and license upgrade fees from existing customers
-
Lost revenue from churned customer accounts
-
Lost revenue from license downgrades or removed add-ons
New versus existing customer subscription revenue: It's important to distinguish between new and existing monthly subscriptions. This allows your business to evaluate the average duration of customer accounts separately from an upcoming anticipated turnover. Otherwise, you might assume that all customers from one month will fully carry over into the next, and for an indefinite period. By operating that way, you don't account for client churn.
Add-on and license upgrade fees: When appropriate, your account managers and product marketing specialists should encourage customers to upgrade their licenses and add on premium paid features.
Lost revenue: Naturally, customers come and go. Some might end their subscriptions, while others may downgrade to a free or less expensive plan. In any case, business owners and sales managers have to account for all these variables when calculating monthly recurring revenue.
Be aware that in most subscription-based businesses, customer acquisition and churn happen consistently throughout the year. But that's not always the case. Pay attention to potential seasonal fluctuations when making your calculations. For example, if your company provides bottled water to offices, average order sizes may increase during the hotter months of the year.
You've already done the hard part. Once you've calculated MRR, multiply your monthly recurring revenue by 12 (for the 12 months of the year) to get your annual recurring revenue.
Here's the formula:
monthly recurring revenue (MRR)
x
12 months
=
Annual recurring revenue (ARR)
Now that you've committed to a recurring revenue model, you'll need to analyze a new set of numbers to understand the health of your business. Here are some key sales metrics to monitor:
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Subscription-based business models make recurring revenue easy and predictable. At the same time, providers are accountable for delivering consistent value with their product or service, companies can access usage data to better innovate their solutions, and technology streamlines the onboarding process while providing self-service upgrades.
Furthermore, subscription-based billing has created more accountability among sellers. Because most customers aren't tied to long-term contracts with complicated termination clauses, businesses are expected to deliver consistent value and reliable service to their clients month after month.
Usage data becomes crucial to measure, too. For example, you need to monitor how much customers use your platform, which features they enjoy the most, and which they use the least to inform the company's product development plans. Companies have worked hard to make it easier for prospects to quickly adopt their platforms, lowering the potential friction otherwise caused by switching costs.
Technology has also made it easier for buyers to sign up and start using a new subscription service. They can often seamlessly add on extra features each month or upgrade their subscription tier using a business's self-service platform. This minimizes the need for account managers to frequently upsell users.
Beyond simply calculating and monitoring MRR and ARR, companies can employ a few strategies to drive growth.
To keep track of all of these metrics, it's helpful to use customer service management (CRM) software and analytic tools.
CRMs can store customer information — things such as contact details, purchase history, and subscription status — in one central location. This helps track customer behavior and preferences, which is essential for understanding the reasons behind retention and churn.
CRMs can also automatically generate reports on key metrics, providing real-time insights into the health of your business. They allow you to segment customers based on criteria such as subscription type, usage patterns, and engagement levels.
Analytic tools can integrate data from multiple sources, providing an omniview of your business performance. These tools also offer customizable dashboards and advanced reporting capabilities, allowing you to identify trends and make informed decisions on the fly.
Combined, CRM data and analytics can help with customer retention, improved financial management, and data-driven decision-making.
Recurring revenue has steadily gained in popularity as a business model for a reason — it provides a steady cash flow. It also encourages customer loyalty, provides accurate forecasting, and transforms businesses from being reactive to proactive. Perhaps most important, though, it fosters an environment that builds meaningful, long-lasting customer relationships.
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