The 7 Levels of Recurring Revenue
It will probably come as no surprise that the most financially healthy companies put tremendous emphasis on having recurring revenue streams. The higher the level of recurring revenue, the more predictable your revenue stream becomes. The more predictable your revenue stream, the better you can scale your operations. The higher the level and the greater the volume, the higher your valuation goes. Every company should always be asking, “How can we strengthen our recurring revenue position?”
Are you looking at recurring revenue in the right way? Which type of recurring revenue drives and increases your business valuation the most?
The fact is, not all recurring revenue is equal. Think of it as a pyramid. The higher up the pyramid you move, the more valuable your company becomes. Think of the pyramid as a way to first increase consistency and predictability, then business scalability, and ultimately market-share dominance where customers find switching to a new provider more costly or problematic.
Let’s take a look at seven different levels of recurring revenue. Each one is important to understand.
Level 1 – Basic Repeat Customers
At this level, you have customers that like doing business with you and repeatedly come back to you even though there is no contractual obligation to do so. Good examples at this level are a supermarket or a gas station. The problems with Level 1 are that the barriers and switching costs are usually low. So, while having repeat customers is far better than not having them, your revenue stream remains risky because you can’t count on your customers stick with you.
Many firms in this mode have built loyalty programs or personally-branded products to create stronger brand preference and make their offers “stickier.”
Level 2 – Network Effect
At this level, the more someone uses a company’s product or service, the more each customer gets out of the experience. This “network effect” creates a barrier to that customer leaving, namely, the perception that no other network is as good. Automobile Association of America (AAA) Membership and American Association of Retired Persons (AARP) are good examples.
You may consider joining other networks, but for anyone who is already a member, it makes no sense to switch because their membership bases are so large that their value streams have paid their members back in multiples. With that said, the cost of switching is still low, and while you can differentiate who is in your network, everyone has access to multiple networks that can provide similar benefits.
Level 3 – Capital Investment with Consumables
In this case, a customer has invested in a product, and now they need to keep buying consumables to support their investment. The longest-standing product and stickiest product in this category is the copier. Other followers to take advantage of this strategy have been desktop printers and coffee machines, like Keurig. However, these later examples failed to be as sticky because the price point to buy new ones at the consumer level is not high enough to prevent someone from jumping ship. Consumables are usually a high-profit, recurring revenue item.
Level 4 – Capital Investments – Subscriptions
At Level 4, customers make a sizable investment in capital equipment and then pay subscriptions to use it. In this case, they usually do not buy the equipment. They lease it due to the significant expense for the equipment, software, maintenance, and upgrades required. Great examples are WestLawNext or Bloomberg, which are staples in the legal and investment communities.
Level 5 – Sequenced Product Purchases or Service Subscriptions
This approach aims to create recurring income by encouraging your customers to upgrade to new product and service offerings consistently. Consider Google Drive. It starts free. As you begin to use it more and more to store your data, you eventually run out of free space and must pay to upgrade for more storage. Next thing you know, you are using Google Photos, and they have captured another revenue opportunity. Even if the company only converts a fraction of its customers over to the premium service, it can create an extremely valuable recurring revenue stream.
This revenue stream tends to be stickier because your customer prefers (i.e., knows how to use) your product, and the cost of switching in terms of time, effort, and costs outweighs the simplicity of staying with the current vendor.
Level 6 – Good-Until-Canceled Revenue
At this level, the customer stays with you month-to-month, year-to-year, until they decide to take their business elsewhere. The best examples at this level are bank accounts and credit cards.
For instance, I hate my bank. They send me a new credit card almost every four months because of their so-called “fraud protection” department’s suspicions. So every four months, I have to change every recurring payment assigned to the old card number. It is a nightmare! Plus, they send policy changes every six months, usually raising fees and reducing benefits. But do we change providers? No, because of the trouble and loss of credit history. How often do people cancel their credit cards or close a bank account? Credit cards or bank accounts have a powerful way of keeping customers over the long haul.
Level 7 – Longer-Term Contracts
The longer the contract, the better! Think about the contract you signed when you got your new cell phone. I do not know about you, but when I signed on with my cell phone provider, I feel like I married the mob! Not only do you agree to pay a certain amount of money each month depending on the plan you select, you usually agree to keep paying for two years. Then, at the end of the contract, it usually takes too much to switch providers, so you stay.
This is an extremely valuable model because you can predict with a higher level of certainty what your recurring revenues will be both in the short-term, as well as over the longer-term.
How Many Revenue Streams Do You Have?
So, as you examine your business, how many of these revenue streams do you have? How many others could you create in your business? It’s time to get creative and strengthen your place in your business space!
At Activate Group, we love to roll up our sleeves alongside our clients to determine the opportunities your company has for multiple revenue streams (as well as other challenges you may be experiencing). Schedule your FREE, 30-MINUTE CONSULTATION to see how we might be of service. Let us help your business evolve and grow during this pandemic.