Building a Better Business Model with Recurring Revenues

July 13, 2017

In the past decade we’ve seen many industries flipped on their heads by new brands willing to use creative business models. Innovators like Netflix and Spotify have dethroned market leaders like Blockbuster and iTunes while brands like Air BnB and Uber have carved out niches in some of the world’s most competitive industries.

These brands have succeeded against the odds (and their competition) because their business models are built for rapid but sustainable growth. This growth can teach us a lot, which is why we’re writing a series on the best strategies you can use to take your business model to the next level. We’ve already covered how to keep your customers engaged using switching costs, so today we’ll turn to a new topic: recurring revenues.

Recurring revenues aren't the only way to build a better business model

          Switching costs, like recurring revenues can help build a better business modelCrowdsourcing, like recurring revenues can help build a better business modelScalability, like recurring revenues can help build a better business model

Revenue is a priority for almost every organization on the planet. Brands forecast it, measure it, and have come up with a million and one ways to increase it. The fortunate thing is that one of the best ways to make an impact on revenue is baked right into the business model itself. Many of today’s best brands use their business models to leverage the power of recurring revenues, and this post will show you how to do the same.

We're tackling the big three recurring revenue questions: What, Why and How.

What is Recurring Revenue?

While it might sound like business jargon, recurring revenue is a just term that helps brands identify revenue over and above a one time purchase interaction. Investopedia defines recurring revenue as “revenue that is predictable, stable and can be counted on… with a high degree of certainty”.

Recurring Revenues definition: revenue that is highly likely to continue in the future.

In essence, recurring revenue is money you can trust to come back into your business. Sounds pretty good, right? Well before you go chasing those dollar signs, you should know that there are a few different ways to create recurring revenue for your brand.

1. Create Recurring Revenue with Repeat Purchases

Repeat purchases are a simple but fundamental example of recurring revenues at work. When a customer first makes a purchase, they create revenue for the brand. All purchases after that point, however, represent recurring revenue. The more frequent and certain a customer’s repeat purchases are, the more valuable that recurring revenue stream is to the brand in question.

Starbucks is a great example of repeat purchases as a revenue stream. They fit into their customers’ lives like a good friend, so when a customer buys their morning coffee, Starbucks can be pretty sure they’ll be back again soon.

Repeat customers create recurring revenues. Learn more in our whitepaper

The best part of repeat purchases is that virtually every brand can use this mechanic to their advantage. The more a brand works to encourage repeat purchases from their customers, the more certainty they will have in their recurring revenue which strengthens their business model.

2. Create Recurring Revenue with Subscriptions

Subscription services have come a long way in a short time and they show no signs of slowing down. Whether it’s music, movies, grooming supplies, clothes, or even B2B products, customers can get almost any product or service through a subscription.

Many popular brands like Spotify, Netflix and Frank & Oak use subscriptions to generate recurring revenue

Subscriptions are a win-win for both brands and their customers. Customers get access to the value of a desired product or service on a continuous basis for smaller, regular payments, and in return brands get - you guessed it - recurring revenue. With consistent scheduled payments, subscriptions like Amazon’s are “prime” examples of recurring revenue.

Subscriptions services are a win-win. Customers get affordable payments and brands get recurring revenues

3. Create Recurring Revenue with the Razor and Blades Model

What do Amazon’s Kindle, Nespresso’s home coffee machine, and Sony’s Playstation have in common? Aside from the fact that they’re all components of my perfect Sunday afternoon, they all also create recurring revenues in a very interesting way.

Each one of these products uses the “razor and blades” model popularized by Gillette. The razor and blades model involves selling a lower-margin item (an item that the brand doesn’t make a ton of money on) up front, but then using that product to incentivize continued purchases of higher margin items (the real moneymakers) afterwards.

The razor and blades model is a perfect example of brands creating recurring revenue streams

With Gillette handheld razors, the razor handle is the low margin item while the replaceable blades are the recurring, high margin purchase. In the same vein, the Kindle, Playstation, and Nespresso machine are all examples of “razors” while the ebooks, games, and coffee pods are the repeatable high margin “blades” that follow suit.

Gillete creates recurring revenue through the sale of replaceable razor blades

This model works well because the two parts of the product work together to create value for the customer (ebooks make a Kindle valuable and vice versa). So when a brand sells a base product, they’ve just opened up a revenue stream of consumable purchases that will very likely follow in the future.

4. Create Recurring Revenue with Payment Plans

Some purchases are just too large to complete all at once. To help customers navigate these bigger budget items, many brands allow customers to pay for their products and services over time. In certain industries this isn’t just accepted - it’s the norm.

Auto companies use car payments to create recurring revenues

Payment plans make big purchases more affordable for customers but they’re also instrumental in creating a recurring revenue stream for the brands that offer them. By allowing customers to pay smaller amounts at regular intervals, a brand can more effectively spread out their cash flow and leverage the power of a recurring revenue stream.

 

Why Is Recurring Revenue Valuable?

Now that we know what recurring revenues are and explored some common industry examples, we should probably discuss why recurring revenues work so well in the first place.  While we won’t be able to address all of the reasons in this post, we do have the key three reasons summarized below.

1. Recurring Revenues Smooth the Effects of Seasonality

Every brand has a “favorite season”. For some industries like swimwear or snowboards the literal four seasons directly impact sales but for other brands annual events like Christmas or back-to-school season are their key drivers. This effect is what we call “seasonality”.

Recurring revenues can even out the peaks and valleys that come from seasonality

The issue with seasonality is that periods of high sales activity followed by slower periods make cash flow management a struggle. These brands oscillate between “feast” and “famine” in a way that makes continuous investment in their products and processes hard to commit to. Additionally, tracking period to period sales growth is much harder for highly seasonal brands.

Take a Halloween costume shop, for example. Comparing their sales in October to those in September or November is pointless because approximately 66% of annual Halloween shopping happens within the month of October. For a more accurate indication of their growth trajectory, they’ll need to compare sales in October to previous October sales which, because of the long cycle in between data points, makes rapid iterations or quick adjustments very hard to pull off.

Recurring revenues spread out earning activity over the course of the entire year

Recurring revenues can help smooth out the effects of seasonality by spreading earning activity out over the year. To illustrate with an example, studies show that customers tend to purchase new cars at the end of a quarter. However, that seasonality doesn’t significantly affect auto companies because their payment plans ensure earnings are spread out in regular intervals over the course of multiple years. This allows them to accurately compare revenue growth month to month without the seasonality bias.

2. Recurring Revenues Build Long-Term Customer Relationships

Recurring revenues also help paint a much more accurate picture of a customer relationship over time. For many businesses, customer relationships are something that starts with advertising and other pre-sale initiatives which introduce the customer to the brand, and end with a customer’s successful purchase of a product. While this view of customer relationships isn’t wrong, it also isn’t complete.

For successful brands, the purchase isn’t the end of the customer relationship but rather a new beginning. It’s at this stage that brands can act as product stewards, working to support and delight their customers as they actually use the product as opposed to simply when they’re making their decision.

Apple provides legendary customer support through Applecare and the Genius Bar

Apple provides us a great example of product stewardship through Applecare and their in-store Genius bars. These services give customers immediate expert support when products aren’t functioning as they should and sometimes even replace items free of charge. This level of post-sale service is a big part of why Apple has one of the most prolific fanbases on the planet even though they don’t have a loyalty program.

Recurring revenues can help improve product stewardship, and in turn customer relationships, by holding both the customer and the brand accountable to post-sale interactions. To use a personal example, I am a huge fan of the monthly subscription service Netflix. As you know, that subscription fee represents a recurring revenue stream for Netflix but it also represents a commitment to ongoing customer service. When customers are constantly reminded that they are paying for a product or service they tend to expect more out of the brand that provides it.

When brands generate recurring revenues from their customers they are more obligated to meet that customer's needs

Netflix understands this and has built a customer help center packed full of ways to support their valued customers. The brand provides a searchable knowledge base that covers everything from learning about the service to quick fixes for all kinds of product issues. Additionally, Netflix lists not one but two ways (phone and live chat) to get in contact with support staff who walk through issues with a customer step by step.

Netflix provides it's customers with world class customer support that keeps customers coming back.

It might sound counterintuitive but the fact that recurring revenues actually raise customer expectations is a major strength as far as business models are concerned. Brands that might be tempted to cut corners on product support and stewardship are now held accountable by their customers and actually end up building stronger business models (and long-term customer relationships) in the process.

3. Recurring Revenues Give a Higher ROI on Acquisition Costs

Customer acquisition is an important but sometimes costly part of doing business. In previous posts we’ve written about how to calculate your customer acquisition costs and the best strategies for reducing CAC, but today we get to explore a different way of thinking about the metric: return on investment (ROI).

ROI Definition: A performance measure used to evaluate the efficiency of an investment

At it’s core, ROI calculates how much you get for how much you paid and communicates that value as a percentage. So if a marketing campaign costs you $50 but ends up making you $50, you have a 100% return on your investment. When deciding between different campaigns, investments, and initiatives, brands often turn to ROI to help steer their decisions and select the wisest path forward. Essentially, the higher ROI the better the investment, and the better off the brand will be down the road.

Recurring revenue mechanisms like repeat purchases and the razor and blades model are excellent ways of increasing the ROI of customer acquisition. Let’s use Nespresso and their home coffee system to explore how recurring revenues can create a higher ROI. To convince a customer to make an expensive purchase like a home coffee machine, brands like Nespresso have to engage in a fairly substantial amount of advertising. These brands buy prime locations in retail stores and produce expensive commercials to educate customers on the value their products provide.

creating recurring revenues can help increase many retention metrics

While this might seem like a lot of money to dedicate towards encouraging a one-time coffee machine purchase, Nespresso knows that the single purchase is only the beginning. Once a customer buys a Nespresso machine, they’re locked into buying Nespresso beverage pods in order to actually make use of the machine over time. Therefore, the brand spent money not to acquire a single customer but to acquire a lifelong revenue stream that will return many times the initial investment over time. So while the customer acquisition cost remains the same, recurring revenues boost customer lifetime value and, in turn, the ROI.

 

How to Create Recurring Revenues with Rewards

As you can see, recurring revenues come in a number of different shapes. From payment plans to the razor and blades model, there are many ways to engineer recurring revenues into your business. While some of the strategies we’ve discussed so far might require a major strategy change, adding a rewards program to your business model is a really easy and effective way to get started for a number of reasons.

First and foremost, rewards programs quite literally specialize in repeat purchases. They are built to incentivize ongoing engagement from your customers and reward them for each purchase they make. These repeat purchases raise ROI and build long term customer relationships.

Learn the big three components of customer psychology in our free guide

Rewards programs also go hand-in-hand with subscriptions. I’ve written an entire article on why rewarding for subscriptions is a must, but the moral of the story is that subscribers are some of the most valuable kinds of customers. Rewarding them allows brands to inspire long term commitment and other valuable actions. Well structured subscription rewards are the kind of initiatives that lead to a reduction in seasonality and higher customer engagement.

Lastly, we’ve discussed the value of maintaining customer relationships after the point of purchase and the role that recurring revenues can play in maintaining that relationship. The thing is, the best customer relationships aren’t purely transactional. You don’t want your customers to think about your brand only when their monthly payment comes out or when they need help resolving an issue. This is where rewards come in, by providing additional touch-points for your long term customers with genuine moments of customer delight.

 

Recurring Revenues Are the Gift That Keeps Giving

We’ve tackled the three big questions when it comes to recurring revenues: what, why, and how. Today’s best brands have realized the power of recurring revenue streams and used them to achieve unprecedented growth. Now it’s your turn try out the some of our revenue mechanics and pretty soon you’ll see why recurring revenues are the gift that keeps on giving.