A steady revenue is the dream of every business owner. But in reality, businesses are prone to market fluctuations affecting their cash flow.
For that reason, instead of using a one-time sales model, most businesses are now moving to recurring revenue models to achieve predictable revenue. Industry leaders like Adobe, Gillette and Microsoft now have a subscription business model.
In a recurring revenue business, you bill your customers at regular, scheduled intervals. It ensures a steady income and long-term relationships with your customers.
The Subscription Economy Index by Zuora shows that the subscription economy has grown 435% in the last nine years. Still, recurring revenue models are complex, and they’re difficult to perfect.
Making the most of subscription-based business models requires a deep understanding. That’s why we’re going to show you how recurring revenue models work and the key factors that impact the success of these models.
Here’s what we’ll cover:
What Is Recurring Revenue Model
Types of Recurring Revenue Models
Advantages and Disadvantages of Subscription-based Businesses
Maximizing the Benefit of Recurring Revenue Business Models
Final Thoughts: How To Maximize the Benefits of Your Recurring Revenue Model
What Is Recurring Revenue Model?
In a recurring revenue model, a business makes money by offering subscription-based products or services. It’s an alternative for the one-time sales model in which a business sells its products/services for an upfront, one-time payment. In a recurring revenue model, the business receives payment at regular intervals. The company might charge their customers monthly, quarterly, or annually.
The bill could be either fixed or variable based on the usage. In short, the recurring revenue model helps businesses make money in small yet frequent chunks.
Types of Businesses Suitable for Recurring Revenue Model
The recurring revenue method may not suit all kinds of businesses. These are the common sectors where a monthly or annual recurring revenue model works the best:
- Software as a Service (SaaS)
- Membership websites
- Content-based services
- Consumables businesses
If your business belongs to any of these categories, the recurring revenue model may suit you well. There are different types of revenue models to choose from. Let’s see what they are.
Types of Recurring Revenue Models
You have plenty of options when it comes to recurring revenue models. Selecting the right model is the first step towards making the most out of it.
Usage-Based Billing
In this model, the customers only need to pay for what they use. The business could charge customers monthly or yearly, but the billing is according to the usage. Post-paid mobile connections are a popular example of usage-based billing.
MessageBird provides a platform for sending text messages. Its SMS service costs $0.006/ message, and its WhatsApp service costs $0.005.
Usage-based billing is a fair trade for customers. It helps you attract more leads, but you need to have accurate methods to meter your services. Also, this model could result in revenue fluctuations as it’s directly tied to usage.
User-Based Billing
In this model, billing is based on the number of users. The customer needs to pay a specific charge per user, no matter what the usage amount is.
Popular team collaboration tools like Slack, Trello and Hubstaff have the user-based billing model. More often than not, these businesses have a minimum user requirement.
However, businesses rarely use per-user billing alone. For example, GitHub has a user-based revenue model, but it provides two tiers of services.
Usage-based billing is a fair trade for customers. It helps you attract more leads, but you need to have accurate methods to meter your services. Also, this model could result in revenue fluctuations as it’s directly tied to usage.
User-Based Billing
In this model, billing is based on the number of users. The customer needs to pay a specific charge per user, no matter what the usage amount is.
Popular team collaboration tools like Slack, Trello and Hubstaff have the user-based billing model. More often than not, these businesses have a minimum user requirement.
However, businesses rarely use per-user billing alone. For example, GitHub has a user-based revenue model, but it provides two tiers of services.
This model will work for you if you have a service or product multiple users can share. Just note it may discourage some customers as they also need to pay for inactive users.
Fixed-Tiers With Auto-renewal
Unlike usage-based and user-based billing, fixed tiers don’t restrict the number of users or the amount of usage.
In fixed-tier, you’ll offer different levels of services. The features and price of each tier are fixed. Usually, the subscription auto-renews on a monthly or yearly basis until the customer cancels.
For example, Bluehost uses a fixed-tier model with two tiers, standard and premium.
Hybrid Models
Most online businesses use a combination of the three models above. For example, Hubstaff uses a hybrid of user-based with a fixed-tier revenue model. It has different tiers, and within each tier, it charges per user. The company also offers a free tier.
Sunk-Money Consumables and Services
In this model, customers first need to make a one-time purchase of a product or service. Then, they need to make recurring purchases to make use of their initial investment.
A water purifier is an example of sunk-money consumable. The customers spend an initial one-time amount on buying the equipment. Then they need to keep buying refills and filters.
Amazon Audible is another example of sunk money service. Customers spend on the initial subscription, and then they need to purchase audible content (at a discounted rate).
Freemium Model
Freemium offers a perpetual free tier of products/services. Along with the free tier, the business will offer premium tiers with advanced features and support. It lowers the entry barrier for customers.
Freemium works well if your customers evolve with your product and gradually find the value in upgrading to a premium tier.
Canva successfully uses a freemium model.
Overall, there are a lot of recurring revenue models you can mix and match. But is a recurring revenue model worth it? Let’s have a look at its pros and cons.
Advantages and Disadvantages of Subscription-based Businesses
If you are considering a recurring revenue model, it’s crucial to understand its pros and cons to decide if it will work for you.
Advantages
- A recurring revenue model offers a steady income
- It’s a great way to create a loyal customer base
- A subscription-based model doesn’t rely heavily on customer acquisition
- It allows businesses to concentrate on current customer’s needs
- It presents excellent upselling and cross-selling opportunities
Disadvantages
- Even though the revenue is regular, the actual profits might fluctuate
- Unpredictable churn rate as customers can cancel their subscription at any time
- Payment barriers and subscription fatigue could also cause customer churn
- Tracking payments and account keeping is difficult
- Long-term customers will be less forgiving of issues they face
- Difficult to change pricing
For deriving the maximum advantage of your recurring revenue model, you’ll need to fine-tune many aspects. Let’s look at the key factors that affect the success of a recurring revenue model.
Maximizing the Benefits of Recurring Revenue Business Models
To make a profit out of the subscription business, you need a deep understanding of these models. Even if your business is a clear candidate for a recurring revenue model, you’ll need to plan certain business elements carefully.
Price Your Plans Strategically
Pricing is a crucial factor for the success of a recurring revenue model. You should evaluate what’s the fair value of your products/services. If your price is too low, you might not get a return on your investment. Too high a price might turn the customers away.
To decide the right price, you need to discuss it with your stakeholders — designers, manufacturers, sales and marketing teams. Recurring revenue pricing is a complex area.
So, make sure you have a good idea of the pricing strategies.
Set Key Performance Indicators (KPIs)
With recurring revenue models, you might see fluctuating revenues. To ensure you aren’t running at a loss, you need to define your KPIs. To start with, decide what metrics you’ll use to measure the success of your business.
These could be the following:
- Monthly recurring revenue (MRR)
- Annual recurring revenue (ARR)
- Customer lifetime value
- Number of new customers
Once you have chosen the KPIs, keep monitoring your business’ performance against them. Monitoring your performance and collecting data will help you adjust your pricing and subscription plans.
Ensure Transparent Billing and Accurate Accounting
Recurring revenue models can be complex in terms of billing and accounting. To make most of your recurring revenue plans, you need accurate billing and bookkeeping.
Make sure you bill your customers correctly. Especially in usage-based models, bills should be transparent. Accurate bills are also crucial for customer retention.
With hundreds of customers at different points in their subscription cycle, manual bookkeeping may not work. That means you’ll need to invest in billing and accounting software to make the most out of your recurring revenue model.
Choose Your Payment Gateways Wisely
You’ll have a large number of customers paying you regularly, resulting in thousands of transactions. With that in mind, you should make sure the payment gateway doesn’t cost you too much for each transaction.
With recurring models, you can also expect a large number of cancellations. It’s easy to overlook the payment gateway penalties associated with canceled transactions.
Therefore, selecting a flexible and cost-effective payment gateway will be crucial for the success of your subscription business.
Adjust Your Models and Price
Choosing a recurring revenue model and fixing your price is a complex task. You might not perfect it right off the bat. As we saw earlier, you need to keep monitoring your performance against your KPIs.
If you aren’t hitting your goals, you might need to experiment with your revenue model and pricing strategies. It might not be an easy exercise for both you and your customers, but you’ll need to strategize your price and fine-tune your revenue model until you hit your KPI goals.
Final Thoughts: How To Maximize the Benefits of Your Recurring Revenue Model
Without a doubt, subscription-based businesses are getting popular. But, there is no one-size-fits-all solution for finding the perfect recurring revenue model. You need to understand different types of revenue models to choose the best model for you.
Once you choose a model, you can make the most out of it through:
- Correct pricing
- Clear goals and performance monitoring
- Accurate billing and accounting
- Fine-tuning the price and model
Are you ready to kickstart your subscription business? Check out Bluehost’s hosting plans today.
