In this guide we’ll be covering the primary appeal of recurring revenue-based business models from an investor’s perspective. We’ll look at a number of favorite Wall Street arguments in favor of subscriptions. Let’s start with predicability.
To investors, the primary appeal of recurring revenue models is the value of predictable recurring revenue, particularly in comparison to one-time transactions. For example, a $20 million dollar company with eighty percent recurring revenue can count on sixteen million dollars at the beginning of every year. That figure is stable and predictable. Management can plan and invest accordingly.
The same cannot be said of a $20 million dollar business with no recurring revenue. That company has to start the year at zero. Of course it can make some predictions based on past performance, but it doesn’t have a contractually obligated revenue stream to base ambitious expansion plans around.
Smart subscription businesses look at something called ARR, which stands for Annual Recurring Revenue, and consists of the subscription revenue from customers for an ongoing service. To get at ARR, subscription businesses take the value of their subscription contracts, normalize it to an annual amount, and add it all up. For a subscription business, more so than cash or revenue, ARR is the true indicator of your company’s health. You can start every year with a very predictable amount of future revenue.
In addition, a healthy subscription-based business benefits from excellent customer retention and robust customer insight for cross-selling or marketing. And relative to other retail models, recurring revenue models tend to be much easier to operate in terms of pricing. Most companies that use subscriptions only need to manage a few pricing tiers, rather than individually pricing an array of products.
All of these tools reinforce predictability. Stock valuations are forward-looking predictions, and subscriptions are forward-looking revenue models. It’s no wonder that Gartner predicts that by 2015, 35% of Global 2000 companies with non-media digital products will generate up to 10% of their revenue from recurring models.