We’ve worked with companies across many industries and one question that comes up all the time is: “how much of your revenue is recurring?” Are customers coming back regularly? Predictably? Are you competing for each sale, or is repeat purchase more typical? Are you “spec’d in” to customers’ products and what’s the lifecycle of those products? Is there a regulatory element to switching costs? Are customers under contract with you? Is there a service or maintenance element to the sale? Is the product sold as a service, e.g. SaaS? What’s the “churn rate”?
What are some examples of recurring revenue in your industry? We’ve seen SaaS software of course, and software maintenance revenue, and also high-specification consumables. We’ve also seen services with extremely high repeat and retention rates, typically driven by regulatory requirements or other market constraints. Is the consumer who buys from you every holiday season driving “recurring revenue”? Certainly repeat customers are valuable and most businesses would do well to understand the cost of keeping a customer vs the cost of acquiring a new customer. How about the business that relies on you for testing or compliance services? The customers whose preventive maintenance you support by virtue of your database of equipment in the field and scheduling processes? The high-profile processes you support for your clients who rely on you to get it right? If you’ve got real switching costs, you’ve got recurring revenue or at least the potential for it.
The certainty and relatively low cost of keeping recurring revenue makes it very attractive compared with revenue you’ve got to win every time. Think of it this way: what’s the value of $100 of revenue at 70% gross margin, with 30% upfront and 10% ongoing SG&A cost, that’s 90% likely to continue year-over-year, vs $100 of revenue at 70% gross margin with 20% SG&A cost for each sale that’s 25% likely to recur? The first is a recurring revenue business model, the second is an example of building up a happy customer base that may or may not buy from you again (1). What if you take a $300 non-recurring sale and turn it into a $100-a-year recurring revenue stream?
One feature of the recurring revenue business model that’s particularly exciting is the tendency for those companies to trade for revenue multiples, rather than EBITDA multiples. Many public Saas software companies are trading at over 15x revenue. Even businesses without contracted recurring revenue can often be analyzed through the lens of a recurring revenue model. How many customers have bought meaningful amounts from you each of the past 5 years? Are you learning about each client’s business as you deal with them, making their cost of doing business with you lower each time and your costs lower as well? Is there an element of your revenue that’s recurring even if the majority is not?
I tend to think of a range of “recurring” – from customers like those who might shop at a store on a regular basis, to “sticky” customers with moderate switching costs, to truly recurring and contracted revenue with high retention rates. One way to evaluate where you are on this spectrum is to answer the question: would your customers really care if you closed up shop? Would they easily move to a less-convenient but still satisfactory solution or would they have real problems making a change? Another way to look at it is: why do customers stop doing business with you? Is it more often the case that they stay for 5 years, or that only half renew after their contract expires? Most businesses can benefit from viewing their model through this lens, collecting the relevant data, and then focusing on building out their recurring revenue offering.
Alan Fullerton is a partner with Mirus Capital Advisors. He works with owners of middle market businesses and can be reached at email@example.com.
(1) I figure the recurring customer in this example is worth about 6x as much as the non-recurring revenue customer.