Recurring revenue is critical to any business. But, I get confused in the discussions I get into with SaaS and other XaaS proponents. Somehow, they have the idea the SaaS recurring revenue model is both superior and has much greater predictability than other business models.
I sit back, scratching my hear. My reaction is, “Huhhhhh, I’m not sure I get it….”
People roll their eyes, “Yeah, Dave, we know back when you helped to invent fire, your currency in trade was apples…. Times have changed….”
But then I ask, “Doesn’t every organization have a recurring revenue model?”
The eyes continue to roll, “Dave, you just don’t get it, the SaaS model is built on recurring revenue—and predictable revenue. That’s why the business model is so compelling.”
I’m not as smart as I look, so I continue to dive into the issues with these groups, I walk them through discussions.
In the SaaS model, we get orders, and the revenue flow occurs over the ensuing 12/24/36 months. I get the predictability. We get a constant payment every month for the term of the agreement. But in a purchase model, I get a purchase order, I get the revenue flow in a single payment, and revenue flows for maintenance/service, but those are included in the PO. We know precisely when we will get these payments, so the purchase model is equally predictable.
As I go through this, I ask, “How is the recurring revenue model any more predictable than a purchase model (and we can go through similar arguments with other business models)? Isn’t predictability about knowing when we realize the revenue?”
There’s a long moment of silence…..
“Well I guess they are both equally predictable, but the purchase model is ‘lumpier,'” is the response.
I think, “Well it is if you look at it as isolated deals, but if you look at all the deals you create, doesn’t that lumpiness get evened out? For example, a large part of Apple’s business is a purchase model (Iphones, IPads, Macs). The revenue flow for those isn’t really very lumpy. Of if you look at a large capital equipment manufacturer, they are constantly bringing in new purchases every month, evening out revenue flow. So I don’t understand the ‘lumpiness’ you are talking about.”
Sometimes, I sit down with them looking at the annual reports of all sorts of companies that have, primarily, a purchase model. What they see is a regular flow of revenue, hopefully growing over time. Not dissimilar to SaaS revenue reporting. Some have ups and downs, usually not precipitous, but we see the same in SaaS models. So the “lumpiness” argument doesn’t seem to apply.
Then the argument gets to retention and renewal. “We get our customers to renew their subscriptions at the end of each contract period, we keep customers for a much longer time, creating more predictable revenue. Once we get a customer, we keep them for life–or at least we try to.”
“I get it,” I respond, “and companies using other business models do exactly the same thing. They serve the customer to make sure they are getting the expected value for the purchases. They sell upgrades, they try to expand their footprint within the customer, as well as acquiring new customers. They aggressively introduce new products to get the customer to upgrade as critical new capabilities are available. Aren’t the SaaS and XaaS models just the same?”
I continue, perhaps I’m guilty of rubbing it in. “One can argue that innovation and new product development is more important in purchase models. To get customers to invest in the next generation of products, they have to continue to introduce new products to the market. Sometimes, don’t the SaaS companies get complacent in enhancing their products?”
Actually, I know the high performing SaaS companies are no different than the “purchase companies.” A key aspect to renewals and expansion is adding new functionality–along with price increases. I suppose I’m taunting these folks…
Frustrated, they reply, “Dave you don’t get it, it’s MONTHLY revenue. We get it every month for the contract period, so it is RECURRING!”
I persist, “How’s that different from other companies? Rather than spreading out the payment, they get it all upfront. And they charge maintenance and services fees, then they sell the new model every few years, getting another upfront payment. Even though they don’t get a monthly payment, they get recurring payments over the entire lifecycle of the relationship with the customer.”
At this point, I tend to roll up my sleeves, put on my green visor, and suggest, “Aren’t we really talking about differences in cashflow, not recurring revenue?” Then, I may nerd out, suggesting, “If you look at the way these things are recorded on your P&L’s, both organizations see exactly the same thing, but call it different things. Each books revenue actually realized. Then they look at revenue commitments, but not yet realized. Purchase and other models call it bookings or backlog. SaaS refers to the same thing as ARR.”
I could go on from here, but I think you get the point.
But here are some things you might take away from this diatribe.
- Every company drives to build it’s recurring revenue. They want to keep customers for life. They want them to use their products, upgrade to the latest models/versions, purchase add-ons, other services.
- Every company drives for net new revenue growth, which in turn they convert to recurring revenue. It may be net new logos. It may be expansion within current customers and accounts.
- Critical to creating recurring revenue for the life cycle of the customer is creating a great customer experience. It’s independent whether they pay for the product up front–because we want them to buy again. Or whether they have it on some sort of installment payment plan, like a monthly subscription. We fail when we don’t get our customers do continue to buy the latest versions of the products from us.
- The only difference in recurring revenue models, is, fundamentally cash flow.
And this final point brings me to an observation, potential solution for many SaaS companies. Too many SaaS companies are facing a cashflow crisis. As investors pull back funding, where do they get the cash to run their operations? While they can count on the contracts bringing in cash over years, too often, they don’t have enough cash to meet their current spending requirements (This is the subject of other posts.)
And we see troubled SaaS companies adapting new models to accelerate cashflow. “If you pay for a year contract up front, you get two months free….” By any other name, that looks like a purchase model.
Recurring revenue is critical to every company. It is not the exclusive domain of SaaS and Xaas companies. It looks different, depending on the business model, but it’s a fundamental for all businesses.
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