Recurring revenue business models have gone beyond the mainstream to become a mission-critical element of a majority of businesses’ growth plans. A recent study commissioned by Gatepoint Research and Aria research showed that consumption and usage-based billing was being used by 52 percent of the respondents—and only 11 percent said that they will continue relying on one-time sales models in the future. Changing to a recurring revenue model represents a significant shift in the way success is measured.
While it’s a totally different game, we’re no longer at a loss to define how it’s scored. One of the byproducts of the success of recurring revenue models is the creation of a new growth industry focused on defining and producing metrics to monitor the health of recurring revenue business lines. Here are five critical recurring revenue metrics and what they can tell you about your business.
Churn rate, when applied to your customer base, refers to the proportion of customers or subscribers who leave during a given time period. The success of every recurring revenue business depends on continually providing value to customers over time—making the purest measure of declining perception of value is when customers choose to leave.
When a customer leaves, that’s a lost revenue opportunity. Losing customers does double damage to the bottom line, as it costs about seven times as much to acquire a customer than it does to retain one. If your churn rate is growing, it’s an indicator that there’s something wrong with your product, a competitor is offering a superior or cheaper alternative, or you’re just being out-marketed.
For more insight on churn, you’ll want to drill into usage data to detect usage patterns that lead to churn, which can then help you design customer interventions to mitigate churn risk. The quickest way to increase your Annual Recurring Revenue and Customer Lifetime Value is to reduce churn.
Annual Recurring Revenue (ARR)
For C-suite executives, ARR is the ultimate measure of recurring revenue business health. Investors view ARR as the gold standard for company valuation, because it represents revenue that is predictable and low risk. The amazing stock valuation results for companies like Adobe demonstrate the power of Annual Recurring Revenue. Since going subscription-only in May 2013, Adobe has increased revenue by about 35%, but stock valuation has climbed by over 120 percent. When Adobe recently outperformed its quarterly projection by $10 million of ARR, its stock spiked 4 percent, increasing market cap by roughly $2 billion. Increasing ARR is a surefire way to make shareholders happy.
In industries like technology where multi-year contracts are common, Total Contract Value (TCV)—the measure of all business under contract—provides an additional measure of long-term business health and value.
Customer Lifetime Value (CLV)
Success in recurring revenue is derived from building and maintaining profitable customer relationships over time. Customer Lifetime Value is a measure of how well you’re accomplishing that task. There are a few definitions and formulas for calculating CLV—I prefer a net present value (NPV) approach where CLV represents the NPV of cash flows realized over the life of a customer relationship.
CLV is a function of margins, the average duration of customer relationships, and acquisition and retention costs. You can increase CLV by increasing your existing margins, leveraging cross-sell and upsell opportunities, and reducing churn (which increases the duration of the average customer relationship).
Net-New Business Revenue
Since recurring revenue is so often associated with new lines of business where customer acquisition is a high priority, tracking monthly and annual revenue growth related to new customers as a key metric makes sense. As an example, in the music industry, revenues from streaming grew industry-wide by almost 60% in 2016, and nearly all that growth was net new business. If you’re in startup mode and racing to acquire market share to build a sustainable revenue base, tracking net new business revenue will be a priority.
New Revenue from Existing Customers
Startups focus on acquisition, but as businesses mature, growth should blend new customer acquisition with existing customer upgrade and add-on sales. It’s easier to sell to existing customers than to acquire new ones. For the best performing companies, an increasing percentage of growth comes from existing customers, year over year. In fact, in the SaaS industry, the highest performing companies see as much as 30% of their revenue growth come from existing customers. Selling to new services to existing customers will be a critical growth strategy for IoT. This strategy can already be seen in the automotive industry with the rapid growth of connected car services, which are expected to reach $42 billion by 2022.
There are many additional metrics like conversion rates, customer acquisition and retention costs, and customer acquisition and retention cost ratios that provide deeper insight into business performance. Companies that are succeeding in recurring revenue have a clear view of the metrics that define their success.
Want to learn more about building recurring revenue business? Download our Guide to Recurring Revenue Success.