Repeat business drives the value of your company, and you can categorize these sales into one of two buckets:

  1. Reoccurring revenue comes from customers who purchase from you sporadically. They’re satisfied with what you offer, and they buy regularly yet not according to a specific timeline.
  2. Recurring revenue is predictable, and you get it from customers who buy on a cadence. Usually in the form of subscription or contract revenue, the main difference is your recurring revenue comes in on a regular rhythm.

Recurring revenue is more valuable than reoccurring sales because of its predictability. Therefore, it’s worth considering how to turn repeat customers into subscribers. 

HP Instant Ink

For an example of an organization that turned reoccurring sales into recurring revenue, let’s look at the “HP Instant Ink” program. HP had been in the business of selling printers for decades before launching their toner replacement subscription. 

HP would sell you a printer in the old days and hope you would come back and buy your toner cartridges from HP. As cheaper replacement options became available, HP started to lose reoccurring revenue from people who owned HP printers but chose a more affordable alternative to refill their cartridge. 

In response, they launched the HP Instant Ink program to solve this problem by offering a toner subscription. HP sends subscribers new toner for their printer each month. You can sign up for a plan based on how many pages you print. If you exceed your page allotment one month, you can top up your account. If you fall short, HP offers to carry over your unused pages. Pricing plans start at $0.99 per month. 

How does HP ensure you never run out of toner? They have embedded a reader in their printer’s hardware that sends a message to HP fulfillment when your cartridge dips below a predetermined threshold. Hence, you never run out. 

It’s a brilliant little program and gives HP some recurring revenue while driving loyalty to HP printers.

Inspired by the HP Instant Ink program, here are three secrets for turning repeat customers into subscribers:

  1. Offer plans based on volume: At HP, their $0.99/month plan allows you to print just 15 pages per month. At the top end, their $24.99 plan gives you 700 pages, and they have a variety of options in between. This range of options gives customers the ability to pick a plan that will work for them most of the time.
  2. Allow carryover: Customers who buy from you on a reoccurring basis will appreciate your various plans. However, they may still hesitate to subscribe if they anticipate their volume will fluctuate. That’s why HP allows you to seamlessly buy overage if your printing volume is higher than expected. Subscribers can also carry over unused pages if they don’t need their entire allotment.
  3. Never let them run out: One of the reasons consumers prefer buying on a subscription over a one-time transaction is that they never want to run out of what you sell. That’s why HP’s integrated toner gauge reads when your cartridge dips below a threshold. Find a way to measure your customers’ supply of what you sell in real time to ensure subscribers never run out. 

Repeat customers are the lifeblood of any business. If you want to jack up your company’s value, consider ripping a page from HP’s playbook, and turn your reoccurring customers into subscribers. 

Many people mix up re-occurring and recurring revenue, but one is much more valuable than the other. 

Re-occurring Revenue

Re-occurring revenue comes from customers that have a re-occurring need for whatever you sell and buy from you on an unpredictable yet regular basis. 

Imagine a health food store. Customers come in to replenish their supply of vitamins when they run out. The owner is never quite sure when a customer will be back, but she’s pretty sure they will return when they run low on a critical supplement. 

Recurring Revenue

Recurring revenue comes from sales to customers that buy from you on a predictable, automatic cadence, for example, a subscription or service contract.

Let’s take the same health food store owner. She recognizes her customer comes in every month or so to buy Vitamin C. She decides to offer a subscription for Vitamin C capsules, where she ships a new bottle to her subscribers each month automatically. The customer doesn’t need to make a dedicated trip to her store, and the owner automatically gets repeat sales. 

Compared to one-off transaction revenue, both re-occurring and recurring revenue contribute positively to your company’s value, but one is much more valuable than the other. 

For example, Mike Malatesta created Advanced Waste Services (AWS), which helped businesses dispose of their industrial waste. Energy giant Covanta (NYSE: CVA) saw acquiring AWS as the perfect way to enter the industrial waste industry and sent Malatesta a Letter of Intent to acquire AWS for $54.5 million.  

Covanta liked that AWS had repeat business from loyal customers that they assumed were on recurring contracts. However, when Covanta started their diligence before closing their acquisition of AWS, they realized some of AWS’s revenue was re-occurring, not recurring, and used that as justification to lower their offer by $4 million. 

To convert re-occurring revenue into recurring revenue:

  1. Start by segmenting your customers that buy on a re-occurring basis.
  2. Look for a segment whose purchase cadence is relatively predictable.
  3. Design an offer for your regular, re-occurring customers that makes it more convenient for them to buy on a subscription or service contract rather than on a transactional business model.
  4. Aim to give re-occurring customers three compelling reasons to subscribe.

For example, in the case of the vitamin store owner, she could make the case that subscribing to a regular shipment of vitamins is 1) more convenient for the customer because there is no need to drive to the store, 2) more reliable because subscribers would be given priority on available stock, and 3) safer because vitamin subscribers would be given a newsletter describing new clinical trial results of emerging vitamin therapies. 

Re-occurring and recurring revenue may sound similar, but when it comes to your company’s value, recurring revenue is far better. Consider converting your re-occurring customers into subscribers, and you’ll build a more predictable—and valuable—business. 

Recurring revenue makes your company more predictable, extends the lifetime value of a customer and ultimately makes your business more valuable. If you’re unsure how to create these automatic sales, a simple service contract can be the place to start. 

A service contract is an agreement to provide an ongoing level of service in return for a regular payment. It can be a way to transform an ordinary service company into a predictable subscription business. 

For example, Walter Bergeron started a small company servicing circuit boards for large food processing plants. It was a classic service business where Bergeron offered his time to fix customer’s circuit boards when they broke. 

The business model worked fine, but cashflow was lumpy. Bergeron had reached a point where he could no longer sell any more of his time, and his growth stalled. Knowing something had to change, Bergeron made a 90-degree turn.

The Switch

He began offering a membership model where, instead of contracting him when a circuit board broke, he asked his customers to subscribe to a plan enabling them to have their circuit boards serviced at any time in return for a fixed monthly fee. Bergeron’s customers paid monthly for access to his technicians when they had a problem. 

The switch to a subscription billing model transformed the business, and Bergeron quickly grew the company to $7 million in annual sales, at which point he sold it for $10 million — a significant premium over a standard service company. 

As the example of Walter Bergeron illustrates, most small businesses begin life using the “break/fix” business model where a customer has a problem, and you swoop in to provide a solution. This business model may make you feel valued as a problem solver, but it comes at the expense of the value of your company. In the break/fix model, you must create demand, sell your product or service, deliver it, and start all over again, which is why acquirers place a lower value on these transactional businesses when compared to subscription-based companies. 

By contrast, with a service contract, you create an ongoing stream of income that has the potential to grow the lifetime value of a customer dramatically. When you can accurately predict how much money you will get from a subscriber, you can invest more in wooing them. 

The most compelling reason to adopt a recurring revenue model is the impact it can have on your company’s valuation. Dollar for dollar, recurring revenue can be worth more than twice that of transactional revenue, depending on your industry.

Service contracts are a simple and effective way to transform a transactional business into a recurring revenue goldmine. 

Have you struggled to identify a recurring revenue model that will work in your business? 

If so, you’re not alone. 

Most owners understand the benefits of recurring revenue, such as predictable cash flow and an increase in their company’s valuation, but struggle with where to start. Just changing your pricing from a one-time transaction to a smaller, recurring fee does not make a sticky subscription model. 

The first step of creating a recurring revenue model for your business has nothing to do with your billing platform and everything to do with your target customer. The secret to reimagining your business into a recurring revenue juggernaut is to niche way down.

Niche Down

For a recurring revenue model to retain subscribers, it needs to provide an outlandishly attractive value proposition to customers who agree to continue with the service over the long run. To create that kind of delight, you have to find a pain point where a group of customers feels uniform. That only happens when you niche way down. 

For example, when Jorey Ramer, the founder of Super, moved to the San Francisco Bay area, he purchased a home. Ramer had previously been a renter and was surprised by the hassles of owning a house.

Ramer realized that everything from the ice maker in his fridge to the lighting in his backyard was susceptible to failing. He decided to create a subscription model that would allow homeowners to pay one monthly fee in return for a mobile app where subscribers can summon a repair person to fix just about anything that could break down in a home. 

Last year Ramer raised $20 million from investors, who see the opportunity in putting home repairs on subscription. 

Ramer’s first step in creating Super was not to put out a shingle as a home repair professional with a different billing model. Instead, he focused on niching down to a customer group with a common need. To begin segmenting, he picked homeowners. Then Ramer went further and identified a subsegment of homeowners who are not do-it-yourself types. 

Some homeowners are tinkerers and don’t mind digging into a “honey-do”” list every weekend, but Ramer knows those aren’t his people. Instead, he chose to focus on the sub-niche of homeowners that don’t want the hassle and surprises that come with homeownership. 

How Peloton Made Their Subscription Sticky

At Peloton, the fitness company that started with a souped-up stationary bike and now includes classes on everything from yoga to running, they have adopted a subscription model. Customers buy the bike (or the treadmill) and then subscribe to Peloton’s content package. To make Peloton’s subscription sticky, they didn’t just target people who wanted to get fit, many of whom were happy to go to a gym before the pandemic. Instead, they targeted relatively affluent people who are too busy to go to the gym. While the single twenty-something sees a spinning class at his local gym as a chance to connect with like-minded people, Peloton knew the forty-something mom with three kids often doesn’t have the time to go to the gym. Therefore, they defined their target customer as relatively affluent fitness enthusiasts who don’t have time to go to the gym—a niche of a niche. 

Year to date for 2020, Peloton’s share price has more than tripled. If you’re stuck trying to come up with a recurring revenue model that would work for your industry, segment your customers based on what makes them buy from you. Then determine if one of your niches has a recurring need for something you sell.

Volvo recently announced they will make their cars available on a subscription model where consumers will pay one fixed fee per month for access to a car which includes insurance and maintenance.

Everything from tooth brushes to flowers are now available with subscription billing.

Could you offer some sort of recurring plan to your customers? Here are six reasons to consider offering your customers a subscription:

  • Predictability: When you have subscribers, you can plan what your business needs in the future. For example, the average flower store in America throws out more than half of its inventory each month because it’s too rotten to sell.

    At H.Bloom, a subscription-based flower company that sells flowers to hotels and spas, say they throw out less than 2% of their flowers because they can perfectly predict how many flowers are needed to fulfill their orders.
  • Eliminate Seasonality: Many businesses suffer through seasonal highs and lows. In fact, a whopping thirty percent of a typical flower store’s revenue comes on Mother’s Day and Valentine’s Day – ultimately leaving them to scramble and make a sale in November.

    By contrast, H.Bloom has a steady stream of subscribers that pay each month. At Mister Car Wash – where they offer a subscription for unlimited car washes – they receive revenue from customers in November and April even though very few people in the Northern east wash their cars in rainy months.

  • Improved Valuation: Recurring revenue boosts the value of your business. Whereas most small companies trade on a multiple of profit, subscription-based businesses often trade on a similar multiple of revenue.

  • The Trojan Horse Effect: Once you subscribe to a service, you become much more likely to buy other things from the same company. That’s one reason Amazon is so keen to get you to buy subscriptions to things like Prime or Subscribe & Save. Amazon knows that once you become a subscriber, you are much more likely to buy additional products.

  • The Sale That Keeps On Giving: Unlike the transaction business model where you have to stimulate demand through advertising to get customers to buy, with a subscription based model, you sell one subscription and it keeps giving month after month.

Data & Market Research: When you get a customer to subscribe, you can start to see their spending and consumption habits. This data is the ultimate in market research. It’s how Netflix knows which new shows to produce and which to kibosh.

Companies like Netflix, UrthBox, and Amazon are leveraging the subscription business model to discover what their customers want next.

In a traditional business, the customer buys your product or service once, and it is up to you to try to convince them to buy again in the future. You often have no idea if they liked what they bought and what would have made them buy more, so you’re left having to guess or invest in costly market research.

In a subscription business, you have “automatic customers” who agree to purchase from you into the future, as long as you keep providing your service or product.

Long-term, direct relationship

Unlike a transactional business model, subscribers are opting into a long-term, directrelationship with you. You know who your customers are and which of your products and services they use, so you have a much better understanding of their preferences than an industry competitor relying on a traditional business model.

A subscription business gives you a direct relationship with your customers and an ability to track their preferences in real time. It’s how Netflix knows which television series to produce next and how Amazon figures out what products their Prime subscribers are dreaming of buying next.

But you don’t have to be a sophisticated media giant or billion-dollar e-tailer to track customer preferences through the subscription model. Look at subscription-based ContractorSelling.com, run by Joe Crisara. In return for a fee of $89 per month, you can subscribe and get information, tips, and advice on how to run a successful contracting business. Plumbers and electricians subscribe to ContractorSelling.com for Crisara’s insight, and as they start to read articles and contribute to the forums, Crisara can see what’s on his subscribers’ minds.

That’s important because Crisara also makes money from conferences. Seeing which articles are most popular and controversial among his members gives Crisara insight that helps when he’s picking speakers and topics for his live events.

UrthBox

For $20 a month, UrthBox offers a monthly selection of hand-picked, natural, GMO-free goods to try. UrthBox asks subscribers what they think of the products in each box and rewards them when they respond or refer a friend. Each referral earns points that the subscriber can then use in the online store.

UrthBox then offers the manufacturers of the samples a custom online portal where marketers can see how UrthBox subscribers rated each product. UrthBox uses the data to select merchandise for its online store and prominently displays the products customers like best.

One of the hidden benefits of turning customers into subscribers is the ongoing, direct nature of a subscription relationship, which means you can watch and ask your customers for feedback, ensuring they stay subscribers and buy more over time.

Repeat customers are the lifeblood of your business, but customers can be fickle. Here’s how to make them sticky.

In a traditional business, the customer buys your product or service once, and it is up to you to try to convince them to buy again in the future. However, in a subscription business, you have what is called an “automatic customer” who agrees to purchase from you in the future, as long as you keep providing your service or product.

Feeding Rover Automatically

One of the reasons subscribers are such attractive customers is that, once they subscribe, they become less price-sensitive. To illustrate, imagine you live in England and own a 100-pound Pyrenean Mountain Dog that eats two hearty bowls of dog food a day. Feeding the love of your life is an expensive proposition, so you’re always on the lookout for a deal on dog food. Once every two weeks, you trudge down to the local pet supply store and cart a case of kibble home. In the meantime, if you see dog food on sale at your local grocery store, you’ll buy it. If you get a coupon for a buy-one-get-one-free offer from another store, you’ll take advantage of it.

Eventually, you get tired of last-minute trips to the store, so you subscribe to Warwickshire, UK-based petshop.co.uk, which offers a “Bottomless Bowl” subscription service. Now you know you’re going to get a shipment of dog food every fortnight, and the part of your brain that scans the flyers for dog food starts to shut down, knowing that the convenience of having dog food shipped automatically far outweighs saving a few dollars on kibble.

Integration Drives Stickiness

Beyond the simple convenience of automatic service, subscribers become even more loyal when they start to integrate their subscriptions into their daily lives. Subscribers knowingly enter into an agreement in which the convenience of uninterrupted, automatic service is exchanged for their future loyalty. Rather than buying once without returning, subscribers stick around—hopefully for years, which is why subscribers drive up the value of your company so dramatically.

You can now buy a subscription for everything from dog treats to razor blades. Music subscription services are booming as our appetite to buy tracks is replaced by our willingness to rent access to them. Starbucks now even offers coffee on subscription.

Why are so many companies leveraging the subscription business model? The obvious reason is that recurring revenue boosts your company’s value, but there are some hidden benefits to augmenting your business with a subscription offering.

Free Market Research

Finding out what your customers want is expensive. By the time you pay attendees, rent a room with a one-way mirror and buy the little sandwiches with the crusts cut off, a focus group can cost you upwards of $6,000. A statistically significant piece of quantitative research, done by a reputable polling company, might approach six figures.

With a subscription company, you get instant market research for free. Netflix knows which shows to produce based on the viewing behavior of its subscribers. No need to ask viewers what they like, Netflix can see what they watch and rate.

For you, a subscription offering can allow you to test new ideas and gives you a direct relationship with your customers so you can see what they like first hand.

Cash Flow

Subscription companies are often criticized for being hungry for cash. Many charge by the month and then have to wait months—sometimes years—to recover the costs of winning a subscriber.

That assumes, however, that you’re charging for your subscription by the month. If you’re selling your subscription to businesses, you may get away with charging for a year’s worth of your subscription up front. That’s what the analyst firm Gartner does, and it means they get an entire year’s worth of cash from their subscriber on day one. Costco charges its annual membership up front, which means it has billions of dollars of subscription revenue to float its retail operations.

Loyalty

Customers can be promiscuous. You may have a perfectly satisfied customer but if they see an offer from one of your competitors, they might jump ship to save a few bucks. However, if you lock your customers into a subscription, they may be less tempted to try a competitor since they have already made an investment with you.

One of the reasons Amazon Prime is so profitable is that Prime subscribers buy more and are stickier than non-Prime subscribers. Prime subscribers want to get their money’s worth, so they buy a wider swath of products from Amazon and are less tempted by competitive offers.

The obvious reason to launch a subscription offering of your own is that the predictable recurring revenue will boost the value of your company. And while that’s certainly true, the hidden benefits may even be more important.

Why are Amazon, Apple and many of the most promising Silicon Valley start-ups leveraging a subscription business model?

Subscribers not only provide steady revenue; they make your company more valuable in the eyes of an acquirer. In a traditional business, customers buy your product or service once and may or may not choose to buy again; but in a subscription business, you have “automatic” customers who have agreed to purchase from you on an ongoing basis.

There are at least nine subscription models that can be leveraged by businesses ranging from service companies to market research firms to manufacturing concerns.

Recurring Revenue

Recurring revenue—the hallmark of a subscription business—is attractive to acquirers and makes your business more valuable when it’s time to sell. How much more valuable? To answer that, one has to first look at how your business will be valued without a subscription offering.

The most common methodology used to value a small to midsize business is discounted cash flow. This methodology forecasts your future stream of profits and then discounts it back to what your future profit is worth to an investor in today’s dollars, given the time value of money. This investment theory may sound like MBA talk, but discounted cash flow valuation is something you have likely applied in your personal life without knowing it. For example, what would you pay today for an investment that you hope will be worth $100 one year from now? You would likely “discount” the $100 by your expectation for a return on investment. If you expect to earn a 7 percent return on your money each year, you’d pay $93.46 ($100 divided by 1.07) today for an investment you expect to be worth $100 in 12 months.

Using the discounted cash flow valuation methodology, the more profit the acquirer expects your company to make in the future—and the more reliable your estimates—the more your company is worth. Therefore, to improve the value of a traditional business, the two most important levers you have are: 1) how much profit you expect to make in the future; and 2) the reliability of those estimates.

At ValueBuilderSystem.com, one can see the effect of this valuation methodology. Since 2012, this methodology has been used to track the offers received by business owners who have completed the Value Builder questionnaire. During that time, the average business with at least $3 million in revenue has been offered 4.6 times its pretax profit. Therefore, a traditional business churning out 10 percent of pretax profit on $5 million in revenue can reasonably expect to be worth around $2,300,000 ($5,000,000 x 10 percent x 4.6).

Then compare the value of a traditional company with the value of a subscription business. When an acquirer looks at a healthy subscription company, she sees an annuity stream of revenue throwing off years of profit into the future. This predictable stream of future profit means she is willing to pay a significant premium over what she would pay for a traditional company. How much of a premium depends on the industry, and some of the biggest premiums today go to companies in the software industry.

Subscription-based Software Companies

To understand what is going on in the valuation of subscription-based software companies, look at Dmitry Buterin. Buterin runs a subscription software company called Wild Apricot. He has also formed one of the world’s first mastermind groups of small and midsize subscription company founders, and each month the group meets to discuss strategies for running a subscription business.

Members of the group were constantly raising money or being courted by investors, so the topic of valuation came up a lot in their conversations. Buterin found that the consensus valuation range being offered to member companies was between 24 and 60 times monthly recurring revenue (MRR), which is equivalent to two to five times annual recurring revenue (ARR).

One way to validate Buterin’s numbers is to check with another guru from the world of subscription-based software companies. Zane Tarence is a partner with Birmingham, Alabama-based Founders Investment Banking, a company that specializes in selling software companies that use the subscription business model. Tarence estimates the valuation ranges he sees as belonging in one of three buckets:

24-48 x MRR (2-4 x ARR)
These are typically very small software companies with less than $5 million in recurring annual revenue. Companies in this first bucket are usually growing modestly, with subscription cancellation rates (i.e., “churn”) in the area of 2-4 percent per month.

48-72 x MRR (4-6 x ARR)
These are larger software companies with recurring revenue of at least $5 million annually, which they are growing at the rate of 25-50 percent per year. Their net churn is typically below 1.5 percent per month.

72-96 x MRR (6-8 x ARR)
These are the rare, fast-growth software companies that are growing more than 50 percent per year, with at least $5 million in annual revenue and net churn below 1 percent per month. These companies usually offer a solution (typically an industry-specific one) that their customers need to use to get their jobs done.

The software business is an extreme example of the benefits of subscription revenue, but no matter what industry you’re in, your company will likely command a premium if it enjoys recurring revenue.

From Alarm Systems to Prescriptions to Mosquitoes

For example, security businesses that monitor alarm systems and charge a recurring monthly monitoring fee to do so are worth about twice as much as security businesses that just do system installations. Retail pharmacies with a large pool of prescriptions for drugs that people take every day, like Lipitor and Lozol, command a premium over a traditional retailer because customers re-up their pills on a regular basis, creating a recurring revenue stream for the pharmacist.

Even tiny companies are worth more if they have subscription revenue. When my colleagues over at the Value Builder Score analyzed very small businesses with less than $500,000 in sales, they found that the average offer these small businesses attract is 2.6 times pretax profit.

Compare that to the average Mosquito Squad franchise. Mosquito Squad is a Richmond, Virginia-based company that offers to keep bugs off your patio by spraying your backyard regularly with a proprietary chemical recipe approved by the Environmental Protection Agency. Mosquito Squad franchisees target affluent home owners with an average home value north of $500,000 who entertain in their backyard and don’t want to be bothered by mosquitoes. Mosquito Squad operates on a subscription basis. You subscribe to a season of spraying, which includes 8 to 12 sprays, depending on how buggy it is where you live.

Mosquito Squad is a franchise business, and the impact of its recurring revenue model on its valuation is remarkable. According to Scott Zide, the president of Mosquito Squad’s parent company, Outdoor Living Brands, Mosquito Squad franchises that changed hands over the most recent five-year period had revenue of $463,223 and sold for 3.7 times their pretax profit. That’s a 42 percent premium over the traditional value of a company with less than $500,000 in sales, and it’s because Mosquito Squad operates on a recurring subscription model and 73 percent of its annual spraying contracts renew each year.

Whether you plan to build a subscription-based software application or the simplest personal services business, having recurring revenue will boost the value of your most important asset.

Are you stuck trying to figure out how to create some recurring revenue for your business? 

You know those automatic sales will make your business more valuable and predictable, but the secret to transforming your company is to think less about what’s in it for you and more about coming up with a reason for customers to agree to a monthly bill.

Take a look at the transformation of Laura Steward’s company, Guardian Angel. Steward had gotten her IT consulting firm up to $400,000 in revenue when she called in a valuation consultant to help her put a price on her business. Steward was disappointed to learn her company was worth less than fifty percent of one year’s sales because she had no recurring revenue and what sales she did have were dependent on her personally.

Steward set about to transform her business into a more valuable company and made three big moves:

  • Angel Watch

The first thing Steward did was to design a monthly program called Angel Watch, which offered her business clients ongoing protection from technology problems. Steward offered her Angel Watch customers ongoing remote monitoring of their networks, pre-emptive virus protection and staff on call if there was ever a problem.  

Steward approached her clients with a calculation of what they had spent with her firm over the most recent 12-month period, including the cost of her customer’s downtime. She made the case that by signing up for Angel Watch, they would save money when taking into consideration both the hard costs of her firm’s time and the soft costs associated with downtime.

90% of her customers switched from hourly billing to the Angel Watch program.

  • Doubling Rates

Next Steward doubled her personal consulting rates. That way, when one of the customers who decided not to opt into Angel Watch called her firm, they were quoted one rate for a technician’s time or twice the price to have Steward herself. Not surprisingly, most customers opted for the cheaper option and others chose to re-consider their decision not to sign up for Angel Watch.

  • Survivor Clause

Steward also credits a small legal manoeuvre for further driving up the value of her business. She included a “survivor clause” in her Angel Watch contracts, which stipulated that the obligations of the agreement would “survive” a change of ownership of her company.

Steward went on to successfully sell her business at a price that was more than four times the original valuation she had received just two years prior to launching Angel Watch.