Outside the Herd

David Skok of Matrix Partners has put up a couple of really good posts on recurring revenue business models: a 2-part discussion, a deck, and related models. Having spent a number of years working on a recurring revenue model, David’s advice totally rings true. Some of it’s obvious, like try getting paid upfront, but I think it is critically important to have the concepts and math down. I’m always amazed when sales managers don’t have math like this baked into their DNA.

Here’s a bullet list of points, but do go read the posts. They’re worth it if you’re running a recurring revenue model.

• Building out the recurring revenue sales team can create a significant cash flow issue as revenues take time to build.
• Over a long period of time, however, recurring revenue can lead to a great return on investment.
• Costs of generating leads for a direct sales force are often overlooked.
• Find your market fit and scalable sales model before ramping the sales team.
• Ratio of churn vs rate of new sales can have a large impact on long term revenues.
• Biggest blocker on scaling is lead flow because lead sources tend to flatten out over time.
• Collecting payments in advance can have an outsized impact on cash flow needs of the business and allow you to scale much faster by eliminating the cash flow trough associated with recurring revenue models. So get paid in advance if you can.
• Quotas and gross margins can have a big impact, though David doesn’t offer explanation on how you would control those.
• Halving your churn rate will double the Life Time Value of a Customer, so do it if you can.
• You can create negative churn by growing existing customers.

I think the PowerPoint is sufficient to get the gist of what David’s outlining. To this I’d add a few of my own points on a recurring revenue model:

• Attrition can’t be brought to zero but if you have to spend on dollar on new sales vs reducing churn, do the latter. It’s a more profitable proposition.
• Investments in customer service shouldn’t only be thought of as a cost center. An extremely high customer satisfaction rate is not just a good selling point, it can have a significant cash flow impact with respect to attrition.
• Setup fees are one way to move the cash flow forward.
• Some large customers, like Fortune 500 companies, actually prefer to pay upfront annually to reduce the administration overhead so don’t be afraid to ask.
• Consider your cost of capital. Discounting to get a larger contract out of the gate is another version of moving the cash flow forward and it may not even cost you anything from an NPV standpoint.
• Keep track of acquisition costs from day one, especially direct sales costs. Ramping the sales team before your first salesperson is an overall positive investment means you in fact have a proven negative margin model. Obviously scaling a negative margin model can kill a recurring revenue company. Sometimes it’s hard to see unless you lay out all of the costs and understand Lifetime Value (LTV).

Some of these concepts might seem like common sense but actually running the models for your own company is when it becomes really powerful. Using Cost of Acquiring a Customer and LTV models that include things like churn and cash requirements to make decisions on ramping the business can have a huge impact on the potential success of your recurring revenue business.