🌟 TL;DR It can be hard to know what the best business model is for your product, but when in doubt do whatever maximizes lifetime value of customers and increases predictability of revenue
In SaaS parlance, there are a few different ways your customer could pay—i.e. a few different kinds of revenue you could earn—and they imply wildly different things about how you should think about your business. Here, we'll offer a handy framework that will hopefully set you down the right path.
The different kinds of revenue
Within SaaS businesses, there are four broad categories of revenue:
- Recurring revenue (think Netflix). There's an amount you get charged automatically every month for access to the app.
- You could break this down into "monthly recurring revenue" and "annual recurring revenue" (think Salesforce). In the annual version, you pay up front for a year of service, and at the end of the year they present you a new contract to pay for the next one.
- Re-occurring revenue (think Steam). You are clearly "recurring," but there's no contractual obligation or auto-charging of credit cards. You just go there regularly and reliably.
- Metered revenue (think Stripe). They don't charge you anything up front, but if you use Stripe, you (hopefully) are processing payments constantly, and Stripe earns a percentage of that. The more you use them, the more they earn.
- Non-recurring revenue (think buying a TV). You buy it as a one-time thing. The next time you need a TV, you may or may not buy the same kind at the same retailer.
Why categorize these types of revenue?
Without differentiating between these revenue types, it's impossible to say whether you have the right balance of lifetime value (LTV) of a customer and the cost to acquire them (known as CAC, or customer acquisition cost). If you lump non-recurring revenue in with the recurring revenue, there's no good way to estimate how much revenue a customer will generate in the future, which means no clear lifetime value.
And the more you earn from a customer over their lifetime with you as a vendor, the more you can afford to do to acquire them (advertise, build brand, make a prettier website, hire salespeople, do paid referral programs, etc).
Guiding principle #1:
⭐ When in doubt, build your business to maximize your customer LTV
If you hold the the CAC constant, the more you can improve their lifetime value with them, and the better your business. If the TV manufacturer could sell you your next 10 TVs for sure by lowering their gross profit per TV by half, that would be worth it by 5x!
Guiding principle #2:
⭐ Work towards higher predictability of revenue from your customers
If you can have a great idea of what your customers will pay you in the future (and that number isn't $0), this level of predictability is incredibly valuable. It's a reassurance that the business isn't going to suddenly stop making money in the future. It's cash flows to borrow money cheaply against. It's a way for outsiders to know that the business is not just valuable now, but will continue to be valuable into the future.
😍 Why recurring revenue is so desirable
Recurring revenue is the most predictable, consistent way to have a high customer lifetime value, especially if churn is low. If you have a service that customers like having, the hardest part for you is simply acquiring them. After that point, staying with a company is a default decision, so that's what people do. You've probably experienced this in your personal life: most of us have a subscription or two that we haven't used for a month or two, but we stick with them anyway because the hassle of canceling just isn't worth it.
It's also entirely predictable - when a customer signs on for a recurring contract, they say exactly what they will pay in the future unless they cancel. So if your churn rate is low (i.e., you know most people won't cancel), your business gets a lot of predictability.
It's no wonder that as a result, nearly every company tries to grow a recurring revenue stream—Amazon sells household products on subscription, and Adobe has had a well documented transition to a subscription software company, to name just a couple.
📏 Metered revenue is often just as good
Metered revenue is revenue that's based on the amount of usage of the product the user has. It could be something like "number of API calls" or "amount of dollars processed" - metrics that vary from one month to the next, and have a different bill as a result.
The poster child of metered revenue is the crazy-successful . Metered revenue works so well for Stripe because once a customer starts using Stripe to bill, there's very little reason to leave. While Stripe isn't cheap, it's best-in-class for all things payments, and getting money is absolutely critical to a business's survival. Best not to mess with it!
As a result, while Stripe doesn't have official contracts with most of its customers, they keep processing payments every month, and Stripe earns money every month. It's not invariably recurring—but it is recurring!
(Side note: the monthly variability can make financial metrics like upsells and downsells very hard—this is where Subscript helps! And, be sure to subscribe to our newsletter get the deep dive article on this topic soon!)
🌀 Re-occurring revenue: when behavior creates the lock-in
There are some products that simply aren't ongoing: you buy them once, and that's it. When a customer buys a game from, say, they get lifetime access to it. There are definitely exceptions within the games themselves (microtransactions, downloadable content, and subscriptions have become arguably as important as the up-front purchases), but that's not Steam's revenue: instead, Steam relies on a cut of the individual, non-recurring purchases as its bread-and-butter.
Could a user simply stop coming back and buying more games? Sure. And doing so wouldn't even be as painful as stopping using Stripe, say—they would lose access to nothing. But for the most part, that's not what happens: people love games, and Steam is best place to buy and access their purchases, so they keep coming back and buying more games.
If your business can create an experience that results in users coming back regularly and periodically, that will maximize your lifetime value! That's what creates amazing value for your business, regardless of whether there's an official recurring contract.
🍀 Maximize lifetime value + predictability
There's been a lot of excitement around recurring revenue for a decade, and rightly so. It's an incredible model for a lot of products. But if it isn't for your product, don't fret! Think about it in terms of lifetime value: if you maximize that, you'll get all the benefits of recurring revenue. And if you need help getting the right metrics to make your recurring, metered, or re-occurring business successful, check out Subscript.com.
Coming soon... (based on your votes!)
- How do you think about subscription metrics if you're a metered revenue company? (vote for this topic)
- How do you think about subscription metrics if you're a re-occuring revenue company? (vote for this topic)
- What are the ingredients that are critical to making your metered revenue strategy successful? (vote for this topic)
- What are pricing models that support the kinds of revenue above, and how can you use contracted minimums in addition to a metered revenue model? (vote for this topic)
🙏 ❤️ Thank you to SaaS guru Sandy Kory (Horizon Partners) for reading drafts of this article!