Like the idea of residual revenue and want to transition to subscriptions as opposed to single transactions? Brace yourself: It’s not like turning on a light.
Estimates vary, but most experts say it can take anywhere from 24 to 36 months to crank up a subscription business that produces healthy recurring revenue. Why so long? Cash flow, one of the three keys to building a healthy residual business.
1. Cash flow
A subscription business that produces residual revenue can take longer to get going. Consider the “Rule of 78,” which is an accounting method to track revenue accrual from subscriptions.
Imagine selling a $12,000 contract in January of a new year. Instead of receiving a lump sum in one payment after the signing of a contract, you’ll receive 12 payments — $1,000 at the beginning of every month. Now imagine selling another $12,000 contract a month later. That contract will pay you 11 payments of $1,000 each for the remainder of the year. A contract sold a month later will produce 10 monthly payments and so on. At the end of the year, the total number of payments you received will be 78, producing $78,000 in total revenue. That’s a lot of revenue for closing just a dozen deals over the course of an entire year.
The downside to this model, however, is that it takes a while before the compounding effect of multiple contracts starts to contribute to your top-line revenue. Because of this, experts advise that organizations transitioning to a recurring revenue model from an all-transactional-based business aim for no more than 20 percent of sales from subscriptions in their first year, and 40 percent in their second.
2. Sales compensation. The second key to mastering recurring revenue is sales compensation. Craig Schlagbaum, vice president of indirect sales at Comcast Business, recommends solution providers divide their sales forces between those who like to be paid over time and those who seek immediate commission checks. Both have their appeal, he said, and both attract a different personality. “It’s tough to manage one program for all types of individuals,” he said.
As for paying salespeople, there are three basic ways to do it: upfront commissions paid for the total value of a residual deal, deferred payments paid only after salespeople retire their yearly quota or deferred commissions paid monthly over the duration of a contract sold. Many solution providers blend elements of each formula into their sales programs. Regardless of what you choose, make it simple, predictable and defensible to all, experts say.
3. Customer Churn. The final key to a subscription business is customer renewal. If customers do not renew, then the force multipliers you expect from recurring revenue will not materialize. This requires everyone in your company to shift their focus from extracting the maximum gain from your customers to creating the maximum value for them. You have to satisfy them, in other words. This means focusing on their outcomes, not their budgets. It also means staying close to them and measuring their satisfaction over the course of your contract.
While this sounds basic, it truly is a mindset shift for many organizations. If your company cannot make this shift, it won’t likely succeed selling residual-based contracts. But if it does, then the sky is the limit on how far you can go.
Learn more in the Cloud Partners Digital Summit, “Creating Business Models for Recurring Revenue.”
You can find more tips for overcoming both the cultural obstacles and process challenges of moving to a recurring revenue business model in the article, “Book It Better: Shifting to Recurring Revenue.”