What is Recurring Revenue Business Model? Types, Benefits & Challenges

The business ecosystem is in the midst of a paradigm shift, as customers are increasingly preferring to pay for access rather than ownership. Many industries have shifted from the one-time sales model to the recurring revenue model, which allows businesses to generate consistent revenue by providing ongoing access to their products or services in exchange for regularly scheduled payments. Interestingly, this business model is no longer limited to magazines, music, and movie subscriptions. It is now becoming prevalent across domains as varied as software, automobiles, groceries, clothing, and furniture.

Let’s take the example of the automobile industry, where customers can now subscribe to cars as a service instead of purchasing them outright. Offered by popular brands like Audi, Porsche, and Nissan, car subscriptions are generally all inclusive - the car, insurance, and maintenance cost are combined into a single monthly fee. Unlike in a traditional lease, here the customer has the option to switch cars during their subscription easily. The model benefits the car manufacturers by creating an additional channel for predictable income and allowing them to quickly adjust to changing customer demands.

With compelling benefits like steady cash flow and high customer retention, the recurring revenue business model is here to stay. In this guide, we will walk you through the basics of the model and how it can benefit your business.

What is the recurring revenue business model?

It is a business model where the vendor provides access to a product or service in exchange for a recurring fee charged at scheduled intervals (monthly, quarterly, or yearly). This model forms the base for subscription businesses and membership services.

Since customers consistently purchase the product or service month after month, it ensures predictable cash flow and a sustainable profit margin for the business. Unlike traditional one-off sales where the relationship between the vendor and the customer ends after a single sale, the recurring revenue business model helps establish a deeper relationship with customers to attain high customer retention.

What are the types of recurring revenue business models?

The potential of this model keeps extending, including more business domains and even different types of recurring revenue business model. Here are some of the most common types of recurring revenue models:

Hard contracts

In this model, a service is provided to customers over a specific period for pre-determined charges. It secures future revenue for the business against unexpected cancellations and delays.

Mobile phone contracts are a good example of this model. Here, once the customer signs the contract, they will pay a fixed amount for the texts, calls, and data they will use for a certain specified period. Some mobile contracts might require the customers to pay a small one-off fee on top of the recurring contract fee when they sign up.

The defining feature of a hard contract is that the customer is locked in until the contract period ends—if they want to cancel early, they generally need to pay a cancellation fee, which can be quite substantial. Once the contract period is up, the customer can generally keep using the service at the same or similar rates with a rolling monthly contract. This way, the business's monthly recurring revenue will continue, even though the hard contract has ended.

Sunk money consumables

Here, the customers initially buy a product or invest in a platform, then make recurring purchases that allow for the continuous usage of the product or service.

Gillette razors are a popular example. The company's founder developed the idea of selling the razors themselves at a low cost and capitalizing on the repeated purchases of disposable blades. This way, customers make the product a habit—they follow the routine of purchasing blades, disposing of them, and replacing them with new ones, making them lifetime users of the product. Another popular example of the sunk money consumable model is the Nespresso coffee machine. After purchasing the machine, the customer has to buy specific, compatible coffee capsules to keep using it.

Auto-renewal subscriptions

In this model, the business collects revenue automatically until the customer voluntarily cancels their subscription. Since auto-renewed subscriptions can essentially go on forever, they are also known as evergreen subscriptions. Streaming services like Netflix and product box subscriptions such as Birchbox are some examples of this model.

Usage-based subscriptions

In usage-based subscriptions , customers are billed at scheduled intervals based on their product usage. For example, MessageBird provides API service for SMS and voice calls for enterprise customers. The users are charged based on the number of SMS messages they send and the duration of the voice calls they make.

Tiered billing

Here, the pricing structure includes multiple tiers or levels of use. Once a customer’s consumption exceeds the quantity allowed in one tier, they move to the next tier, which generally offers additional functionalities and more units of usage. SaaS products offering multiple tiers of pricing (like Basic, Professional, and Enterprise plans) are common examples of tiered billing.

User-based billing

In the user-based or per-seat billing model, the customer is billed based on the number of users accessing the product each month or year. The charges scale up linearly with the number of users.

Software products used by entire teams, like Customer Relationship Management (CRM) apps and team collaboration apps like Slack use this model to generate recurring revenue.

Hybrid billing

When the aspects of two or more revenue models are combined, the result is called a hybrid billing model. Birchbox, a personalized beauty box service business, uses a hybrid model that combines the recurring and one-time sale models. The company charges a subscription fee of $30 per month and also offers one-time purchases of products such as brush kits and makeup bags.

Freemium

A freemium model provides customers lifetime access to the product or service free of charge, but in order to get additional or advanced features, they need to upgrade to a paid plan. For instance, you can use Spotify free of cost to listen to songs and save them in playlists. However, to get additional features like ad-free listening and high-quality audio, you need to upgrade to the paid plan.

Businesses that are best suited for the recurring revenue model

Even though businesses from many different industries have been transforming themselves to fit into the recurring revenue model, there are certain business types that are particularly suited for this business model.

Content-based

Businesses that provide access to media content, like audio, video, and books, have been very successful adopters of the recurring revenue model. Netflix, HBO, and Spotify are some popular examples.

When people subscribe to these services, they sign up to enjoy access to the services exclusively. The appeal of the content-based business is the fact that the only way to get complete access to the content you want (be it movies, songs, or books) is to be a subscriber of that particular service. For example, if you are a subscriber of Amazon Prime, you can access some e-books in Kindle format. However, to get unlimited e-books, you have to subscribe to Amazon Kindle specifically.

Service-based

Many software companies offer access to their apps on a subscription basis (SaaS) instead of one-time sales. SaaS eliminates the cost of initial software setup and the difficulty of implementing product updates. While the traditional one-off sales model makes it quite tedious for the software developers to deliver product updates to the end users, the SaaS model makes it a simple, automated process and the new features can be added seamlessly.

Product-based

A popular example of the product-based subscription model is subscription boxes, where customers sign up to receive boxes of a particular kind of product at scheduled intervals (weekly, monthly, or quarterly). Based on demand, these boxes are roughly categorized into two types: convenience and curated.

If the products in the subscribed box are replenished periodically with more of the same items, they fall under the convenience subscriptions category. Dollar Shave Club for razors, Blue Apron for groceries, and BarkBox for pet food are some of the best examples of convenience subscription boxes. In these boxes, the customer generally knows what they'll be receiving and may have the option to select the specific items they want in their box.

In contrast, customers who subscribe to curated subscription boxes are sent an assortment of products based on a theme. These customers have not preselected the specific items they'll be receiving, and don't generally know which products will be included. These are also called "surprise boxes." CrateJoy (a curated gift box) and ArtCrate (curated home decor products) are some popular examples of curated subscription boxes.

The growth of e-commerce and social media has contributed tremendously to the popularity of subscription boxes. The convenience and personalized experience that these boxes provide is a major hit with customers.

What are the benefits of the recurring revenue business model?

There are several reasons why many businesses are shifting towards the recurring revenue model:

Predictable revenue

In a traditional business model based on one-time sales, revenue is prone to market-based fluctuations. The recurring revenue model guarantees the business a certain amount of revenue at scheduled intervals. This predictability helps the business in budgeting expenses, stocking inventory, and investing in growth and expansion.

Expand your customer base

The primary reason for the success of the recurring revenue model among customers is the flexibility it offers. Smaller recurring payments reduce the price barrier for potential customers and make it easy for them to purchase. Though customers may pay more over the term of the subscription, the smaller monthly payments allow them to spread out the financial impact, while enjoying the benefits of the product or service as soon as they sign up. By offering the products under a recurring revenue model with several payment options, the products can be made accessible to more people and thus expand the customer base.

Customer retention

In traditional business models, you acquire a customer, sell your product once, and then get a new customer to make another sale. Though acquiring a new customer generates the initial sale, making new sales to existing customers is simpler than finding entirely new ones who have yet to discover your product. Besides, it is five times cheaper to retain your existing customers than to acquire new ones. If you focus on customer retention you will spend relatively little on customer acquisition and gain more by retaining customers for a longer period.

One way to retain customers successfully is with personalized engagement, where you capture and analyze your customers' purchase patterns to predict their preferences in advance. Netflix is a great example that uses its users' behavioral data effectively. The company analyzes patterns like the user’s most-watched content, ratings, searches, and scrolling habits to personalize the content to their preferences. With such a commitment to personalization, Netflix has better insights into keeping the users engaged, satisfied, and coming back for more.

Drive more revenue

Up-selling and cross-selling are a lot easier with a recurring revenue model, where businesses have ongoing long-term relationships with the customers. Continuous contact with customers provides room to build bonds of trust, which makes it easier to sell additional services. Besides, implementing strategic price models like tiered pricing, volume pricing, and bundled pricing allows your customers to upgrade to higher plans on their own.

What are some challenges of the recurring revenue business model?

While the recurring revenue model has attained immense popularity, it is not without its challenges. Plenty can still go wrong if the customer requirements, products, and competitive factors are not managed well.

Managing churn

Managing churn is a common problem that all subscription businesses deal with. It can grow from a minor issue to a major challenge if the business is unable to retain most of its customers and the churn rate gets out of control. However, churn can be minimized by identifying the cause and taking suitable measures.

Customers may churn out voluntarily due to dissatisfaction with the product, service, or pricing, or they might stop using the product once their short-term needs are fulfilled. By offering products that provide value to the customers, meet their continuing needs, and exceed their expectations, you can reduce voluntary churn. Other factors like non-payment due to network issues, outdated card information, and other technical glitches can make customers leave your business without intending to. Fortunately, this type of involuntary churn can be minimized by having a proper dunning management system in place.

Subscription fatigue

Subscription fatigue is when customers feel overwhelmed and tired of signing up for many subscriptions. The explosion of subscription services has provided customers with numerous choices across many industries. While it’s good to have choices, recent studies reveal that too many options eventually create subscription fatigue, causing customers to cancel their subscriptions.

For example, in recent years, video streaming subscription services have become the best alternative to cable subscriptions for many consumers. However, the number of streaming options keeps growing. According to GlobalWebIndex reports, one in four people surveyed reported that they are frustrated as the content they want to watch is spread across many platforms. 33% say they wouldn't opt for another service since they have enough options already, while another 10% of customers stated that they would cancel an existing subscription before subscribing to a new one.

It's best for businesses to keep a close eye on customer buying patterns, purchasing behavior, and feedback, so that they can tailor their offerings to suit changing consumer needs and offer enough value to mitigate the possible impact of subscription fatigue.

Key Takeaway

The recurring revenue business model has become an attractive choice for customers as well as business owners. With its different types adopted in diverse business domains, the recurring revenue business model is gaining tremendous popularity. However, like any business model, the recurring revenue model is not without its challenges. Nonetheless, by navigating through initial adoption difficulties and making no compromise in providing value to the customers, the businesses can sail through the challenges like customer churn and subscription fatigue. Thus, when implemented correctly, the recurring revenue model can help you forecast revenue, plan growth, expand your market, retain more customers, and ultimately enhance your profits.