Recurring revenue models explained: What businesses need to know

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  1. Introduction
  2. What is a recurring revenue model?
  3. Types of recurring revenue models
  4. Benefits of using a recurring revenue model
  5. Challenges of using a recurring revenue model
  6. How Stripe powers recurring revenue models

Recurring revenue models, where customers are charged at regular intervals for access to a product or service, were once reserved for niche sectors. Recently, however, more businesses have implemented recurring revenue models, fundamentally rethinking how they generate revenue and build enduring relationships with their customers. Shifting to a recurring revenue model can increase customer lifetime value and enable businesses to grow more sustainably.

Implementing a recurring revenue model requires thoughtful planning. In this article, we'll describe the various types of recurring revenue models, discuss their benefits and challenges and provide insights to aid your decision-making process as you explore this shift in business strategy. Whether you're just starting out or refining an existing revenue model, here's an overview of what you need to know.

What's in this article?

  • What is a recurring revenue model?
  • Types of recurring revenue models
  • Benefits of using a recurring revenue model
  • Challenges of using a recurring revenue model
  • How Stripe powers recurring revenue models

What is a recurring revenue model?

Recurring revenue is a business model that generates consistent, predictable revenue streams by charging customers on a regular, ongoing basis for a product or service. Rather than focusing on one-off transactions, businesses using this model create ongoing, sustainable revenue by providing continual value, which customers pay for periodically – often through subscriptions or memberships.

Here are some of the primary aspects of recurring revenue models:

  • Consistency and predictability
    The recurring revenue model is designed to create predictable and stable income streams for businesses. Businesses bill customers at regular intervals (monthly, quarterly, annually, etc.), allowing them to forecast revenue with a higher degree of certainty than they could with sporadic or one-off sales.

  • Periodic payments
    The model requires customers to make regular payments for continued access to a product or service. Businesses can charge for this access in various ways, such as fixed subscriptions for unlimited or defined usage, or variable payments based on usage metrics (also known as a pay-as-you-go or metered model).

  • Ongoing value delivery
    The model needs to continually provide value in order to justify recurring payments from customers. This could be access to software (software-as-a-service, or SaaS), digital content (news, music, films), physical goods (product subscription boxes) or services (gym memberships and maintenance contracts).

  • Customer retention
    The recurring revenue model inherently emphasises customer retention over customer acquisition. Since revenue generation depends on the ongoing relationship with the customer, recurring-revenue businesses focus their efforts on maintaining customer satisfaction, keeping churn rates low and increasing customer lifetime value (CLV).

  • Automatic renewal
    Typically, recurring revenue payments renew automatically by default, though customers often have the option to cancel, pause or modify their subscription at any time. Automatic renewal simplifies the payment process and increases predictability for businesses.

Types of recurring revenue models

Recurring revenue models have helped businesses across the world build sustainable, long-term relationships with their customers. Diverse in form and function, these models can match the various needs and consumption habits of customers, while also offering businesses a more predictable revenue stream. Here are some of the most common types of recurring revenue models:

  • Subscription model
    In this model, customers pay a recurring fee to gain access to a product or service. The fee is typically fixed and charged on a regular basis, such as monthly or annually. Examples of this model include Netflix, where users pay a monthly fee for access to a wide variety of shows and movies, or Adobe Creative Cloud, where customers pay for access to a suite of creative software tools.

  • Usage-based or pay-as-you-go model
    In this model, businesses charge customers based on how much they use a product or service. This can be beneficial for customers who don't use the service heavily. An example would be cloud computing services like Amazon Web Services (AWS), where customers are billed based on the computing resources they consume.

  • Freemium model
    This model involves offering a product or service for free while charging for premium features or enhancements. The idea is to acquire a large user base with the free product and then convert a portion of those users to paying customers. An example is Spotify, which offers free ad-supported music streaming but charges for an ad-free and feature-rich premium service.

  • Membership model
    Similar to the subscription model, the membership model involves customers paying a recurring fee for access to exclusive benefits, services or products. It's often used where there's an exclusive community aspect. An example of a company that uses this model is Costco, to whom customers pay an annual membership fee to gain access to shop at their warehouse clubs.

  • Retainer model
    In this model, customers pay a recurring fee for access to a service on an ongoing basis. This is commonly used in professional services, such as legal or consultancy services. For example, a company might retain a law firm for ongoing legal advice and pay them a set monthly retainer fee.

  • Licence model
    In this model, customers pay a recurring fee to license a product or service. It's particularly common in software, where customers pay for the right to use software during a certain time period. For example, many businesses license Microsoft's suite of productivity software on a per-user, per-month basis.

Benefits of using a recurring revenue model

A recurring revenue model has many benefits for businesses, especially in a digital economy where sustainable customer relationships and predictable revenue streams are valuable. Let's dig into these benefits in detail:

  • Predictability of revenue
    Businesses can forecast their revenue more accurately. This improves financial planning and budgeting, providing a valuable sense of stability when planning for growth or navigating market uncertainties.

  • Customer retention
    A recurring revenue model incentivises businesses to retain their customers, shifting the focus from generating one-off transactions to cultivating long-term relationships. This emphasis on retention often increases customer lifetime value.

  • Increased cash flow
    With regular payments coming in, businesses benefit from a consistent cash flow. This can significantly improve the financial health of a company and provide funds for reinvestment or growth initiatives.

  • Scalability
    Recurring revenue models, especially in digital or service-based businesses, are often highly scalable. As the customer base grows, the business can increase its revenue without necessarily needing to proportionally increase its resources or costs.

  • Flexibility for customers
    These models can provide greater flexibility and affordability for customers, particularly with models such as subscriptions or memberships. For a predictable fee, customers can access a wide range of products or services that might be prohibitively expensive to purchase outright.

  • Opportunity for upselling and cross-selling
    Businesses have more opportunities to offer additional premium services or complementary products, increasing the revenue per customer.

  • Increased business valuation
    Businesses with recurring revenue are often valued higher than those with transactional revenue models. Predictable revenue can make the business more attractive to investors or buyers.

These benefits make a compelling case for adopting a recurring revenue model. Keep in mind, however, that the success of this model depends on a business's ability to continuously deliver value.

Challenges of using a recurring revenue model

While there are many advantages to adopting a recurring revenue model, businesses should also be aware of potential challenges:

  • High customer service demand
    With ongoing customer relationships, there's more demand for continuous customer support. Providing high-quality, responsive service may require additional resources, but it is important for retaining customers and reducing churn.

  • Customer retention effort
    Retaining customers over the long term requires continuous effort. Businesses need to regularly prove their value to prevent customers from leaving. This might involve regular product updates or re-engagement strategies.

  • Price sensitivity
    Customers paying a regular fee are often more sensitive to price changes. Increases in price, even if minor, can increase churn if not managed properly.

  • Regulatory compliance
    Depending on the sector, businesses may need to comply with regulations related to subscriptions and recurring payments; for example, making it easy for customers to cancel their subscriptions or providing certain disclosures about recurring charges.

  • Billing complexity
    Managing recurring payments can be complex, especially when dealing with upgrades, downgrades, prorations, refunds or cancellations. This complexity requires robust billing systems and processes.

  • Revenue recognition
    For many recurring revenue models, it can be complicated to time revenue recognition – especially for subscription businesses that collect payment up front but deliver value over time. This can impact financial reporting and taxation.

  • Slower initial revenue growth
    Compared to one-off transaction models, recurring revenue models might grow revenue slowly at first. Businesses need to be prepared for this gradual climb and plan their financials accordingly.

While these challenges can seem daunting, they can be addressed effectively with careful planning, the right resources and strategic decision-making. Understanding these potential roadblocks can help businesses transition to a recurring revenue model or refine their existing recurring revenue strategies.

How Stripe powers recurring revenue models

Stripe Billing is a dynamic platform with a comprehensive suite of tools designed to handle the unique requirements of recurring revenue models. It addresses many of the challenges of establishing and managing subscription or recurring billing. Here's how Stripe Billing improves various aspects of recurring revenue models:

  • Flexible billing periods
    Stripe enables businesses to customise their billing cycles, frequencies and intervals, providing a pricing structure that resonates with the unique needs of the business and its customers.

  • Usage-based billing
    Stripe supports metered billing for businesses operating under a usage-based or pay-as-you-go model, making it possible to charge customers based on their consumption of a product or service.

  • Automated invoicing
    Stripe simplifies invoicing by automating the process. This includes managing billing adjustments, prorations and dunning (recovering overdue payments), reducing administrative workload and minimising errors.

  • Subscription changes
    In the event of mid-cycle subscription changes, such as upgrades, downgrades or cancellations, Stripe Billing automatically adjusts the billing accordingly.

  • Trial periods and discounts
    With Stripe, businesses can offer free trials, discount coupons or promotional offers, attracting new customers to a subscription model. Stripe handles the tracking and applying of these discounts.

  • Multicurrency and international payments
    For businesses with a global footprint, Stripe supports over 135 currencies and a variety of payment methods, simplifying the process of international transactions.

  • Revenue recognition and reporting
    Stripe provides valuable tools for recognising revenue and generating financial reports, helping businesses comply with accounting standards.

  • Scalability
    Whether the customer base in question is small or large, Stripe Billing is designed to scale as the business grows.

To learn more about how Stripe powers recurring revenue models for businesses, go here.

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