Blog / LearnMonday, May 13, 2019
Fanny Josefine Fredskilde
Adopting a recurring revenue model for any business is a great way to grow revenue. For a business offering a SaaS solution, adopting a recurring revenue, or subscription based, model, can have many benefits both for themselves as well as for them customers.
Recurring revenue models aren’t just reserved for SaaS platforms, either. Subscription based services are increasingly available across a range of industries, including food and drink, cosmetics, and even clothes.
Let’s look at the logic behind adopting a recurring revenue model and explore different types of recurring revenue models and the types of businesses they might be best for.
Recurring revenue is predictable income that you can use to both forecast future revenues while also getting a snapshot of the health of your business. When you adopt a recurring revenue model, this gives you the ability to use and analyse a wide variety of metrics which will help you to take strategic decisions related to the direction of your business.
It can therefore be extremely powerful to structure your business around a recurring revenue model, both for making internal business decisions but also for things like attracting external investment into your business.
In both a B2B and a B2C context, buyers today are trending towards a preference for subscription-based services. Such services allow users to use them when they need to without needing to make individual purchases, while from the seller perspective you can automate the process of selling and allowing people to use your SaaS platform.
As a result, increasing numbers of companies across a range of industries are choosing to offer subscription models.
A look around the internet will quickly take you to several real-life recurring revenue success stories.
You probably use some of them yourself:
Let’s take Amazon Prime as an example.
At $12.99 per month in the United States, with a reported 101million users, Amazon Prime has recurring monthly revenue of $1,311,990,000.
Before we look at different SaaS revenue models and help you decide which one might be best for your business, let’s sum up the benefits of selling subscription-based services.
Not only does a recurring revenue model help you to predict your future income, but it can work as an early warning system if people start to cancel their subscription, enabling you to take action to reduce churn or attract new business to offset those cancellations.
If your SaaS business is affected by seasonality, you can use your recurring revenue projections to plan activity around this to try and maintain subscriptions, such as offering a promotion to reduce loss or to add new customers to your subscriber base.
Acquiring customers is tough, and it can also be expensive. The beauty of a recurring revenue model is that your sale repeats, thus compounding your revenue from customers, but you don’t incur the acquisition costs for each recurring payment. Thus, so long as your customer stays subscribed, your profit from that customer continues to increase.
If your SaaS solution is amazing, your customers will generally stay with you. Customers will be loyal if you deliver value and make them happy, and with a recurring payment model they don’t have to do anything, you automate payments while they continue to use your platform as you wish.
There are five main recurring revenue models for you to choose from. Let’s look at the potential pros and cons of each to help you decide which model might be best for your SaaS business.
Usage-based billing gives your customers control of what they use, and thus what they spend.
For example, if you were to launch a SaaS platform based on email, you could potentially bill customers on a sliding scale based on how many emails they send per month, from a minimum amount and/or up to a maximum about, depending on how you wanted to bill your subscriber base.
Pros: Flexibility for customers, keeping costs low if they are low-volume or sporadic users.
Cons: Can be unpredictable in terms of revenue projections for you and may be difficult to manage support costs to keep low spending accounts profitable. If you use maximum pricing, you may also be limiting your profitability from high volume users.
Works Best For: SaaS businesses that can track usage, be this the number of emails sent, APIs used, or reports generated. Usage-based billing could work as an add-on to your subscriptions. For example, you could make API usage an additional option, available at extra cost on top of a regular subscription payment.
User-based billing is when a client pays for the number of people who use the platform.
For example, Dropbox offers team solutions where they charge for usage on a “per user” basis.
Pros: Offers a more stable and predictable revenue base for forecasting and is easily scalable if you’re selling at “Enterprise” level. You don’t require any resources to track usage as you would be billing a flat fee per user to use your SaaS platform as much or as little as they wish. Can be combined with a model such as tiered pricing to reduce the cost per user as more users are added by customers.
Cons: This model may put off companies who are looking to control costs and may decide to only take out a limited number of accounts. Customers may get limited value if users don’t always use the platform. Slack deals with this scenario by only charging customers for active users, but this obviously then reduces revenue albeit being a good customer service measure.
Works Best For: Collaboration or customer service SaaS tools.
Tiered pricing is hugely popular and common in SaaS. Tiered pricing can be tailored with specific buyer personas or customer segments in mind, and if users it a usage limit in a tier, they can easily be moved up to the next tier. Likewise, if they are on a higher tier but only using your SaaS platform on a limited basis, they can easily downgrade.
Pros: You can market your SaaS platform to a wide range of users and tailor your tiers for a specific range of needs. You enjoy predictable recurring revenue, and you can use subscriber numbers in each tier to understand where your customers get the most value from your SaaS solution.
Cons: As a business you might start to overcomplicate the different tiers you offer. As you will appeal to a wide user base, feedback on what you should change will be wide-ranging, meaning it’s important you have a clear focus on what you want to achieve as your platform grows.
Works Best For: Businesses offering a SaaS solution built around sales and marketing.
As the name suggests, hybrid billing is where you combine different subscription models, as we suggested earlier. A typical example would be where hitting a usage level, or exceeding a certain number of users, triggers a change in pricing.
Pros: Hybrid billing enables you to charge a premium fee for your SaaS platform but to also maintain a level of flexibility in what you offer. This may help you provide pricing that is more closely aligned with what your customers perceive as value.
Cons: Implementing hybrid billing could make your overall pricing model complex, so you need to take care to keep things simple.
Works Best For: Businesses that can capitalise on the benefits of bringing more than one subscription model together.
A Freemium model is a “free for life” subscription plan, with an option to upgrade onto a paid or premium plan. The idea for SaaS platforms offering a Freemium model is that users will both love the service provided and use it often enough, or in sufficiently high volume, that it is worth upgrading to a paid version. Dropbox is a great version of a SaaS platform that offers a Freemium solution. SaaS platforms with Freemium options are effectively running a hybrid model, unless they are funded by advertising or have another means of generating revenue other than paid subscriptions.
Pros: It can be easier to build a customer base if they’re getting something for nothing when they first sign-up.
Cons: It’s easy for you to end up running your SaaS business at a loss, particularly if you are incurring servicing costs for Freemium accounts and struggling to convert Freemium users into paid ones. You might also find yourself attracting huge numbers of customers who only want to use your free version, and as they approach a usage limit or point where they would need to pay, they choose to seek out an alternative free solution.
Works Best For: SaaS platforms who have very low costs for servicing accounts and have a high probability of converting them into paying subscribers within a specified time frame.
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