03 Dec What Drives Recurring Revenue in the IT Industry?
The information technology (IT) industry is shifting to business models that generate more recurring revenue, the portion of revenue that is stable and expected to continue at regular intervals in the future. Recurring revenue models can benefit customers as well as service providers, hence their increasing popularity.
Customers like the “pay as you go” aspect – they can buy as much service as they need, pay for it through a monthly subscription, and scale it up or down as needed. Providers like the predictability of revenue and consistent cash flow, the improved customer and brand loyalty, the simplified pricing and distribution of software and updates, and the scalability that comes from using the Internet to distribute services. These benefits drive up valuations of companies that have significant amounts of recurring revenue, often increasing their valuation as much as two to eight times (2x to 8x) more than comparable companies that lack recurring revenue.
Recurring revenue is often associated with companies that offer subscription or usage-based billing, such as software companies and IT managed service providers (MSPs). But what products and services generate recurring revenue for these types of companies? Let’s look at them in more detail.
Software Company Recurring Revenue
There are two dominant licensing models in the software industry, perpetual and software-as-a-service (SaaS). Each model has different strengths and implications for service delivery and revenue, but the industry is moving towards the SaaS model.
The traditional, on-premise delivery of software is correlated with perpetual licensing, in which the customer makes a one-time payment to obtain rights to use the software on its own computers for an unspecified time period. This model usually includes support and maintenance as a separate, on-going purchase. If your company sells and supports on-premise software, you may have a significant recurring revenue stream from support and maintenance. Recently, some companies have also transitioned to a SaaS licensing model for on-premise delivered software, effectively amortizing the software license cost across a series of subscription payments.
The SaaS model is correlated with subscription or usage-based pricing, in which the customer is buying access to a software service, which may or may not include hosting services – support and maintenance are included in the subscription price. Under subscription billing, customers sign up to use the software product for a certain amount of time for a specified number of users. This allows users to opt in and out of using your product on a monthly, quarterly, or annual basis. Under usage-based billing, customers pay to use software products based on how much they use them, like paying their utility company for electricity. A variety of this model is a “transaction fees” model in which users are charged for transactions performed by the software product, such as eBay charging a commission for sales on their platform.
Managed Service Provider Recurring Revenue
There are many services that MSPs can offer to generate recurring revenue, for example:
- Network monitoring
- Managing firewalls and network usage
- Filtering customers’ email for spam
- Data backup and recovery
- Virus and malware monitoring, defense and recovery
- IP phone service
- Help desk and workstation support
Many MSPs offer these and other services to generate recurring revenue.
For entrepreneurs and business owners, recurring revenue models are attractive for several reasons, including the financial predictability and enhanced valuation multiples. There are additional benefits that add to the appeal of moving to a recurring revenue model:
- Maintaining customers over a long term in order to increase their lifetime value.
- Gaining insights into your customers’ preferences and usage patterns, which can inform your pricing, incentives, packaging, etc.
- Providing products and services from the cloud offers the opportunity to provide new, incremental revenues.
- Subscription plans and usage-based models enable companies to package and sell their products as pay-as-you-go offerings.