Recurring revenue is a phrase that often appears during business valuations. The most profitable businesses (and therefore the most attractive to a potential buyer) are those that retain recurring revenues, meaning that the same customers continue to return time and time again. Rather than constantly seeking out new clients, a company with recurring revenues can earn a large portion of profits from repeat customers that have become loyal to the brand. Potential buyers seek out these types of businesses because, not only are they highly profitable and offer a high return on investment, but they also require less work and possess a lower risk factor.
The following guide describes various manners in which a business owner can create barriers to entry through instating a continual cash flow. When the time comes for the owner to sell the business, a company with recurring revenues will have a higher valuation number due to its client retention.
Perhaps the most obvious type of recurring revenue products are those that people consume on a regular basis. Examples include soap, toilet paper, and cleaning supplies. When the consumer runs out, they purchase the same things again (usually from the same brand).
Consumables that require the customer to purchase other parts as well are also highly beneficial to a buyer. For example, a vacuum company that also sells compatible vacuum bags is often much more profitable than a business that only sells a portion of the total product that the customer utilizes.
Memberships and Subscriptions
One excellent manner in which to ensure that customers will continue to pay for a product regularly can be found in creating a member- or subscription-based service. For companies such as gyms, memberships are an excellent way to receive payment up front, whether or not the consumer chooses to utilize what they purchase. Oftentimes, a customer will forget about his or her subscription and continue to pay for it, even after they have ceased using the service. Automatically renewing contracts are also an excellent way to retain clientele.
Warranties and Contracts
Offering warranties is another valuable way for a business owner to capture a customer for an extended period of time. The profits made on warranties are typically high, since the number of clients that actually utilize the warranty's protection is far lower than the number of clients who do not.
Contracts also lock the customers into an extended period of loyalty to a specific company. Contracts with cell service providers are an excellent example. Contracts and subscriptions are a way to ensure that clients will remain with the company for a certain period of time, despite the business changing hands. Contracts allow the buyer ample time to prove themselves as the new owner before customers become wary of the merger or acquisition and take their business elsewhere. This manner of security will cause the company to be more attractive to buyers and it will improve the valuation numbers.
Service fees can be beneficial, especially for those vending only one product. Providing maintenance or training on a central product is an excellent method for acquiring return customers for products that are not consumables (such as a vehicle). Encourage the clientele to return before they are due to purchase their next item, in order to maintain a steady revenue stream. Not only does this provide the company with more frequent business, but it helps build relationships with patrons and create brand loyalty.
Multiple Streams of Income
Instead of offering a singular high-quality product or service, consider branching out into various revenue streams. One manner in which a seller may accomplish this is through vertical integration; or buying out other facets of the production line.
Creating a brand that sells different, but similar, products can assist in revenue growth. Selling both laundry detergent and fabric softer can prove to be more beneficial than selling only one or the other. The seller is then able to combine these products into bundles in order to convince the customer to remain with their specific brand for all of their household needs. However, it is important for business owners to be careful not to branch out into too many different products, as this could result in sub-par commodities.
It is vital to note that while considering instating the above solutions, that cancellation policies must also be in place. Business owners walk a fine line between profitability and causing the customer to feel cheated or held hostage. It is critical to achieve a fair balance, which is why a business should establish a constructive policy for handling unhappy customers.
Now that you are armed with models to help you invent recurring revenues in your own business, the next step is to reflect on ways in which they will fit in to your business strategies. While many of these models may appear irrelevant to your own products or services, consider ways in which you may successfully implement at least one of the above methods. It may be surprising to discover how almost any business type may benefit from one of these models.
If you would like to learn more about creating value for your business, please contact George & Company. We are experienced M&A professionals that would enjoy assisting you in the appraisal and sale of your business.