Software Pricing Fundamentals Determining if a Recurring Revenue Model is Right for You

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Audio Transcript

Jim Geisman: First, I thought it would be useful to talk about where recurring revenue fits, I mean everybody has a business model which by and large is driven by revenue. A revenue model in turn is driven by a pricing model, but we’re really going to focus on the revenue model today.

It’s useful to take a look at recurring revenue across a number of dimensions. We’ll talk about the dimensions of recurring revenue and identify where there are opportunities. Then we’ll talk about how you can monetize them and then how you move forward. So here here are just a handful of recurring revenue businesses, you can see they run the gamut you know B2B, B2C and a little of both. You can see the different businesses and you can see the different financial arrangements.

You can identify a number of recurring revenue characteristics and these are the ones that sort of make sense to us. There’s the commitment: is it an annual subscription is it a per transaction? The variety of products that are included: is it pretty constant or does it change? The deliverables: are they single line items or they multiple ones? The invoicing may be event-driven (i.e. periodic) and the payments may be fixed like Netflix monthly or like Expedia.

The payments are variable according to what you’re trying to do. So if we map those companies against the dimensions what do you see? It’s a mess, I mean what it really tells you is recurring revenue businesses can be anything. As John said the revenue is predictable and it applies to any type of product.

If it’s a continuous stream of payments or transactions, you don’t need to lock people in. But you have to deliver value continuously. That last point is really the heart of the issue and to do that you have to be financially aware of what’s going on and aware of what your customers are doing, so that you can respond appropriately.

So let’s turn now to the opportunities: where are they? Well there are three components to virtually any opportunity: (1) there are the products and (2) the services that deliver value to the customer for which the customer pays and generates revenue. As we saw before products and services can be anything: it can be digital, can be physical or the product can be based on timing. For example, the shipping options for Amazon or the immediacy of Expedia. In terms of customer value it can be based on a number of factors, usage or consumption it can make their purchasing process easier (for example, Amazon’s recommendation engines). Or, it can facilitate the decision making such as Expedia where it’s it’s tough to make a choice of what flights you want but Expedia among other travel sites help you in that regard. Then when we turn to (3) revenue source, we take a look at the the transaction with the customers.

“An aggregation is where you have so many customers that you can play the law of large numbers and predict your revenue stream”Jim Geisman, Software Pricing Partners, LLC

Any customer transaction can have volume. In other words, you can have a number of transactions from a single customer. Or conversely you can have volume across all of your customers. The duration refers to how long you’re engaged with your customer and the frequency refers to how often they order.

An aggregation is where you have so many customers that you can play the law of large numbers and predict your revenue stream. For example, in Amazon Prime or in the case of Air Products that both rent cylinders and sell gas. They have so many customers that at any given time they know what percentage of customers are going to do what sort of thing. All of this is well and good, but you’re missing one critical set of skills and that has to do with the logistics and the financial aspects of these elements. In terms of logistics, it doesn’t do any good if you can’t fulfill the orders, deliver the orders and manage channels if you have them and work with international distributors.

On the financial side, we all like to get paid so you have to do invoicing, manage the terms, keep track of promotions and then finally you have to do payment processing. Since a lot of business is done via credit cards, these are non-trivial issues and that’s basically what Aria does. But I think it’s really important to note this if you look at promotions one critical aspect there that a lot of people overlook is that this is an ability to test prices, to test different terms and if you can’t keep track of all of your promotions, you’re dead in the water. You have limited your opportunities for growth, revenue, potential revenue, sources and so forth.

So if we take a look at these elements against the companies we can see that it kind of fits the revenue sources. Netflix has a lot of volume for entertainment. The customers’ value is availability, especially the streaming product. It doesn’t matter whether you’re getting CDs delivered to your your home, or you’re streaming.

You have to fulfill it at the other end of the line if you look at Air Products, who rent cylinders and sell gas. It’s the frequency that does it. The products are gas and what’s the customer value? Well, Air Products basically provides peace of mind because they monitor usage and they make sure that what you need is what you get. And obviously delivery and fulfillment is a critical skill. But you can see that along all of these very different businesses these four elements have to be in play otherwise you’re dead in water.

I think the message here is opportunities everywhere. Like motorcycles are everywhere but opportunities are everywhere and I think it’s up to you to try to encourage other members of your team to find them. If you’re looking for new opportunities, often that will take you off your normal beaten path, and you really need a framework to develop these new opportunities and the business model canvas is one of the better frameworks that I’ve seen that can call it to your attention.

“If you’re looking for new opportunities to monetize, you really need a framework to help take you off the beaten path.”Jim Geisman, Software Pricing Partners, LLC

It’s an orderly way of looking at your business or a new opportunity and understanding what you have to do to succeed. So for those of you that have a recurring revenue stream perhaps this will be old hat to you, I hope not. For the others I hope it will make the challenge of monetizing a recurring revenue stream less formidable.

So how do you monetize? First of all, as as you know nobody is going to pay if they get nothing in return. So customers will pay for value and you need to take a look at the core of what you’re offering and how it’s structured. Determine what the hard dollar or the emotional impact of better/faster/cheaper is. A better/faster/cheaper is really just shorthand for the advantages you have over current solutions. This works particularly well in a B2B environment. Relative to emotional impact, even though you may not be able to quantify it, you can judge the intensity of that emotional impact and the more intense the emotional impact is probably the higher value.

Well, as you probably know, pricing is a mess, it’s very difficult to do pricing. Either you have a high volume of SKUs to do pricing on and you need some system for doing that. Or your pricing some basic products that may drive your volume and people tend to go around and around on pricing and I think there’s more heat than there is light.

What we’ve done over the over the years has developed a framework that parses a complex problem into some pieces and then once you have addressed each of the pieces then you can put them back together and make sure that they work.

At the heart of any Monetization Model is the metric, what you charge for and your commercial terms and conditions. Then B2B it’s very important that you’re metric (what you charge for) lines up with the way your customers get value in their business. In B2C clearly what you’re charging for should scale according to how the customers experience your product.

After you’re done dealing with the License Model (formerly referred to as the Rights Model) — and by the way T’s and C’s also add value. You’re all familiar with companies that have 15 day terms versus 60 day terms. 60 day terms often translates into real value especially for very large companies.

In terms of offering structure what we’re talking about here are the products and services. You know you can have services surrounding a product you can have products surrounding services. The point is that these things often reinforce each other. Then finally once you know what you’re going to charge for and what the “it” is then you can go about the price setting process of actually setting the list prices and then determining your discounts or other incentives you’re going to provide your customers.

If you do this in a systematic way, which is really all I’m advocating here, it just makes it a lot easier for you to do standard or tailored transactions. The standard transactions are really like ordering off a multiple choice menu where you choose a couple from the first column and something from the second column and, in effect, what you’re doing is customizing a configuration which you then offer as a standard. Or you’re customizing a configuration on the floor to meet a specific customer need. That’s a tailored transaction and is the hardest thing to deal with. Most companies are these custom configured transactions where every transaction is different.

Now the question is: I understand that recurring revenue opportunities have a number of dimensions and there are plenty of opportunities and if I go about them systematically I can monetize them, but how do I move forward?

First, you have to think creatively and outside of the box. Furthermore, thinking outside of the box is often very risky and if your organization is risk-averse you want to insulate these out-of-the-box thinkers about new business opportunities or new business models so that they have a chance to succeed.

Even if you think outside of the box you really need to plan carefully, I think many of us are familiar with this this puzzle, where you try to take these blocks and you move them to another peg and that can only be done if you do things very systematically. You can’t do it haphazardly but even if you plan carefully what you really need to do is execute and you need to execute ruthlessly. And this may mean changing your computer systems or integrating their pieces in. It may change your people, processes and where you need different skill sets amongst the people. And certainly it will take different business processes as well and you’ll need to change them.

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About the Author

Chris Mele

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Chris is a software monetization and pricing expert and former CEO of an award-winning SaaS company. An avid scuba diver, Chris should probably move closer to the beach.

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