Before outlining my top five recurring revenue metrics, I’d like to share my views of recurring revenue and its importance in business valuations and exit strategy. Recurring revenue will do more to increase the value of your business than any other factor, other than a piece of intellectual property (IP) that is a game changer. Combine solid MRR and IP and you’ll build a business that has multiples you can only dream of right now.
I don’t have a negative view of the economy in general. In fact, I believe that, generally, business is good right now, but we’re starting to see foundational changes at the customer level. Customers are beginning to change their purchasing patterns. When they look to refresh, or add new IT capabilities – they start with a viewpoint that a monthly OPEX consumption model is the objective, and then work backwards if they can’t find a cloud solution to fulfill the need. The numbers are too compelling to think otherwise. And that’s why you need to plan now, and add a significant recurring revenue plan to your business.
Start Today! It Takes Time
Let’s assume you want to add a significant recurring revenue plan to your business. great, but assess where you stand today and determine the pace you’re comfortable with prior to altering your business model. Remember, you can expect that your revenue, gross margins and cash flow will be under pressure as you make the move. All issues are foreseeable, but need to be factored into your plan, approach and timeline. This journey should be considered a marathon rather than a sprint.
Crossing the recurring revenue chasm is hard work. But, the rewards significantly outweigh the troubles you’ll encounter during your progression to a business that generates income in a more predictable and consistent way – year in, year out.
We all hear about the incredible story surrounding Amazon that went from an idea in 2006 to approximately $9B in revenue today. That’s a good story, but the best part of the story is that when they go to bed on December 31, 2016 they’ll have ~$9B in recurring revenue and when they wake up on New Year’s Day 2017 – they have ~$9B in revenue because Amazon, like Microsoft (@MSCloud), Cisco (@Cisco), Salesforce (@salesforce), Intelisys (@IntelisysCorp), Veeam (@veeam), understand the significance and power of recurring revenue. Now that’s a great story we can all buy into and look to emulate in our own business model.
The Metrics
If you’re a born-in-the-cloud player these metrics are like motherhood and apple pie. You track these metrics and others on a daily, weekly and monthly basis. In fact, you’ve probably already noted that I didn’t include churn in my story above.
Let’s look at the five most important metrics you should track if you’re building a serious business that is built on recurring revenue.
The 5 most important metrics are:
1.) Customer Lifetime Value (LTV)– used to predict the profit a company will derive from a customer relationship.
LTV = ARPA * GM * Life
ARPA = Average Revenue per Account
GM = Gross Margin
Life = how long the customer was with us
(Cadillac calculates that their LTV is $500K for their best customers – that’s why you never want to lose a profitable customer).
2.) Annual Contract Value (ACV)– the sum of all recurring revenue contracts.
ACV = sum of all billed contracts per annum
The key is to drive MRR up month over month, create inverse churn and drive annual billings up year over year – while keeping your costs constant via automation, skills and process improvements.
3.) Customer Net Profitability Value (CNPV)– the amount of profit generated per customer across their lifetime.
Revenue – CAC
CAC – Customer Acquisition Cost
4.) Customer Retention Costs (CRC)– all expenses incurred in retaining and growing customers.
CRC = Customer Care | Sales Costs applied to delight client
Costs include such things as customer marketing, account management costs, contract renewal, customer enablement, training, etc.
5.) Churn (%)– the percentage of customers you lose during a given period (month, quarter, year)
Customers Lost [period]
Total Customers [period]
The best way to counteract churn is to focus on creating inverse churn which is essentially replacing any lost customer revenue with contract additions or upsells that can be used to offset any client losses.
Now’s the time to begin building a sustainable, profitable and growth-oriented recurring revenue cloud services business. Start thinking about the metrics above. Ensure your current systems can calculate, track and output your most vital signs beyond revenue, gross profit and cash flow.
Remember even if you’re not moving – your customers are.
