Betting on the Recurring Revenue Market

12/17/13Follow @salil

Big companies are betting big on recurring revenue—that is, pricing plans designed to guarantee continuing income, as opposed to one-time payments. They believe that if they play their hands correctly, this strategy will deliver profitability and growth.

We’ve been watching the red-hot recurring revenue market closely, and in recent months, we’ve seen one established company after another implement new recurring revenue models in order to attract new customers, expand sales, and smooth out annual revenue cycles.

But implementing a recurring revenue model can be tricky. Companies risk their reputation and revenues with its success—on the one hand not wanting to leave money on the table through missed opportunities, on the other not wanting to damage customer relationships through poor automation and intelligence that doesn’t allow for quick, responsive, and up-to-date customer interactions wherever they occur. As you might expect, there’s a new category of companies aiming to help businesses get the model right, and as investors we’re excited about supporting these new “recurring revenue management” ventures.

It’s clear that recurring revenue models such as subscriptions, usage fees, tiered services, freemium, prepay, or a hybrid combination of these models, have exploded in the last few years. Recurring revenue is now estimated to be a $300 billion market across all industries and companies. From companies to end users to investors, everyone wants “in” when it comes to recurring revenue.

A wide variety of goods and services are now being monetized on a recurring basis, ranging from software to digital entertainment to multi-million dollar capital equipment to baby supplies. Enterprises around the world are using recurring revenue to expand their markets and maximize customer lifetime value.

Consider Birchbox, the three-year old New York City startup, which has become the case study for how recurring revenue models can transform the retail sales channel. For a monthly fee of $10, subscribers receive a new, neatly wrapped box from Birchbox, filled with sample cosmetics and beauty products.

Customers like the service so much that the company reports more than 40 percent of its subscribers make additional purchases after they receive their monthly delivery.

The proof of how rewarding recurring revenue can be is in the financials. Birchbox generated $40 million in sales in 2012, compared to $5.6 million a year earlier, according to a Chicago trade publication. And recently, Netflix has reported a whopping 315 percent increase in net income for the quarter ending September 30 of this year.

This success has captured the attention of both new businesses and legacy companies, many of which are still struggling to recover from the losses of the 2008-2009 recession.

Consumers are embracing recurring models because of their convenience and flexibility. One of the most popular and visible examples of a recurring revenue model is subscriptions. Once used only for things such as renting movies, downloading music, and signing up to play video games online, subscriptions are now offered for an expansive assortment of goods and services.

Target, for example, recently announced that it is using subscription billing to sell and deliver baby supplies. United Airlines has added a subscription billing service for frequent fliers, allowing them to pay a fixed monthly fee for privileges such as checked baggage and seating with extra legroom. Toyota Motor in Europe will sell updates to its onboard navigation system to new car buyers through annual subscriptions.

A growing list of tech companies are also jumping into the fray, including Adobe, which has dropped sales of packaged software in favor of a subscription model, and Microsoft, which has adopted a recurring model for selling its Lync suite as well as its Office 365 product.

Red Hat, the world’s leading provider of open source solutions, has had great success with the model too. The company reported first quarter revenue of $363 million, of which $316 million, or 87 percent, came from subscription services. The list goes on.

However, with the drive towards creation and delivery of these cloud-based services, vendors of cloud services face new pain points.

Managing all the permutations and combinations of different pricing tiers, charging models, billing frequencies and product bundles is incredibly complex. As pricing models for cloud apps continue to evolve, businesses need help implementing effective recurring revenue strategies.

That’s where companies that we refer to as the “Revenue Pit Crew” come in. These technology partners work behind the scenes, in the cloud, to make the systems work seamlessly and profitably for businesses and their customers. Their technology also helps other cloud apps maximize growth and profitability across the revenue value chain, whether it’s cheaper acquisition, maximizing up-sells or more efficient billing. I’m talking about companies like NetSuite, ServiceSource, Vindicia, Gainsight, Totango, Zuora, Optimizely and Aria Systems. (Bain Capital Ventures recently led a $40 million investment in Aria; Gainsight and Optimizely are also Bain Capital Ventures portfolio companies.)

Prior to cloud apps, only certain industries such as telecom and insurance needed to deal with complex recurring revenue management. In the new world, everyone needs to.

Analysts have been predicting for years that employing a recurring revenue model would become a fundamental means for merchandising in the 21st century. The time has come.

Salil Deshpande is managing director at Bain Capital Ventures in Palo Alto, CA. Follow @salil

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