There’s usually only one thing better than revenue in your digital business — recurring revenue.
Recurring revenue helps to smooth any uncertainty and provide your business with predictable income from month-to-month. This is helpful if you’re trying to prepare forecasts and make major business decisions. It’s also a great boost if you’re trying to put a price on your business or make it more attractive for acquisition.
Many digital businesses don’t start out this way though, often choosing to sell products or services on a one-off basis, or even making revenue through ads or affiliate marketing.
Over 226 million adults in the U.S. alone take advantage of online subscription models, while nearly half of U.S. businesses have adopted or are planning to adopt a recurring revenue model.
In short, recurring revenue models do represent big opportunities for digital business owners, but it’s always good to take a balanced approach and look at the pros and cons. We’re looking at three of the most common for digital business: subscription eCommerce, SaaS and productized services.
It may seem like there is suddenly a proliferation of “monthly boxes” available, from food to beauty, to home-care or pets, but subscription services for physical products are certainly nothing new.
“Mail order” used to be a big deal! Especially for those who lived away from bigger cities or towns with more shopping options. Earlier subscriptions included anything from monthly records to Mills and Boon romance novels.
Old Columbia Record Club ad – source: Pinterest
If you’re operating the type of ecommerce (or even digital product) store where customers make one-off purchases every time through a checkout, you may have some scope to create a recurring revenue line.
For example, Soma makes high quality, sustainable pitchers and carafes for filtering water. Their subscription product? The filters for their products. Their “filters by mail” program automatically delivers a new filter to customers every two months.
You could even make a subscription model work for digital products. News publications like The Wall St Journal and The Atlantic are doing it. They’re information publishers like other digital-based businesses out there.
You could also go down the route of membership sites where you give exclusive benefits and information. Copyblogger’s “Authority” is an example of this, where customers pay monthly or annual membership fees to be included.
Pros & Cons of Subscription Ecommerce (Or Digital Commerce)
As already mentioned, the recurring revenue aspect of the subscription model is obviously going to be a huge pro. Other pros might include:
- Margins on physical products - Subscription outfits are often able to run at a slightly higher margin than one-off purchases and can have better purchasing power by knowing ahead of time numbers needed for bulk orders.
- Cash flow - The subscription model means you have cash upfront, so you won’t be waiting to recover inventory costs.
- Long-term relationships - Subscriptions give you a great opportunity to build longer-term relationships with customers. Models such as membership sites give you the opportunity to gather feedback and take action very quickly.
- Reduce Waste - Another one for physical product sellers: you know almost exactly what your numbers are, so there’s less chance you’ll need to throw out dated stock.
- “Set and forget” - You often have to work quite hard creating incentives and sending out campaigns to draw one-off shoppers back, but subscriptions tend to be much more “set and forget” so retention becomes a little easier.
Those are just a few of the pros of subscriptions - we’re sure we can bring up more! Let’s look at some of the cons, though:
- Subscription fatigue - It’s a thing. People are finding themselves with many subscriptions and needing to find ways to cut back monthly expenses. One-off products can be an easier sell because they’re perceived as lower risk.
- Product risk - This is for physical products: if you’re sending out one type of product (Soma’s water filters for example) and there is a fault with a batch, your whole line is suddenly at risk.
- Less upsell opportunities - This is more for your physical product subscription, as you will naturally have more digital touchpoints with customers who are members of your membership site or who receive digital products. With physical products which are sold as one-off, you get the opportunity to grow your revenue by asking for the upsell in the cart. When you’re automatically sending out subscriptions, you could send out email offers, but they are less “hot” than when the customer is in the shopping cart making a purchase.
The SaaS business is highly competitive and has grown rapidly in the last few years. It seems there are new startups virtually daily, all jockeying to grow quickly or to attract funding rounds. However, there is also a relatively high rate of failure for SaaS companies as these CB Insights examples show.
SaaS can be a very lucrative recurring revenue model because you build the software, then can sell it repeatedly on a subscription basis. Of course you need to be prepared to be available to customers and to do any upgrades or maintenance as needed, so it can be quite a hands-on business.
According to Chargebee, one of the main reasons (apart from financial) that SaaS fail is lack of a market, or poor product/market fit. The key to doing well as a SaaS is to identify a specific problem which the market has and wants solved, and solve it better than competitors. You need to have a stand-out unique value proposition.
SaaS can be very expensive to build and market, especially if you want high quality, plus you run the risk of building your expensive product, then struggling to get sign-ups. Customer churn is common and of great concern to SaaS.
It could also be more difficult and expensive to change direction with a SaaS, especially if you get most of the way through a build before finding you don’t have enough of a market. There can also be a significant period where you either need to be working a second job to pay your bills before the SaaS is profitable, churning through your savings, or relying on a funding round.
Another interesting phenomena that can occur with SaaS is when they grow so fast that the company can’t keep up with itself. Rapid growth takes resources and as Jason Lemkin points out in this InsightSquared interview, a poor key hire made in haste can set the company back even further. Rapid growth has been partly blamed for the recent Zenefits woes too, with them being described as a company which “spun out of control.”
On the other hand, one of the great pros of a SaaS which is managed well and has identified a lucrative market is that it can grow to be a huge success.
If you’re looking to scale up services that you offer online (for example, consulting work, web design or other services which often start out on a one-to-one basis with clients), a productized service is another way of bringing in recurring revenue.
This simply means packaging up your service as a “done-for-you” product for which you charge clients a monthly fee. Examples of businesses who do this are Design Pickle for graphic design and Freedom Podcasting for podcast packages.
Here are some pros of productized services:
- You can set them up quickly and inexpensively, meaning you can validate your market more easily and with less chance of large financial loss than a SaaS.
- You can productize skills which you already have and sell, possibly even finding your first clients from those you already have.
- You can become profitable quickly due to not having to wait months for development.
- You can change direction quickly and inexpensively, if necessary.
- You have a closer relationship with customers and can take onboard feedback quickly.
- You can systemize the whole thing, build a team and start to take yourself out as the founder.
The cons of productized services? Depending on the services you offer, you may find that it becomes difficult to price your product, especially if there may be variables depending on the customer. If a client has come through checkout and paid a set price for your productized service, it’s difficult to go back to them and say, “Actually, we need another $300 for that because of (X variable).”
Depending on your preferences, some people might view the closer contact with customers as a con. There are many who set up a digital business because they want to attain some level of personal freedom, but a productized service requires regular customer contact.
Another point to consider is that as you scale, you will need to hire team members to take over the parts you would have done for customers yourself. Managing a team and finding the right people for the job presents a whole new set of challenges from what you’ve been used to as a small or solo operation.
A recurring revenue model can be a huge help for digital businesses, particularly from the point of view of scaling up and having a regular, predictable income.
While the thought of recurring revenue can be very attractive for digital businesses who have irregular income, it’s worth weighing up the pros and cons before rushing into a business model. For one thing, any kind of subscription can be a harder sell, especially because “subscription fatigue” is now quite common.
SaaS can be expensive and all-consuming, while productized services can face challenges with how to package and price. Both types can strike difficulties with scaling if growth comes on quickly.
What do you choose? Is a recurring revenue model right for your digital business?
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.