Monthly recurring revenue (MRR) is the part of a business’ total revenue that’s likely to continue on a monthly basis and help companies predict annual recurring revenue. Companies with recurring revenue are generally more valuable and more attractive to both investors and consumers. Recurring revenue generation indicates stability, as the organization expects to receive revenue every month. The recurring revenue model creates tighter relationships between the company and its existing customer base. With such a loyal customer base, those companies spend less time and money on acquiring new customers, which increases their valuation. In the past, businesses increased their valuation by lowering expenses and through continued investment in marketing, strategic planning, and staff and equipment. But what every investor today wants to see is how a company boosts profits and increases sales.
Businesses are Moving to the Subscription Business Model
There are many examples of businesses moving to the subscription model to increase their valuation. For example, online pet supply stores like Chewy offer subscriptions to pet food, medications, litter, and other things pets need on a regular basis. Netflix relies on the subscription model to ensure recurring revenue and affordability, which leads to new customer acquisition. With 167 million subscribers (2019), this type of streaming service has proven more profitable and led to the downfall of Blockbuster. By switching their services and financial modeling to subscription-only, Digital Telepathy (UX firm) managed to increase revenue by 300%.
The switch to the subscription model allows companies to focus on improving customer retention through better customer service and improved customer relationships. Instead of developing project plans and focusing on their products or services, a company operating on a subscription-based business model can get more aligned with their customers’ needs.
Monthly Recurring Revenue Makes Businesses More Appealing to Investors
Introducing a subscription-based business model could increase a company’s valuation by up to 8 times. Successful SaaS businesses that can demonstrate a recurring revenue for their software platforms average a six-fold revenue increase for valuation when compared to companies that sell perpetual licenses. Private equity investors and VCs are more interested in these businesses because they can demonstrate reliable revenue streams.
MRR indicates that a business has achieved a product-market fit. In other words. It has a product or service that customers want and are ready to pay for. In most cases, monthly recurring revenue implies some type of a subscription model, which is well-proven, comes with well-known risks, and allows investors to evaluate the business much easier. Besides MRR, other important metrics that investors pay attention to include monthly customer churn, month-over-month growth, and customer acquisition costs (CAC).
Recurring revenue models are appealing to investors due to their:
- Predictability. Businesses operating on a monthly subscription-based model rarely miss their monthly forecasts because their financial forecast models are much more accurate. Instead of starting from zero, a company begins with a base to grow upon at the beginning of each period. Company owners and potential buyers are rarely surprised by major fluctuations in business results, and the predictability of monthly subscription comes with a range of downstream benefits.
- Scalability. Since they produce predictable cash flow to invest in business growth, recurring revenue model businesses are easier to scale. With the deep data insights provided by a subscription model, companies can understand their cash flow and effectively invest in business growth with minimal risk. When a product/service has reached standardized quality and subscription values, you can be sure that you will minimize churn and maximize recurring revenue from existing, satisfied customers.
- Expense management. With such predictability regarding their revenue, companies are able to manage their expenses more accurately. The challenge of lumpy revenue models is that you can’t know how well you did until the quarter or the year is over. With monthly recurring revenue, it is easier to increase or reduce expenses to match revenues.
- Flexibility. Monthly recurring revenue brings flexibility that benefits both your consumers and your company because there is no need to rewrite a contract if their needs change. You can increase the subscription to expand or speed it up, or decrease it to slow provision down.
- Visibility. Unexpected changes in business won’t completely blindside you if you know where you start each month and where you can expect to end up. Thanks to your monthly recurring revenue model, you can make business decisions a year in advance. If unexpected changes occur, there will be plenty of warning and time to adjust.
- Durability. With monthly recurring revenues, you never start a month with zero. Thanks to accurate forecasting and in-depth insights, you can use the collected information to reduce risk when making important decisions regarding taking on new business or reducing churn rates.
Thanks to the subscription model, tracking and reporting MRR, churn, customer lifetime value (CLV), and sales become more simplified. You will be able to predict monthly revenue minimums and maximums based on the types of subscribers and the number of subscribers.
Why is the Monthly Recurring Revenue Metric Important?
Monthly Recurring Revenue (MRR) is one of the most important metrics for financial growth, and it is just as important for management as it is to individual sales reps. Other important metrics include sales rep productivity, customer retention, average sales price, and growth rate, but at the end of the day, MRR shows the amount of monthly recurring revenue that your customers are willing to pay for your products or services. Investors judge the performance of companies and their teams, divisions, and individuals based on MRR. It is the foundational metric for examining sales rep and team performance.
1. Budgeting
It is challenging to run a successful business if there is no steady income stream. Monthly recurring revenue tells you how much money can be reinvested each month. The revenue you’re bringing in is one of the deciding factors when determining whether you can run a lead generation campaign or hire more business development representatives for the next month. If you’re experiencing cash flow disruptions and struggling to make a profit, you can identify MRR trends over a specific time period that might indicate financial trouble.
On the other hand, if your monthly recurring revenue is going up, the MRR metric can motivate your sales team – as they close high MRR deals and build momentum, they will be much more engaged in their roles.
2. Tracking individual, team, and division performance
With MRR, sales reps can see the size of the deals and accounts they manage. If your company is struggling to hit the MRR quota from month to month, you should take a closer look at the deals with high monthly recurring revenue that you’ve closed. Are there any similarities among the customers? Was there anything specific that you did throughout the sales cycle that impacted the sale positively? By focusing on these details, you could modify your sales approach to start closing higher MRR deals.
Besides the individual performance of sales reps, business leaders, and sales managers can look at the big picture to see how the division is performing as a whole. By calculating MRR, the sales department can make more precise sales projections and forecasts, which helps the sales team plan for short-term and long-term growth. MRR can be calculated in two ways: determining the monthly recurring revenue per customer or using the average revenue per user (ARPU).
Customers Love the Business Model
It is easy to retain customers who love businesses that make things convenient for them; a subscription-based business model offers that. Besides the recurring revenue for your company, this business model offers convenience to your customers, such as:
- No more anxiety about running out of supplies or losing service due to missing payments (thanks to an automated billing system)
- No more need for repeat shopping thanks to automatic delivery of products/services
- Thanks to a predictable monthly fee, budgeting becomes more manageable for customers
To investors, the value of predictable recurring revenue is the primary appeal of the recurring revenue business model (especially in comparison to one-time transactions). For example, a $10 million business with 80% recurring revenue can count on $8 million at the beginning of each year, and that figure is predictable and stable. The company’s management can invest and plan accordingly. On the other hand, we cannot say the same for a $10 million business with no recurring revenue because that company starts each year at zero. It can plan and make predictions based on past financial performance, but there is no contractually obligated revenue stream for it to base its plans around.
Furthermore, a solid subscription-based business has robust customer insight for marketing or cross-selling, as well as excellent customer retention. In terms of pricing, recurring revenue models are often much easier to operate (when compared to other retail models) because they only have to manage a few pricing tiers (instead of an array of individually-priced products).
With in-depth insights and business intelligence, what you need to grow your recurring revenue business is the right accounting services. Depending on what type of accounting services are the most suitable for your needs, you can opt for outsourced, in-house, and back-office solutions. Consero Global can help ensure that your executive team is making the right moves and implementing the best management strategies to keep your business growing. Besides our experienced staff, what we bring to the table are cloud computing technologies and advanced financial management solutions that will help you achieve operational efficiency and financial clarity.
