Choosing the right business model is one of a startup’s most important decisions.
A startup by definition is a temporary organization designed to find a scalable and repeatable business model and subscription – recurring revenue business model – is probably the most efficient and scalable business model out there.
Recurring revenue has been around for a while and many great businesses have been built on top of it. It has revolutionized enterprise software, making SaaS one of the fastest growing categories of startups.
It gave a new face to ecommerce, making companies like Blue Apron or Jessica Alba’s Honest Company reach billion dollar valuations in a record time. Even Amazon, the largest online retailer, is now pushing subscription sales in grocery and supplement categories.
And likewise many of the leading media shifted to online subscriptions, gaining an incredible advantage as they no longer have to rely on clickbait titles and high traffic to make money from ads, serving the reader instead.
New York Times has now reached more subscribers than ever before and their digital revenue is soaring while the entire industry struggles because the ad revenues decline.
The list of case studies can go on forever. If you look at business models of startup unicorns over 50% of them use recurring revenue as their primary business model.
Here’s what makes it so efficient.
Once you make a sale, all you have to do is not screw up to keep the customer for the long term. As a result, you can grow faster as opposed to other businesses that have to start from scratch every month and throw money on ads to get the same numbers in.
Unpredictable events kill many businesses each year. When Google changed its search algorithm, many startups went bankrupt because they relied on organic traffic from SEO. Their revenue stream suddenly dried up while their burn rates remained the same.
But with recurring revenue, your payments come in automatically and you’re able to spot trends in churn rate well ahead of time.
Better customer retention
If you convince someone to give you their credit card details the hardest part is over.
All you have to do is to keep your customers happy. You don’t have to worry about losing users to competitors as much as other businesses, as there are switching costs associated with this. An ecommerce customer can decide to shop from someone else another month. A SaaS customer has to first to cancel the subscription then create a new account and shift all the data and preferences there.
It’s simple, if you don’t have to spend money on retention you’re going to generate much higher profit margins.
Faster feedback loop
If your customers purchase on a monthly basis it won’t take you long to figure out what their problems are and how to fix them.
When things go wrong you get a much longer time to make adjustments and compensate users before they lapse. You can remove problems and create a better product much quicker.
If a customer receives something from you every month, you become part of their life, and they can help amplify your brand via word of mouth or social media.
Angel and VC investment in SaaS and subscription model companies is higher than ever before and keeps growing.
Today, it’s the most popular startup investment category and everything suggests it will stay that way. If you can tell an investor “we’ll generate $3 million next month” and know it for sure, your startup is going to be more attractive than the same company without the near-guarantee of income.