February 17

by Richard McMullan

Recurring revenue makes your company more predictable, extends the lifetime value of a customer and ultimately makes your business more valuable. If you’re unsure how to create these automatic sales, start with a simple service contract. 

Basically, you ask your customer to enter into an agreement for you to provide an ongoing level of service in return for a regular payment. It can be an easy way to transform an ordinary service company into a predictable subscription business.

For example, my local dentist introduced a service contract last year. For £13 a month, I get two checkups and two cleans a year, and I save money.   Provided I go regularly, which I didn't use to. However he's set his system up to prompt me every six months to attend, and I'm getting great value.

That simple contract is making my dentist's business more profitable and valuable.  His income per customer is higher, he's got much better retention rates (or lower churn rate, if you prefer), and his cashflow is predictable every month.

From servicing teeth to servicing electronics...

Re-occurring revenue vs recurring revenue

Walter Bergeron started a small company servicing circuit boards for large food processing plants. It was a classic service business where Bergeron offered his time to fix customer’s circuit boards when they broke.  

The business model worked fine, his customers came back and bought time and time again. It was solid re-occuring revenue but cashflow was lumpy.

Bergeron had reached a point where he could no longer sell any more of his time, and his growth stalled. Knowing something had to change, Bergeron made a 90-degree turn.

He began offering a membership model where, instead of contracting him when a circuit board broke, he asked his customers to subscribe to a plan enabling them to have their circuit boards serviced at any time in return for a fixed monthly fee.

Bergeron’s customers paid monthly for access to his technicians when they had a problem.

The switch to a subscription billing model transformed the business, and Bergeron quickly grew the company to $7 million in annual sales, at which point he sold it for $10 million — a significant premium over a standard service company.

Using service contracts to increase your company value

As the example of my dentist friend and Walter Bergeron illustrate, most small businesses begin life using the “break/fix” business model where a customer has a problem, and you swoop in to provide a solution.

This business model may make you feel valued as a problem solver, but it comes at the expense of the value of your company.

In the break/fix model, you must create demand, sell your product or service, deliver it, and start all over again, which is why acquirers place a lower value on these transactional businesses when compared to subscription-based companies.

By contrast, with a service contract, you create an ongoing stream of income that has the potential to grow the lifetime value of a customer dramatically. When you can accurately predict how much money you will get from a subscriber, you can invest more in wooing them.

The most compelling reason to adopt a recurring revenue model is the impact it can have on your company’s valuation. Dollar for dollar, recurring revenue can be worth more than twice that of transactional revenue, depending on your industry.

Service contracts are a simple and effective way to transform a transactional business into a recurring revenue goldmine.

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