Repeat business as recurring revenue
November 05, 2019
Often times, people tell me that I do not understand recurring revenue models. It is true that I avoid subscription (and retainer) revenue. The mistake is in thinking that a subscription is the only, or the best, recurring revenue model. This is just not true. Recurring revenue is revenue that is predictable, stable, and highly likely to continue in the future. A subscription is paying a fixed fee, based on a schedule, in order to receive or participate in something. While subscription revenue is a type of recurring revenue, it has its downsides, particularly regarding what I do.
My first complaint about subscription models is that they are often, not always, leveraged in a way that attempts to take advantage of the client. The model is to get customers to pay every month or year, even if the provider does nothing or very little. This often isn’t fair or appropriate. My second complaint is that subscription revenue locks the customer in at a fixed price, aside from incremental increases. While this can be good for both sides, in terms of predicting finances, it limits my ability to charge a fair price based on the current market conditions and my current capabilities. Long-term, this is very bad for me, as I endlessly invest in process development, R&D, automation, innovation, learning, etc.
However, recurring revenue is highly preferable for various reasons. So, how do I tap into recurring revenue and its advantages? Simply put: repeat business and return customers.
While plain old repeat business may not appear as stable or predictable as subscription revenue, there is more to the story. For one, repeat customers on average, spend 20% more, convert at a higher rate, and convert more quickly. I gladly trade a bit of predictability for a 20% bump in topline revenue, a shorter sales cycle, and a higher conversion rate. Even the best subscription models expect a 5-7% cancellation rate. This means that you have to constantly replace 5-7%, just to stay even with attrition.
The question becomes, how much predictability and stability am I trading away? Depending on the year, 85-90% of my revenue is from repeat business and returning clients. That is to say, 85-90% of the dollars that come in the door are from customers that have spent money with me at some point in the past. This has been the case for several years running. Barring something wholly unexpected, my revenue is highly stable, relatively predictable, and very much so likely to continue into the future. I still actively pursue new clients, but not as a matter of survival, more as a way to further grow my business. This means that I have essentially created a recurring revenue model while offering zero subscriptions and avoiding retainers. Here is how I have done that.
Start small and leverage versioning
It could be said that I stack the deck in favor of repeat business and do so in two ways. 1 Start with a small project first. 2 Break projects into versions or multiple smaller projects.
The primary idea is to see if the client and I get along well, work well together, communicate well, etc. In the unfortunate event that we do not, at least we find out on a small project or during the first phase of a project. Either we struggle through, but relatively briefly, or we just chalk it up as a loss and move on. Walking away from a small project or early into a large but phased project, can be in the best interest of the client as well as me. A key here is open and honest communication. If things don’t seem to be going well for you, the same is probably true for the client. Just talk it out. It might be best to part ways.
I never charge deposits, which makes this option particularly easy for us both. I never “hijack” or “hold hostage” a project that is partially done but not going well. I happily hand over all that I have done, apologize for things not going as expected, and move on. I can’t tell you the number of times this approach has mended fences and retained a good standing with clients.
Using this “small project first” / versioning approach, there is less risk for everyone, which is good, but there is a secondary and often overlooked benefit.
After a small project (or a phase 1) goes well, we generally move onto a larger project (or phase 2). We have built a rapport, learned about each other, gained efficiency, and both are eager and excited to continue. All further projects are repeat business, which converts quickly, at a high rate, and on average at 20% more than a new customer. This is a take on the basic loss-leader approach. I don’t even care about profitability on the first project, and instead, invest in learning how the client and I will work together best. The return on the subsequent projects is well worth any investment I make on that first project.
Yet another benefit, the versioning, or breaking up of projects, allows me to more accurately scope projects. This allows me to utilize the second tool in cultivating repeat business ….
Reasonable and fair pricing
Nobody likes being taken advantage of, and fair pricing should be the cornerstone of every business. I generally see unfair pricing resulting from a defensive pricing strategy, the difficulties presented by the Cone of Uncertainty, or a combination of the two. However, small projects naturally create a less defensive pricing approach because there is very little risk for everyone involved. Also, small projects are far easier to scope which means you are more likely to estimate accurately and therefore give a more reasonable, and fair price.
Another benefit of reasonable pricing – it is far easier to show the client a good return on investment when that investment is small. While you might be able to charge $1,000 for a service, it might make more sense to charge $750. The sooner the client sees a return on the investment, the sooner they will invest again. By offering reasonable pricing, you encourage the client spend more over the long run. Even better, you benefit the client more because they invested less. It is a win-win which is always what I am after.
What is really key here, “reasonable” varies by client and the project. Some clients have a very high price point for their product, and others not so much. The solution is to utilize a pricing policy that allows those with larger budgets to pay more for the same product-service bundle. While this may sound crazy, it is basic value-based pricing.
Airline tickets work this way. The outcome of a first-class and an economy ticket is effectively the same – the passenger arrived at their destination. However, a reasonable cost for each passenger is different, and the airlines tailor experiences for each. Each passenger has paid what they consider a reasonable rate for what they received. Going into further minutia, passengers often pay a different rate than their neighbor based on when they purchased their tickets, who from, if they checked bags or have carry-ons and so forth. The lesson here is that fixed pricing is not a reality and embracing flexible pricing is the key to happy customers and increased profits. This brings me to ….
Give clients what they want
Start by documenting requirements in a way that allows you to accurately deliver on what the client values most. Leveraging the MoSCoW Method works really well. I highly recommend embracing Agile methodologies and I truly value responding to change over negotiating contracts. Get a good feel for what the client wants but don’t fall into the false trap of “scope creep”. If a customer wants something, give it to them. This is how you demonstrate value.
Keep in mind, clients receive value in all kinds of ways that are beyond the core product-service bundle. The more you work with a client, the easier it is to understand what they value most (quality, efficiency, ease of business, cost-sensitivity, etc). When you understand what a client values, it is easier to deliver those things. When clients receive the things they value, they are happy, pay a premium (assuming you leverage value-based pricing) and enthusiastically return. It is a flywheel effect and works incredibly well.
You will often find it is the same stuff over and over. Make things easy for the client. Communicate using methods they prefer. Go to them and not vice versa. Do everything you can to build trust (E.g. don’t charge deposits). In every way you can, reduce friction and embrace the techniques of Lean Manufacturing. You should do this for all clients, but of course, it will be skewed a bit towards your highest paying clients. Just like first-class passengers, the highest paying clients will go to the front of the line and get your absolute best, but everyone will get to their destination just the same.
This is not to say you can’t offer perks to your clients on a tighter budget. Offer a payment plan or be flexible on payment terms. Conversely, let your clients on a budget know, you can bump them a little further forward in the cue if they pay their invoices right away. It doesn’t cost them a penny more to pay invoices promptly, but it does help you with cashflow. The key is to communicate with your clients and give them what they specifically want. No two clients will be the same. Fostering a relationship of give and take encourages clients to return to you. However, there is another side to this coin …
Say no more than yes, within reason
Specialization allows for automation and efficiency. Specialization is rooted in saying no more than saying yes. You don’t want to specialize yourself into a corner, but having a niche is really helpful. If a project is outside of your wheelhouse, you should probably pass. It is generally not a great idea to “learn on the job”. Taking a project that causes you to stretch and grow is one thing, accepting work you are not actually qualified for is another. When in doubt, say no and help find a different resource.
Similarly, you have to learn to be selective with clients. As you build a business that leverages return customers, you will find yourself overwhelmed with work and too many clients wanting to work with you. This is a high-quality problem, but is a problem. You have to have a system for deciding who you work with, and when to say no. I use a fairly sophisticated algorithm that ranks clients based on the clients’ past spend, length of relationship, time to pay, number of past invoices, current budget, current scope, current deadline, expected margin, type of project (“money maker” Vs. “portfolio piece”), ease of business, number of referrals, anticipated future business and more. The point being, I track and evaluate a ton of data about my clients and I know with great precision which are the very best. As painful as it is, I occasionally have to trim a few clients off the bottom of the list in order to not get overwhelmed with work.
In the same vein, you have to be selective with projects, even for the best clients. Understanding the difference between “good” and “bad” deals is key. As painful as it can be, sometimes you have to say no to a client (good, great or otherwise) and recommend them to someone else. Things can go well for years and then fall apart. Always keep in mind that saying no is always an option and is often the best option for everyone involved. With that in mind …
Don’t resell work, and avoid resellers
The same people who say I don’t understand recurring revenue often tell me I should resell the work of others, hire employees, and so on. They will lecture me on all the money I am missing out on. I argue that they do not understand opportunity cost.
My first argument against me reselling work is that my clients want to work with me, so I can’t really resell the work of others. When a business resells work, it is no longer able to fully control the process, nor can it create a close bond and working relationship that fosters repeat business. Certainly, it is possible to hire amazing employees, train them properly and build a team that clients want to return to. However, this hard. Like, really, really hard. Also, it is well outside of my wheelhouse, so I just don’t do it.
Not reselling work and not hiring employees is another example of saying no and sticking to my core competency. There are people that specialize in building and developing teams, but I am not one of them. It is far easier for me to simply say no to that revenue stream and instead focus on what I do best, and how I can give my clients what they want.
On the flip side of the coin, I don’t work with resellers (people who resell my work) too much. I recommend that resellers make up less than 20% of your revenue. Working with a reseller of your work can provide lots of things: new opportunities, a glimpse into how others work, a chance to expand your skillset and so on. However, the biggest misconception is that working with a reseller somehow gives you “security and stability like an employer” can. I once heard the wise words “being an employee is freelancing for one client”, and there is just no security in that.
When you devote too much of your time to one or a few clients, your business will naturally become stagnant and ultimately fail. It is much the same with resellers. You have to consider the opportunity cost. If I work with 3 clients on 3 projects and impress them all, I might get 10, 20 or more new clients out of it. Satisfied clients tend to recommend you to others and that is how you naturally grow your business. Conversely, if I complete 3 projects for 3 resellers, they each might be happy, and they will likely hire me again, but my customer base has not grown one bit.
Even setting aside that selling direct is usually more profitable than selling via reseller (there are exceptions for very high-end firms), you have to acknowledge that working with resellers is stunting your business growth. Here again, we see how saying no to something is far better than saying yes.
Final thoughts
Clearly this is not an overnight fix, but neither is any recurring revenue model. Both approaches take a lot of time and are investments that pay off down the road. However, I will argue that the repeat business model, for someone like me, is far superior in every way.