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Recurring Revenue and the Metrics that Matter…

January 5, 2018

 

Now let me start by saying that revenue, profit and cash flow are the ultimate measurements that validate how you are truly doing as a business – the ultimate scorecard, if you will.  In this brief I want to highlight and explore some supporting metrics that tend to get either overlooked or are not part of an organizations day-to-day dialog.

 

Business Valuation and Worth

 

Now if you’re not considering building out your monthly recurring revenue (MRR) capabilities to enhance your overall business value and worth – this brief may not be for you.  However, if you are looking to add steady and sustainable recurring revenue to your business mix, this read will be worth your time.

 

So, prior to outlining my top five (5) recurring revenue metrics that matter, I’d like to frame up my views of recurring revenue and its importance in business valuations and ones exit strategy.  Recurring revenue will do more to increase the value of your business than any other single element, other than perhaps a piece of intellectual property (IP) that is a game changer.  Combine solid MRR and IP and you’ll have a business that will have multiples you can only dream of right now - more on IP down the road.  Now back to the topic at hand…

 

Let me first start by saying that I’m not one to espouse a viewpoint that the sky is falling.  In fact, I believe that generally business is good right now, but we’re starting to see foundational changes at the customer level.  Customers are beginning to change their purchasing patterns and when they look to refresh or add new IT capabilities – they start with a viewpoint that a monthly OPEX consumption model is the objective and then work backwards if they can’t find a cloud solution to fulfill the need.  The numbers are too compelling to think otherwise that’s why you need to begin to plan and add a significant recurring revenue component to your business.

 

Start Today – it’s going to take awhile

 

If you are just beginning to contemplate adding a significant recurring revenue component to your business mix – great, but assess where you stand today and determine the pace you’re comfortable with prior to altering your business model and mix.  Remember, you can expect that your revenue, gross margins and cash flow will be under pressure as you make the move.  All issues are foreseeable, but need to be factored into your plan, approach and timeline.  This journey should be considered a marathon rather than a sprint.

 

Crossing the recurring revenue chasm is hard work, but the rewards significantly outweigh the troubles you’ll encounter during your progression to a business that generates income in a more predictable and consistent way – year in, year out.

 

We all hear about the incredible story surrounding Amazon that went from an idea in 2006 to approximately $9B in revenue today.  That’s a good story, but the best part of the story is that when they go to bed on December 31, 2016 they’ll have ~$9B in recurring revenue and when they wake up on New Year’s Day 2017 – they have ~$9B in revenue because they like Microsoft (@MSCloud), Cisco (@Cisco), SalesForce (@salesforce), Westcon Comstor Cloud (@WestconcomstorC), Veeam (@veeam), VMware (@VMware, @, @VMwarevSphere) and others understand the significance and power of recurring revenue – now that’s a great story we can all buy into and look to emulate in our own way.

 

The Metrics

 

If you’re a born in the cloud player these metrics are like motherhood and apple pie – you track these metrics and others on a daily, weekly and monthly basis.  In fact, you’ve probably already noted that I didn’t include churn in my story above – silly me…

Now let’s take a look at the five (5) most important metrics you should track if you’re building a serious recurring revenue business.  The metrics include:

 

1.)  Customer Lifetime Value (LTV) – used to predict the profit a company will derive from a customer relationship.

 

LTV = ARPA * GM * Life

 

ARPA = Average Revenue per Account

GM = Gross Margin

Life = how long the customer was with us

 

Cadillac calculates that their LTV is $500K for their best customers – that’s why you never want to lose a profitable customer…

 

2.)  Annual Contract Value (ACV) – is the sum of all recurring revenue contracts

 

ACV = sum of all billed contracts per annum

 

The key is to drive MRR up month over month, create inverse churn and drive annual billings up year over year – while keeping your costs constant via automation, skills and process improvements.

 

3.)  Customer Net Profitability Value (CNPV) – the amount of profit generated per customer across their lifetime.

 

Revenue – CAC

 

CAC – Customer Acquisition Cost

 

4.)  Customer Retention Costs (CRC) – all expenses incurred in retaining and growing customers

 

 

CRC = Customer Care | Sales Costs applied to delight client

 

Costs include such things as customer marketing, account management costs, contract renewal, customer enablement and training, etc.

 

5.)  Churn (%) – the percentage of customers you lose during a given period (month, quarter, annual)

 

 

Customers Lost [period]

Total Customers [period]

 

The best way to counteract Churn is to focus on creating Inverse Churn which is essentially replacing any lost customer revenue with contract additions or upsells that can be used to offset any client losses.

 

Now’s the time to begin building a sustainable, profitable and growth orientated recurring revenue cloud services business.  Start to think about the metrics above and ensure your current systems can calculate, track and output your most vital signs beyond revenue, gross profit and cash flow.

 

Remember even if you’re not moving – your customers are…

 

Keep Calm and turn the recurring on!

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