Picture this: You’re a young entrepreneur who’s had that a-ha! moment that most only ever dream of. You’ve found your niche, built your offering, compiled an impressive team of engineers and salespeople that checkbook-wielding VCs are drooling over — you’re nearly ready to take the world by storm.
The last remaining barrier to realizing a successful launch of your offering, though, is arguably the single most important decision you’ll make on the road to establishing (or failing to establish) a successful startup: your monetization strategy.
Oftentimes your monetization strategy, which is the single greatest influence on your larger go-to-market plan, is what will differentiate you from a crowded field of competitors. You can have the world’s most innovative product or service, but it can all go to waste if you don’t have a consistent, reliable way to generate and retain revenue.
Over the past decade, as offerings of all kinds have shifted to Web-based delivery, there’s been a paradigm shift away from traditional business models that are built around a single “pay and go away” type transaction to recurring revenue models that emphasize continuous relationships and transactions (e.g. on a monthly or quarterly basis) for a more predictable revenue stream.
Modern IT innovations have enabled organizations of all shapes and sizes to interact with their customers like never before, which has in turn created a more dynamic environment in which recurring revenue models can thrive. When thinking about the difference between traditional licensing and recurring revenue models, consider Virgin Megastores and Spotify. Both companies offer essentially the same service — music for consumers– but their fates have gone in drastically different directions over the past couple of years. Spotify is now an extremely successful company enjoying hyper-growth, while Virgin, once a titan of the retail industry, has literally closed its doors across America.
Virgin, the established player, was not quick enough to modernize its offering and keep pace with the advent of streaming, online music services. Instead, it continued to place its bets on retail outlets and an online store, and the associated one-off transactions that came with each.
Spotify, on the other hand, disrupted the market with a streaming service that offered a monthly subscription that allows users to stream music from their computers, phones and other mobile devices. The service was extremely appealing to individuals accustomed to paying US$1 per song download on iTunes and other online music stores; for a marginally higher amount, they could consume as many songs as they wanted on a monthly basis. Spotify quickly gained market share due to its large customer base and predictable (and ever-increasing) revenue streams, and soon took Virgin’s mantle as industry leader.
While it’s clear that a recurring revenue model like the one Spotify offers is a solid foundation for any monetization strategy, it’s not as cut and dry as it may seem. Even once you’ve opted for this type of model, there are a number of additional factors to consider.
There are three generally accepted business models that fall under the larger “recurring revenue” umbrella. Which model you choose depends largely on the service you offer. If it’s a fixed good like an MP3 file, you’re probably best off going with a subscription-based model. If it’s a good you or your buyers prefer to procure based on actual usage, such as bandwidth consumption, you may want to consider alternative models.
The three models are:
- Subscription — fixed payment for a good or service over a specific period of time. Think about subscribing to a magazine: You opt in for a year’s subscription at a monthly rate that will not change for the duration of your subscription. It’s a flat rate for a fixed quantity of a good or service.
- Metered — solely focused on usage rates, which can vary on a day-by-day or month-by-month basis. The oldest example of this is home electricity bills. Your monthly fee depends entirely on how much you consume in a given month. Another more modern example of this phenomenon can be found in Amazon’s EC2 cloud offering. Users are charged for how much computing capacity they consume each month.
- Subscription plus metered — hybrid of both subscription and metered models. This is a popular model for Internet and cellular service providers that charge a flat rate for a pre-specified amount of bandwidth/data or minutes in a given month. If you exceed that limit, you’re generally charged overage at an additional, often premium expense. If you’ve ever traveled abroad and forgotten to change your phone plan beforehand, you’ll know what I’m talking about.
Another reason that recurring revenue models are a great fit for young companies, as well as for new divisions within more established companies, is the flexibility they offer. Rare is the company that has maintained the same overall revenue model from inception onward; the most successful organizations are the ones that anticipate market tendencies and react before the rest of their field. This can be done by deploying creative means of pricing, packaging and bundling of options, and how you charge for them in terms of usage based, pre-paid, post paid, freemium and so on.
To do so requires a great deal of flexibility to reduce the complexities that come with changing your basic offering, which include associated global tax and payment systems in addition to integration to your existing internal systems. These added complexities are also something that should be factored in to your decision to choose between a “do-it-yourself” billing solution and an external billing partner. While the DIY route may seem more financially appealing in the short term, it can come at the cost of the agility required to optimize your offering in the medium- and long-term, as you look to expand your business into new markets.