Recurring Revenue: Types, Formula, and How to Improve It
August 2, 2021
The SaaS industry is thriving because its business model is based on recurring revenue. It helped skyrocket the industry, likely reaching $370 billion by 2024 with an annual growth rate of 17%.
These numbers are a great incentive for everyone using the SaaS business model.
There are multiple benefits to having recurring revenue, but we’ll first cover the basics. You will learn the basic types of recurring revenue for SaaS, a few ways to track it, and what to do to improve your numbers.
TABLE OF CONTENTS
What is Recurring Revenue?
Recurring revenue is the base for subscription-based businesses. Customers have to pay a recurring fee in regular intervals (monthly or annually) to gain access to products and services.
Although recurring revenue can apply to various industries, it is primarily associated with the SaaS industry.
Here are some businesses that thrive with recurring revenue model:
- Content-based - any business that provides media content (audio, video, etc.).
- Service-based - plain service businesses that charge a monthly fee
- Product-based - subscription box providers that offer physical products customers receive in regular intervals and Software as a Service companies that offer subscriptions for using their software product.
There are several benefits to adopting a recurring revenue business model. The first is the predictable revenue. Money coming in at regular intervals brings stability to the business.
Likewise, recurring revenue is ground for expanding the customer base because it also brings predictability to users. Recurring monthly fees provides customers with clarity on expenses and necessary budgets for consuming services or products.
The third benefit comes in the form of higher customer retention. Since subscription-based businesses often track their customers’ behavior in order to improve their experience, they can also improve retention through personalized engagement campaigns or subscription plans.
Finally, there are chances for driving more revenue growth with this business model because of the opportunities for upselling and cross-selling.
Recurring revenue businesses have users around for months and years, which allows them to build relationships with their customers. And as they do that, they have a higher chance of accumulating more revenue.
But keep in mind that even though recurring revenue is predictable, it doesn’t mean success is guaranteed. Market changes quickly, and companies must remain vigilant and aligned with trends to stay in business.
In addition, the SaaS market suffers from a highly competitive environment, and growth sometimes isn’t as fast as companies want.
That only means you should pick the correct type of recurring revenue model for your business and focus on improving it. The rest of our article will help you do that.
Types of Recurring Revenue in SaaS
There are several ways SaaS businesses generate recurring revenue. Let’s analyze each revenue model’s pros and cons.
With the usage-based subscription, you bill customers regularly based on how much they use the product.
The great thing about the usage-based model is that people save money when they don’t use the product as much, which should prevent them from canceling the subscription.
Stripe uses this type of recurring revenue. Stripe charges customers per successful transaction, i.e., per usage. Their billing is pretty understandable and straightforward for customers, which is paramount for this type of model.
This model is perhaps suitable for customers, but it comes with big cons for your business.
It’s very unpredictable for businesses in terms of predictable revenue since earnings depend on customer usage.
However, there might also be some unexpected cash flow increases if the customer goes over their regular use and increases its usage costs.
Each tier offers a different price for a set of features that can suit a wide range of customers—those who want to use your product a little with only the basic features and those wanting all the bells and whistles.
Here is an example of a standard tiered billing model:
The main benefit of this model is that it lets you attract a broader range of users with different needs and budgets as they use a tier that’s most suitable for their current situation.
Tiered pricing also offers users great flexibility since they can upgrade or downgrade their plans as much as they want. For providers, an added benefit lies in great upselling opportunities and understanding where customers see the most value of the product.
However, if you want to use tiered subscriptions as your revenue source, keep in mind that offering more tiers can become complicated to manage if customers wish to customize plans or add additional products or services.
Here, revenue comes from the number of people using the product.
This type of billing is also called a ‘per seat’ subscription model. It works simply—when people add more users to the account, their price increases per added user.
Here is an example of a user-based billing model:
Use this model if you target companies with large teams who don’t need to track app usage and get charged per active employee.
User-based billing is most suitable for team collaboration and CRM (Customer Relationship Management) tools.
The hybrid model means companies can have any number of billing combinations that best suit their business.
For example, Zendesk offers different annual subscription plans with various features.
Not only that, but each subscription tier also charges per user and enables more customization with each level. So we can say they combine per-feature, per-user, and tiered SaaS pricing models.
This pricing offers their users more options and more value, as they can choose exactly what they need.
The main benefit here is aligning pricing with the product’s perceived value. Customers associate more customized feature packages with higher product value.
But it can also get complicated to maintain and explain pricing to customers in the sales process. Overall, our advice would be to apply a hybrid model if you can’t reap the benefits from one recurring revenue type.
The freemium model offers free plans to customers forever, in addition to other paid subscription plans.
This model is beneficial since you can get anyone to start with your product and see the initial value without spending a dime. There lies an opportunity that they’ll get hooked on your product and use it so much that they’ll have to become a paying customer.
However, some users will take advantage of your free plan indefinitely, so it might not be the most viable solution for every SaaS company. The freemium model is great if users can do basic things for free and realize what their opportunities would be if they would switch to paid plans.
Monday.com offers a free service for individuals or micro teams (two seats) for tracking their work tasks, but once customers have a bigger team, they need to upgrade and pay.
If the product is a right fit, those two seats are enough for users to grasp all the possibilities and adopt the product in their daily workflow. From there, it is a natural progression for them to continue using the software as they grow the team.
In the long run, having a freemium model can be pretty expensive to maintain. If you have a large customer base who don’t pay for your service, you can’t cover the costs associated with heavy usage.
Consider the freemium model for marketing strategies only and put effort into converting free plan users by highlighting all the benefits of the paid plans.
How to Calculate Recurring Revenue?
Since money trickles in predictably, you can forecast and calculate your revenue to make better business decisions. There are two ways to do that: MRR and ARR.
Monthly Recurring Revenue (MRR) is a metric that tracks the revenue you receive from subscriptions every month.
MRR is also used to make financial projections and measure growth. It tracks your revenue on a minor scale, so it’s better to predict whether your company is on a rising trajectory or failing.
You can calculate MRR with the following formula:
Monthly ARPU x Total Number of Customers
This is a simple way to calculate it, but if you want to dig into your metrics more to get more exact numbers, you can include other things that change your MRR, like expansion and downgrades.
The best way to access and query your data is by using a business intelligence tool like Trevor.io, which can help non-technical answer ad hoc data questions in just a few clicks.
Analyzing MRR also helps you develop better features and make deals with more qualified leads.
Calculating both MRR alongside ARR can show you the financial health of your company and set goals for the future. Here’s how to work with the ARR metric.
Annual recurring revenue (ARR) is the monetary value of your subscriptions gathered in one year. This is a crucial metric to showcase your company’s finances year over year.
If we want to calculate it accurately, we need to account for other things that affect revenue, like upgrades, downgrades, and acquisitions.
Calculating ARR can be summed in the following:
Beginning MRR + New Customers MRR + upgrades - downgrades - churn. Then you multiply this number by 12, and you get your ARR.
Most companies track their revenue monthly, but it’s best if you track both ARR and MRR to account for long-term and short-term business decisions. If your company garners more than $10M ARR, it’s better to shift all of your metrics annually.
Why is ARR significant?
Tracking this metric can help you in different areas of your business, most importantly sales and finance. ARR is standard for sales teams to improve user experience and battle churn.
But insights from the ARR can even lead the development team to add product features that will help salespeople deliver on the promised experience.
Overall, ARR helps you understand cash flows on a yearly scale, and it’s an easy way to give your potential investors a status report of your company’s financial performance.
Tips for Improving Your Recurring Revenue
Though recurring revenue in SaaS companies can be relatively predictable and stable, there are always opportunities for further growth. Read through our following tips and implement them to scale your business’ revenue further.
Raise Your Pricing
Your revenue depends on your set prices, so you need to invest time in your pricing strategy.
Unfortunately, SaaS companies sometimes spend just six hours on average calculating a fair price for their product. That’s crazy because six hours is not nearly enough time to factor in all the elements like:
- your competition
- your customers’ price sensitivity
- analyzing your costs
- matching your perceived value
You need to invest more time into price optimization because it can impact your company’s bottom line by 12.7%, compared to acquisition and retention.
If you want to increase your sales and your revenue, increase your prices as your business grows. Some customers will not be happy about it, but there will be those who will not bat an eye with a minimum increase because they cannot live without your product anymore.
Stormpulse increased its pricing by 10x and had great results.
They moved from a freemium to a premium-only model and increased the $49.95 annual subscription price to $499 a year. They also completely removed the monthly payments option.
Minimum user backslash, happy customers, and a finally profitable business.
The most important thing is to have a product that solves issues for your customers and offers a matching price even if that price might be higher than with similar products.
Your best solution is to test, test and test. Keep researching the market, your competitor’s offerings, and listen to your customers. As your product increases its perceived value, tweak your pricing.
Get More Leads
Getting more paying customers into your sales funnel is a surefire way to increase your recurring revenue.
However, lead generation and new user acquisition are not free. So to spend less money on new leads, it’s best to go after those who will stick with you for the longest.
One solution to getting better leads is to use different lead conversion channels to maximize your potential of reaching customers.
Social media is becoming an increasingly powerful tool for new user acquisition, even in the B2B market. Almost 89% of B2B marketers used social media platforms in the past year as a leading distribution channel, jumping from 60% in the year before.
84% of businesses used content marketing to generate more leads in 2020, and over 70% of them said their efforts were more successful than in the previous year.
For more leads, aim to provide more value through your content. Surveyed companies mostly opted for creating educational content through blog articles, email newsletters, infographics, and case studies.
Remove a Free Plan Option
Free plans have certain popularity because they provide awareness of your brand and opportunities for upselling. But after you’ve been in the market for some time, you can ditch the freemium.
See how CrazyEgg planned their pricing.
They don’t offer freemiums, but instead, they opted for a trial period to provide value for their customers and weed out those who might take advantage.
If you still want to cling to your freemiums, consider reducing the number of features to push your customers toward paying plans.
Of course, you’ll need to be sure which features best fit their needs and provide the best experience once they upgrade.
Freemium models are not intended for long-term business growth. Logically, your conversion rates will stagnate or decrease if your offer is too good and free of charge.
Unbundle Product Features
Don’t put all your features into one basket. Customers want the most out of the price they’re paying, so they might be frustrated if they pay for things they don’t use.
A simple solution is to split your features and offer a personalized service for users to pick and choose which features they want. You can also equip your product with essential features only and show others as add-ons.
Hubspot does that. They have product bundles and offer custom add-ons like API limit increase with their CRM product.
When you give your customers the option to customize your product to their needs, they will be more loyal to you.
That way, you can also focus on improving your most popular features and further increase their customer satisfaction. You’re also reducing costs on research and development.
Personalization is the key to customer satisfaction, and your product offering should mimic the same.
Moving upmarket has excellent opportunities for scaling.
If you’re already providing outstanding service to many startups and SMBs, consider whether your product can benefit enterprise customers and what would satisfy those higher ticket users.
Almost 41% of SaaS companies that moved upmarket in the past two years said they had faster revenue growth due to larger contracts.
Big businesses will pay more, but there’s one caveat—they also require more attention.
Your product will likely have to be more customizable to their specific business needs, and you’ll have to create a fantastic customer success program dedicated to their goals.
Many SaaS companies that serve enterprise clients customize their pricing, so there is no price for enterprise tiers on their pricing pages.
Look at Teamwork, for example:
Like many other SaaS companies, they let enterprise clients contact them first, and then they provide individual pricing plans depending on their needs.
But you can also see that some features listed in this billing tier also indicate customization, such as customer onboarding training.
While managing enterprise clients is often more demanding, the revenue you receive can outweigh anything you can get from small businesses.
Another benefit to moving upmarket is your pricing strategy. If you have per-user pricing, it makes more sense to target customers with large teams so you can increase your revenue significantly.
Focus on Upselling
Upselling means offering premium plans and services to your existing customers to increase customer stickiness. If you implement it at the right time, you can significantly boost your revenue.
In fact, Databox reports that some upselling tactics generated a 20% increase in conversions.
Your main tactic is to find the right customer and the right time to upsell to. Tipping points like users running out of storage space are an excellent incentive to upgrade their plans. Both Airtable and Dropbox use this tactic.
When users run out of storage, they cannot effectively use the software unless they upgrade their subscription. And since that often happens amid work, all users need is a gentle nudge and a simplified way to upgrade their plan within the app.
Another tip for upselling is to look at your existing customers who have recently achieved milestones with your product. They are right in the middle of experiencing the value of your product and might be more inclined to upgrade so they can gain even more.
You can also upsell more by focusing on products with higher price points (if you have more than one). If you can convert more customers to those products, your revenue will grow faster than upselling cheaper products.
Offer Yearly Contracts
Yes, annual contracts force your customers to spend more upfront, but they are certified to increase customer loyalty and retention rates.
To nudge users toward spending more money upfront, SaaS companies often resort to giving discounts.
At first, this might look counterintuitive, but in fact, you’re more likely to raise your revenue and user LTV because you’ll have more time to nurture these annual contracts and secure regular renewals.
Trengo offers both monthly and annual plans, but their default setting is annually, and they offer discounts for yearly billing, saving users 22% of the monthly price.
Here’s an excerpt from their pricing page:
Most SaaS companies keep monthly plans, but annual plans benefit from reduced churn rates and increased cash flow.
When you’re asking for payment in advance, you limit your customer base to only those who are reliable with their payment. You will avoid nasty surprises and businesses that are one step towards closing, thus losing any potential revenue.
Sweeten the deal with annual contracts by offering enticing discounts to make switching to annual the best choice.
Related posts: Understanding ACV for SaaS Business
Boost Recurring Revenue With Promotions
Using promotions can entice prospective leads and generate more revenue.
Your promotional campaigns should be versatile but used for a limited time to bank on exclusivity and urgency. For example, the most effective way to run them so far have been email campaigns, and they will likely continue to be.
Loyalty programs are also a great way of promoting your SaaS. You just have to think about the best perks to offer.
The most popular incentives for these programs are free upgrades, special training, exclusive features, etc. You can even offer compounding discounts as rewards for loyalty—so the longer users have their subscription, the cheaper it gets.
Airtable, for example, offers a $10 worth of credit collection for every referral. You get a new user to join your team, and you can deduct $10 from your monthly subscription.
Promotional campaigns are an easy way to attract new customers as they can be used in different lead generation channels and excite your existing customers.
Listen to Your Customers
Meeting your customer’s needs is an ongoing process since the market changes rapidly and customers change their minds accordingly.
To know what your customers want, start surveying them through low-cost options like SurveyMonkey or Google Forms to get the initial information.
Surveys are not the only source of information—you will receive feedback from support tickets and social media.
User feedback serves to identify pain points, so you can help your customers achieve their goals. This is what you are after.
Slack is a perfect example of a multi-billion dollar company that grew by listening to customer feedback. Word of mouth is what helped Slack reach 2.3 million MAU in just two years. They have continued growing since.
Such an approach resulted in a loyal customer base and incredible business results. They even have a wall of love on Twitter where customers share their love for the app.
Slack’s founder Stewart Butterfield said they made user feedback the center of their efforts. It proved to be so effective that they could grow quickly even without hiring salespeople or marketing teams.
They took user feedback seriously, and even the founders read support tickets. Then, they acted on feedback and fixed anything that users said wasn't working, even when it was the opposite of what they envisioned for their app.
Overall, listening to the market and leveraging the feedback users give you can change the path of your software business. Still, it can also pave the way for solid business growth and build you a very loyal customer base.
Today, individuals and teams alike can’t imagine their lives without using SaaS products, which companies like yours can use to improve their recurring revenue.
Still, as customers get pickier and demanding, there will be more need to increase revenue with strategic planning. Thinking more about your pricing and adjusting it, leveraging user feedback, and moving upmarket are some of the first steps to do so sustainably.
When you know which options are on the table, you can make better decisions that will positively impact your bottom line. Even minor changes can reap enormous benefits to scale your business.