Last editedMay 20234 min read
When software was first distributed in the early days of the tech boom, it was traded like any traditional physical commodity. However, with cloud computing allowing anyone with a stable internet connection access to a product that’s always evolving and can be used across multiple platforms, software is rarely used in a “one and done” fashion anymore.
This led to the rise of the software as a service company, with the market enjoying around 59 billion customers worldwide in 2022. For many software as a service (SaaS) ventures, setting up a practical business model will be of primary concern. It is this model that’s used to define how the business operates, how it scales and how it turns a profit.
Inevitably, there is going to be a large amount of capital spending in the initial stages of the business as the software itself is developed, a customer base is gathered, and marketing is set into motion. Arguably the best way to ensure this spend is recuperated is to focus on a recurring revenue model.
A recurring revenue model for SaaS means businesses generate revenue every month or year from the same users. They need to ensure they are offering a strong enough product to warrant that kind of financial commitment, of course, but SaaS and cloud-based services in general lend themselves naturally to the model. Indeed, recurring revenue models are a cornerstone of most SaaS businesses.
What is meant by recurring revenue models in SaaS?
A recurring revenue model refers to a business model that gives customers access to products or services in return for regular, scheduled payments. Given the fluid nature of cloud-based SaaS businesses, it’s a natural fit for most as it represents a more stable and consistent model that allows for greater customer flexibility.
The benefits of a recurring revenue model are obvious for companies offering SaaS products that are in a constant state of flux and are always being perfected. The customer is also paying for the convenience of 24/7 access to the software from wherever they might be and from whatever platform they happen to be using.
A recurring revenue stream allows companies to estimate their value and make more considered plans more accurately. It also offers a level of stability and predictability that is always encouraging for investors.
Monthly Recurring Revenue vs Annual Recurring Revenue
When discussing recurring revenue for SaaS, businesses will typically be looking to instigate a monthly recurring revenue model (MRR) or an annual recurring revenue model (ARR). They might also choose to give their customers a choice, offering incentives for the more immediately profitable ARR solution. But which model will work best for you will depend on your business and your customers.
The MRR model is more liable to fall victim to churn, with monthly recurring revenue churn in SaaS businesses a common problem that requires constant effort to mitigate. MRR churn refers to the total amount a business loses every month due to voluntary churn (cancellations, downgrades) and involuntary churn (expired or cancelled cards).
An ARR model is always going to experience less churn as customers are locked in for 12 months. However, ARR models are also inherently less flexible and might not be feasible for some consumers. Finding the right balance in your offerings is crucial when ensuring your customers have the best opportunity to use your product the way they want to use it while keeping your revenue stable.
Simple Recurring Revenue Models to get started?
There are five basic types of recurring revenue models to consider for your SaaS business.
Usage-based billing
This is a scaling model that only charges the user when they use the service. It’s more flexible for the customer and saves low-volume users money. For the business, however, it means unpredictable revenue.
User-based billing
For SaaS businesses focused on providing services for larger teams, this could be a strong option as it involves charging based on how many users in a team utilise the service. This scales well with large teams, and you don’t need to track usage, but it might prove untenable for teams with inactive users.
Tiered billing
This is perhaps the most common model as it covers a wide range of users with a wide range of needs. The idea is to offer different functionality for a different price, with those paying more offered more than those paying less. This is the most flexible option and will help you understand what your customers place more value on, but it can also become quite complicated.
Hybrid billing
A more flexible revenue model that takes aspects from several other models, an example here would be a service that requires users to upgrade to a higher tier when they hit a specific level of users. This is the most complex and flexible option.
Freemium
Offering the basic service for free and then converting free customers into paying customers by giving them incentives to upgrade is typically referred to as a freemium model. This could work well for businesses targeting low-income customers, but it could also backfire if you find too many users settling for the free service.
Considerations for implementing a recurring revenue model
The end goal is to settle on the model that provides the best value for you and your customers. Consider your customer acquisition rate and your customer retention rate when making your decision, as this is the most accurate metric for gauging what kind of payment model your customers might prefer.
It’s also important to remember that you can always adapt your model to suit customer trends. If more customers, for example, are resubscribing for a certain tier than any other tier, you might want to consider consolidating your recurring revenue model. Similarly, if you are seeing more annual subscribers than monthly subscribers, you might want to make the latter more enticing or do away with it entirely.
How can GoCardless help?
For SaaS businesses looking to use a recurring revenue model, GoCardless is a powerful and flexible tool that takes direct debit payments directly from customer accounts. This means fewer involuntary churn problems for monthly payments and is easy to set up. Indeed, with GoCardless you can start taking direct debit payments in less than a day!
GoCardless streamlines payment systems, reducing friction and pain points for one-off and recurring payments alike.
