Recurring Revenue as the Lifeblood of your Professional Service Business
Selling services to other businesses is a proven business model. It is easy to get started and requires little upfront capital. As long as you provide a valuable skill, you’re good to go. Whether it is in marketing, accounting, law or other services needed by businesses to operate.
We can make a few distinctions when looking at the service industry in general. Hairdressers and taxi drivers are prime examples of services businesses you can come across as a consumer. Engagements are typically very short, at different intervals and have a clear end result. Other services are project-based, such as those offered by landscapers or house painters. These typically run longer and are customized to your requirements.
Professional services (those catering to other businesses) are often project-based, too. The project-size is typically larger, more knowledge-intensive and has a longer sales process compared to consumer-focused services. Because of these factors this type of business is considered lumpy; workloads fluctuate as projects ramp up and wind down. The increased project size and it’s requirements make it harder to effectively schedule the required resources, exacerbating the lumpiness issue further.
So why is this problematic? When workload is unpredictable, revenue is unpredictable. After wrapping up a project, the work is done and you’re on to the next project and customer. A large number of cases, you won’t see the client requiring that specific service for several years. Your business model isn’t sticky. This makes it incredibly hard to sustainably grow your business. For small professional service businesses the difference between landing two or three large projects can make or break a year – and the possibility to grow.
Finding your golden goose
In order to counteract these forces many professional service businesses offer additional services or products that provide recurring revenue, such as retainers, service level agreements or simply allow customers to commit to a number of billable hours over a whole year. In turn customers get a guaranteed level of services, improved response times or even a discount. These are all valid options, but certainly not created equal.
Take a look at an accounting firm that provides payroll services. Every few weeks they run their client’s payroll and make sure every employee is paid appropriately. It is highly standardized and literally runs like clockwork. There is a bit of work getting everything set up, but once done it’s done, it requires comparatively little work on a per-customer basis. It is also incredibly sticky. This is probably the holy grail of recurring revenue.
Let’s continue with an online advertising firm. Their work generally involves figuring out a strategy, researching what channels to use, develop assets and setting up the ads. This typically takes a few days to a few weeks. After setting up the ads the agency monitors its performance and makes adjustments as needed. Spending money on these optimizations makes a lot of sense as you’re probably spending a multiple amount on running the ads themselves–you better make sure this money is well spent.
A final example is that of a digital agency that creates a new corporate website for a medium-sized business. The process typically takes a few months and after taking delivery the customer may decide to commit to a continued development agreement to improve its website over the next year. How does this stack up to the other examples?
Better recurring revenue
One of the goals of creating recurring revenue is creating consistency. It compensates for the lumpiness of project-based work and allows a company to grow at a lower level of risk as recurring business dampens any fluctuations. Recurring revenue in itself is not a silver bullet, especially if these additional services are tied to hourly work. Time that is spent on recurring services can not be simultaneously spent on project-based work.
In order to quantify the quality of a recurring revenue there are a few characteristics to consider. Quality is defined as the ability to provide stable revenue throughout the lifetime of a customer. Characteristics to consider are:
Recurring Revenue Lead Time: How long does it take for a project to result into recurring revenue? In the case of an accounting firm, this can be days. For business that run complex projects, this can take up to several months.
Recurring Revenue to Project Revenue: How much of your customer’s revenue is derived from recurring revenue compared to project-based services, on a yearly basis? If this ratio is below 1, it indicates you’re in a lumpy business.
Recurring Revenue Conversion: How many clients convert from project-based services to recurring products? Ideally this number is close to 1. For some businesses this ratio will always be 1, for instance when providing payroll services.
Businesses with short lead times, a high ratio of recurring revenue and high conversion will find that their revenues are relatively stable and easier to grow over time. When the next year of contract renewals comes around, you know what to expect and are able to hire for additional customers that are likely to commit to products that provide recurring revenue over the next year. Businesses that exhibit the opposite, will find it a lot harder to do so.
Some businesses may find it difficult to find a product that will drive recurring revenue throughout the year, but it’s good to understand that the same characteristics can be applied to a portfolio of recurring revenue services. Landscapers might provide general garden maintenance from spring to autumn, but offer a snow removal service over the winter to compensate for downtime. An online advertising form can offer quarterly search engine ranking reports next to ad management. A diversified service portfolio of recurring revenue services can alleviate revenue fluctuations, as long as it’s well proportioned to project-based revenue on a per client basis.
You need recurring revenue in order to grow your professional service business. Not just to allow for growth, but also to provide a better service to your customer. Understand that not all recurring revenue products provide the same level of resolve you might be looking for. Analyse your recurring revenue products based on the characteristic outline above; this will help you find the gaps and act accordingly.