Driving value with a recurring revenue model

Fast growth might grab headlines, but you also want to build a business that's robust enough to survive a few knocks. Introducing a recurring revenue model could be the answer.

Have you ever been caught in one of those automated phone systems where, even after negotiating several menus, you end up on hold, seething more and more each time you’re assured that ‘your call is important to us and will be answered shortly’?

Well, plucky Cambridge-based Netcall believes it has the answer. It provides “intelligent” telephony for call centres, helping clients like Thames Water and KwikFit deal with queues on their customer service phone lines by organising a call-back service.

Three years ago, however, Netcall was struggling and CEO Henrik Bang was under pressure to revive its fortunes. ‘We were making almost all of our money from licence revenues,’ he reflects.

‘This created a high degree of unpredictability as you couldn’t guarantee when a new sale would be made. That causes uncertainty about cash flow and it’s very hard to plan.’

Bang took a gamble and introduced a hosted rental service. He says: ‘One thing we didn’t know was whether the company was suitable for this model – we just guessed. We retained the licence model just in case, with the focus on recurring revenues.’

The gamble paid off. Around three-quarters of Netcall’s business is now recurring and the company has enjoyed fast growth. Recent half-year results recorded a 192 per cent surge in profits to £375,100 on sales up 26 per cent to £2 million.

Better proposition

Buttressing your company via recurring revenues as Bang did should drive up the value of your business and minimise risk. But it can be hard to actually put it into practice. According to Andrew Hayden of private equity firm Sovereign Capital, your ability to properly stabilise your concern will vary depending on the sector you’re in.

‘Many manufacturers don’t have any recurring revenue streams and have to keep going out and selling,’ he argues. ‘That’s fine, but you can never say you’re definitely going to sell such-and-such volume of products next month or the month after that. If you look at service-based businesses, they trade on the stock market for average multiples of around 19 or 20 times their earnings, whereas manufacturing businesses will be nearer ten times.’

That isn’t to suggest it’s easy for service companies. Corporate promotions provider MKM has toiled valiantly to increase its levels of repeat business and is finally enjoying the benefits.

Fruitful partnerships

Since 2005, chief executive Andrew Johnson and his team have reassembled and repackaged existing products and services in order to generate long-term recurring revenues from new and regular clients. MKM can now proudly boast that 56 per cent of sales in the past year came from these endeavours.

Johnson realised that making customers come back for more was crucial for longevity. ‘In business-to-business companies like MKM, it’s about building real solutions for clients rather than one-off ideas,’ he says. ‘For example, where we provide our partners with good offers for their clients, we also put forward an online capability which they can use to promote the offer to their clients.’

This creates “stickability” or “traction”. He continues: ‘Because clients are on our technical platform, they’re more likely to use our offers than those of our competitors in the future. It increases the costs for them to switch and so, on a like-for-like basis, we’ve got an advantage.’

Rather than struggle to establish a durable model to dig your business out of a financial hole, it may be better to put together plans for sustainability at as early a stage as possible. Michael Clark, founder and chief executive of Imagesound, which provides tailored radio stations for retailers, made sure ‘from day one’ that his business was secured by a recurring revenue model.

Imagesound’s approach is straightforward, requiring clients to buy or lease equipment and then sign a one- to three-year contract for the music. It bills customers monthly, quarterly, half-yearly or yearly, depending on their preference.

The inevitable challenge for Clark was to balance the slower and steadier path of sustainable revenues with an appetite for fast growth. He explains that the answer lay in making six acquisitions since 2004. By expanding operations geographically and by diversifying away from the retail sector into leisure, the company should be better prepared to ride out market volatility.

It appears that Clark has realised what many regard as a clever concept spun out from the classrooms of business schools: sustainability and fast growth.

That said, once your company has reached the point where income covers costs and you’re reasonably satisfied with your rate of growth, it might make sense to hold off from new projects and take stock of where you are in the market. After all, entrepreneurs are notorious for getting bored quickly and wanting to leap onto the next big idea.

Alysoun Stewart, head of strategic services at Grant Thornton, observes that ‘with rapid growth, businesses sometimes have to be brave enough to put their foot on the brake pedal to allow other parts of the business to catch up, such as recruitment, business processes and so on’.

If you are seeking to shore up your venture with a sustainable approach, then you need to accept that the first year will be tough.

Netcall’s Bang has never looked back after introducing rental agreements for clients. ‘In the short term you sacrifice growth, so you may have to explain that to your investors,’ he says.

Time for bootstrapping

MKM’s Johnson says: ‘As a rule, when you produce an innovative product you can charge a lot on the basis that you’re not going to have a long-term relationship with your client.

‘In this context, your attitude to customer care and after-sales contact will probably be weak so, if you’re changing your approach, you may have to invest in order to provide that level of service. Therefore, you might forgo some short-term profit to obtain long-term stability.’

The type of relationship you have with a buyer and how you conduct business may require a rethink. ‘When you’re entering into two- or three-year contracts, the purchasing process is much more protracted,’ comments Johnson. ‘Businesses, especially larger ones, will look at your operation in greater detail, so we invested in the ISO 9002 quality standard, which says you have good quality and management processes. In addition to that, we have invested in a high level of IT security as that’s what is required by many larger companies.’

A sustainable approach won’t be right for every sector, but if you can pinpoint where your future sales are coming from and combine that with a healthy strategy for growth, your business will undoubtedly be the stronger for it.

Marc Barber

Raven Connelly

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.