Recurring Revenues

This question was raised over at Advice Tap by Susan Varty (WordTree) – how to create recurring income in a consulting-based business. There were some good answers there, but for a more complete answer, one must understand why people will pay recurring fees in the first place.

In a service-based business, recurring fees are simple – if you want to continue to receive service, you have to continue to pay. Think of paying for your cellphone: the company provides you with a phone and a plan, and for that, you pay a monthly fee.

Warranties are a little different, in that what you get for the ongoing fees you pay is a guarantee that if something happens to your product, the manufacturer will replace it. In that, they are very much like insurance policies.

Other businesses operate on a cyclical schedule; for example, you have to file your taxes once a year, and so your accountant can depend on your return each year.

If, however, your business falls into none of the above categories, how can you get your customers to continue to pay you month after month?

In order to do that, you need to turn your business model to something which offers ongoing value, which will be removed if the customer does not continue to pay. As an example, software licensing can work that way, where the purchase of the program entitles you to use of the program, but not support. An ongoing fee provides the user with access to support (yes, some companies really do distribute software like that).

Alternatively, you can have the customer pay a retainer, which gives them access to a certain amount of your time at a reduced rate. By paying up-front, the customer guarantees a lower rate, but if they don’t use the time allocated, then the time does not carry forward. In a business where most customers require some time on a monthly basis (for example, supporting websites in a typical month will involve some work for pretty much every client), this model can work well.

The problem here is determining a price that is fair to both you (the provider) and the client. In order to figure out what a fair retainer is, you need to estimate how much time you usually spend on each client on a monthly basis, and the rate you would want if you were guaranteed to get paid whether you worked this month or not (this is typically less than your normal rate by a significant amount). From the client’s perspective, the price has to be such that even in months where they don’t have work, they’re still going to be saving money overall.

My personal formula is something along the lines of the average number of hours I expect to work (say, 2 hours per month) times my hourly rate times 80%. For that, the client gets 2 hours of work, and can carry forward 50% of the hours each month. For me, the risk is low, since in any given month I’ve committed up to 3 hours (in the example provided) so there’s little risk of having to do large volumes of work for little pay (no banking hours). Additionally, from the client’s perspective, they know that they’ll often go over the two hour allocation, but by paying me upfront, they get a reduced rate on the first few hours. In the long-run, they’ll usually save between 10 and 20 percent of their total costs by paying me upfront, even though some months they don’t get any work done by me.

What do you do to establish recurring revenues? What models have you found to work well?