Stephan Liozu | Chief Value Officer
The experts call it many things: digital transformation, servitization strategies, and business model diversification. Regardless of the name, the end result is the same: recurring revenues. During the Covid-19 crisis, companies that have successfully invested and executed recurring business models have proven more resilient than those who have not. The latest Zuora Subscription Economy Index shows that companies using subscription business model grew 5 times faster in 2020 than the average S&P 500 growth.
Many of these companies have realized that, while their customers did not have the Capex to acquire new equipment, they were interested in maintaining existing assets, in leveraging their installed based, and in launching service innovations on their own. In the manufacturing and high-tech world, suppliers are increasingly starting to offer more aftermarket services which include maintenance, spare parts, and other value-added services.
They have done so in response to customer demands for more outcome-based servicing agreements, for extension of existing asset lifetime, and/or for assistance in transitioning to recurring business models themselves.
The Benefits of Recurring
The benefits of investing in a recurring revenue strategy for suppliers include:
1) Greater predictability for everyone: one-time transactions come and go and are subject to high levels of pricing competition. Signing longer term recurring agreements with customer allow for more stability for suppliers as well as better predictability for the customers. Recurring pricing strategies offer a greater deal of transparency to the customer for a period of 3 to 5 years on average.
2) Higher margins: the value of recurring transactions is generally lower, but they are also traditionally high in profit. Deloitte reports that aftermarkets parts and services deliver over 50% of a manufacturer’s profit (Deloitte Insights, “The Rise of Aftermarket Services”, 2020). Another analysis conducted by McKinsey in 2017 across 30 industries that average earnings-before-interest-and-taxes (EBIT) margin for aftermarket services was 25 percent, compared to 10 percent for new equipment (McKinsey, “Industrial aftermarket services: Growing the core – July 2017).
3) Diversification in business models: The Covid-19 crisis created a sense of urgency for business model diversification and accelerated the transition to the cloud and to SaaS models for many suppliers. The crisis forces companies to re-evaluate their strategies and business model portfolio to help mitigate the high level of uncertainty. As customers face severe cash crunch, suppliers can transition them from traditional CAPEX to OPEX models and continue transacting.
4) Alignment with customers value metric: As more and more companies move to recurring business models; they expect their suppliers to do the same transition to align the suppliers’ pricing mechanisms with their internal value metric. For example, a customer moving to a SaaS model will expect their suppliers of software and cloud services to also sell to them using a similar subscription model or a model based on usage.
5) Reinforcing customer relationships over time: the transition to a recurring business model allows for more customer touchpoints and numerous possible transactions during the relationship. As a result, suppliers develop greater intimacy about customer behaviors and product usage. They can in turn introduce additional services or digital innovations to delight the customers even more.
6) Focusing on customer life-time value: the main benefit of recurring revenue models is to extract greater value from customers and markets over time. There are lots of opportunity to innovate, to upsell, cross-sell to maximize customer satisfaction and retention over time. The end goal of a recurring business strategy is to capture as much of the customer life-time value as possible.
The Types of Recurring Revenue Sources
There are multiple sources of recurring revenues. The goal is to maximize the number of sources through a diversified portfolio of recurring business models.
1) Internal Efficiency Opportunities: selling recurring opportunities internally through intercompany mechanisms to test the value propositions and pricing models.
2) After-Market Services and Parts: selling traditional services including maintenance, repair, diagnostics, monitoring, and others in the form of recurring service agreements.
3) Software-as-a-Service (SaaS): launching new software in the form of subscriptions or transition existing software from perpetual licenses to SaaS.
4) Connected Products and Services (PaaS, EaaS, HaaS, DaaS): transitioning from one-time transactions to monthly or annual subscriptions to product, equipment, hardware, or devices.
5) APIs and Data: selling subscriptions to APIs or other data-related services or offers. These can be stand-alone offers or included in a digital bundle.
6) Digital Platforms and Marketplaces: extracting value from marketplaces or platform by collecting transaction fees, entry fees, subscriptions to offers within the ecosystem.
Companies that have embraced the recurring business model have set corporate recurring revenue targets as part of their corporate strategic plans. What is the magic number? Anywhere between 15% to 25% of total sales is a good and challenging target according to experts.
The Pillars of a Recurring-Based Strategy
What are the critical success factors for a solid recurring-based strategy?
Here are five of them:
1) A dedicated strategic priority and not an afterthought: top executives must realize the benefits of recurring business models and the need to leverage customer relationships. They must make it a priority to leverage the existing installed base and to diversify their business model portfolio. Have an informal network of managers or one initiative around installed base are not enough. It must be on top of the strategic agenda.
2) Build and operate a service-focused organization: the champions in recurring strategies have established dedicated business units for their recurring businesses with dedicated processes, systems, and talent strategies. Successful digital transformation or recurring business model requires a strong service orientation.
3) A shift from cost to value orientation: a customer value management orientation is also required. Recurring opportunities are studied from a customer value perspective and priced based on quantified value proposition. Customer success teams work together with value engineering teams to deliver the promised value to customer. Costs are still critical but not the heart of the recurring value and pricing strategies.
4) A shift from a product-based mindset to a usage-solutions mindset: the product is no longer at the center of the business model. The customer and/or subscriber is. That requires a focus on customer processes, desired outcomes, and jobs-to-be-done. Technical teams are organized around customer needs and pains. Priorities are set to deliver outstanding value and experience.
5) A pipeline of digital and service innovations: greater customer centricity and intimacy generate a tremendous amount of customer data that can be turned into service and digital innovations. Recurring business models require a focus on retention, renewal, and increased customer value over time. It is a way of life!
The transition towards recurring business models can be powerful for a company that makes it a part of the strategic agenda. The focus of digital transformations should the design and launch of high margin and differentiated recurring innovations. That requires an electro-shock internally to change the culture and put the customer at the center of the business model. Many companies have done this transition successfully and reaped the benefits of recurring business models. For the laggards, it is not too late to get started!
Stephan Liozu is a featured speaker at Sentinel Insights 2021.
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Bio
Stephan Liozu, Chief Value Officer, Thales (www.stephanliozu.com) is Founder of Value Innoruption Advisors (www.valueinnoruption.com), a consulting boutique specializing in industrial pricing, digital business and pricing models, and value-based pricing. Stephan has 30 years of experience in the industrial and manufacturing sectors with companies like Owens Corning, Saint-Gobain, Freudenberg, and Thales. He holds a PhD. In Management from Case Western Reserve University. He has written several books, including “Monetizing Data” published in 2018. His next book, the “Industrial Subscription Economy” is due out in the Fall of 2021.