Recurring revenue is undeniably the best revenue source. Several industries such as telecommunications, rental and information services have always had recurring revenue pricing models. However, in this new digitized era, many other industries, including software, hardware and health care, are moving toward this model.
A recurring revenue model is a solution/pricing model that generates a continuous revenue stream throughout the customer’s entire lifetime. This type of selling requires different types of customer contact jobs, including land, adopt, expand and retain roles. It also has significant implications for sales compensation plans: When and how should companies pay salespeople for sales results?
Sales Measure Options and Definitions
Measures and their associated weights drive seller time and focus. There are a variety of recurring revenue measure options and sales crediting events. The selection of the right measure involves selecting both the measure and associated crediting rule. Below are the 10 most commonly used sales measures. The first five are bookings metrics — sales credit at time of order. The second five are various revenue metric types.
- Total Contract Value (TCV): The full committed or estimated contract value over the contract’s term length.
- Annual Contract Value (ACV): One-year committed or estimated contract value, generally calculated as TCV/number of years. ACV may include nonrecurring revenue such as one-time implementation or professional services.
- First-Year Contract Value (FYCV): First-year committed or estimated contract value, usually used when committed contract value substantially increases each year.
- Out-Year Contract Value (OYCV): Pre-identified future-year committed or estimated contract value, generally second- and third-year values in a multiyear contract.
- Booked Annual Recurring Revenue (Booked Quarterly RR or Booked Monthly RR): One-year (quarter or month) committed or estimated contract value, generally calculated as TCV/number of years (quarters or months). Booked ARR and ACV are technically the same measure. However, ACV may include one-time implementation or professional services, whereas Booked ARR only includes recurring revenue offerings.
- Recurring Revenue (ARR, QRR or MRR): The recurring revenue is the ongoing contract value for each year (quarter or month) in committed contracts, regardless of when delivered, billed or recognized.
- Delivered Revenue: When the company delivers the service to the customer.
- Billed/Invoice Revenue: When the company sends a bill or invoice to the customer.
- Revenue: When the company receives the customer’s payments.
- Recognized Revenue: When the company can report revenue according to Generally Accepted Accounting Principles (GAAP). Note: Every company has its own measure definitions. Therefore, it is best practice to define each measure explicitly within the company’s context.
‘AS A SERVICE’ PRICING MODELS
Companies with recurring revenue models sell their offerings “as a service” versus one-time purchases. Common nomenclature for “as a service” is “aaS” or “XaaS” where the “X” can be replaced by business process (BPaaS), information technology (ITaaS), software (SaaS), infrastructure (IaaS) or platform (PaaS). There are three common recurring revenue-pricing models: 1) Customers pay a fixed committed price for a time period; 2) Customers pay a variable price for the service as they use or consume it; 3) Customers pay both a minimum fixed committed price and a variable price as they use it. Many companies often offer a discount to lock a customer into a commitment.
RECURRING REVENUE MODEL’S PREVALENCE
Recurring revenue models are becoming more prevalent. Companies in all industries are leveraging technology and the internet to provide innovative, differentiated and high-value offerings. For example, a tractor company that only sold tractors can now sell farming services, which include tractor rental, tractor maintenance and crop/field utilization information.
Customers also like to purchase a solution as an operating expense versus a capital expense. It is easier to purchase a solution in smaller increments over time as opposed to a larger upfront payment. In the case of consumption-based pricing models, buyers pay only for what they consume. The investment community highly values this form of recurring revenue. They expect the lifetime value of the contract to exceed the value of a comparable one-time purchased solution.
Finally, companies reap several benefits by implementing a recurring revenue model. Providing lower upfront costs opens new buyer markets, particularly in small- and medium-sized business sectors. Additionally, companies that move to aaS form deeper, more intimate relationships with their customers as they help them recognize the value of the offering. These deeper relationships generally translate into increased customer retention and higher customer lifetime value (CLV) than a traditional sales model focused on one-time purchases.
GO-TO-CUSTOMER MODEL IMPACT
The go-to-customer strategy for companies with recurring revenue models is dramatically different from companies with standard one-time purchases. Value propositions must include use cases that describe how customers can maximize value from their offering versus what the offering does. A company’s sales processes must align with how customers identify needs and ensure they realize the offering’s value. Sales jobs are more specialized as vendors deploy multiple roles across the entire customer life cycle, including land, adopt, expand and renew (the LAER model). Companies with recurring revenue models have more sales compensation plans to reward these roles and more nuanced incentive designs to recognize the different types of recurring revenue.
LAND, ADOPT, EXPAND AND RENEW JOBS
Recurring revenue models include four distinct sales motions: land, adopt, expand and renew. It is too challenging for one person to effectively execute all four sales motions, which is why companies specialize these roles. Account coverage can be owned by one role, a two-person team or separate hunters and farmers. There are about 15 sales coverage models that include one or more of these four jobs: account executive, account manager, customer success manager and renewal representative. Figure 1 displays the four sales motions and three common coverage models. By understanding the jobs and their roles within the LAER model, sales compensation professionals can determine whether the job should focus on new, renewal or expanded business.
Select the right measures by focusing on seller persuasion. (See Sales Measure Options and Definitions on page 44.) Companies hire sellers to persuade customers and partners to buy their offerings. The sales compensation plan rewards for the persuasion outcome. It should reinforce good outcomes by tying payments as close as possible to the persuasion event.
Each sales motion in the LAER model represents a persuasion point, including adopt. Persuasion points vary based on whether the pricing model is committed. Use a bookings metric for committed contracts. Use a forward, nonbooking metric for noncommitted contracts. The most common nonbooking metric is delivered or billed revenue. Some startup companies use paid revenue when they need sellers to collect payments. Use recognized revenue only if sellers can easily understand the accounting principles. Recognized revenue also needs timely GAAP reports.
Bookings timing, or when a contract closes, is substantially more important for a recurring revenue solution versus a one-time purchase. Remember, companies offer aaS offerings for a smaller upfront cost in hopes of reaping a higher value over the purchase life of the customer. If a company on a calendar fiscal year sells a $1,000- per-month deal in January, it will receive 12 months of value in that year. However, if the company sells a $1,000-per-month deal in December, it will only receive one month of value in that year. Consequently, some companies use measures to drive bookings timing. If the contract is committed, they may use recurring revenue. If the contract is noncommitted, they may use delivered or billed revenue.
To determine how to reward for multiyear deals, companies must decide if they need to drive longer-term deals. Factors affecting a company’s multiyear strategy include renewal type; retention rates; level of discounting; and expected price increases. Companies that focus on annual or shorter periods generally have the following attributes: sticky offerings with high retention rates; easy renewal reorders; high multiyear customer discounts and/or significant annual price increases. Companies that focus on locking customers into longer deals with multiyear deals have the opposite attribute: non-sticky offerings with retention issues; costly renewal resells; low multiyear customer discounts and/or limited annual price increases. Some companies need to focus on both short- and long-term measures.
The best measure to drive multiyear deals is total contract value, which recognizes the full value of the deal over its term length. However, many companies offer multiple term lengths (e.g., one-year, two-year and three-year deals). Setting quotas when term lengths vary is problematic. Companies not only have to estimate the number of deals and average size, but also the average term length. If sellers exceed their average term length, they can receive exceptionally high payouts without bringing in net new customer lifetime value. Companies can still drive multiyear focus while using an annual contract value measure. Figure 2 displays the continuum of ACV and TCV measure options in order of annual to multiyear focus.
DRIVING PRODUCTIVITY AND GROWTH
Many sales compensation professionals work in recurring revenue models today with more expected in the future. To help provide the right incentive solutions, sales compensation professionals must understand and correctly apply measure and crediting options. In addition, to be a consultative partner to their revenue executives, sales compensation professionals must be well-versed on the business/pricing model, revenue processes and jobs. All have a significant impact on designing the right sales compensation plan to drive productivity and revenue growth.