Moving From a Perpetual to a Recurring-Revenue Model: Where to Start
- A revenue stream refers to how revenue is recognized when an offering is sold
- Many B2B companies have moved from a perpetual to a recurring-revenue business model
- Sales operations needs to know how to value different types of revenue stream opportunities
B2B companies have been moving from perpetual to recurring-revenue business models for some time now – prompted by the savings, flexibility and access delivered by cloud computing. In writing, that transition may sound straightforward, but making such a transformation can be like switching to driving a car with a standard transmission when you’ve driven an automatic all your life (or vice versa) – it’ll still get you there, but you’ll need to completely change your routine, and you may be discombobulated for a while.
To help sales ops get a handle on these concepts, I recently spoke with Dana Therrien, service director of SiriusDecisions’ Sales Operations Strategies service. Dana first provided some basic definitions:
A revenue stream refers to how revenue is recognized when an offering is sold, over an agreed timeframe, or until canceled. There are two main types of revenue streams – perpetual and recurring. Perpetual revenue streams come from revenue recognized on delivery of an offering or completion of a task. Recurring revenue can be broken into two types:
- Recurring term. Also known as subscription term, this type of revenue stream comes from periodic delivery of offerings at an agreed-upon interval and price.
- Recurring usage. Also called utility pricing, this type of revenue stream is more flexible; customers pay a subscription on the basis of their service consumption.
According to Dana, one of the headaches in moving from perpetual to recurring revenue is the revenue hit that occurs when, all of the sudden, the large lump-sum revenue the company is accustomed to recognizing with a perpetual revenue model disappears and is replaced by multiple periodic payments. To avoid this shock, sales operations needs to work with finance and sales leaders to set revenue expectations that take into account the increased expense percentages of revenue as amortization schedules even out.
Sales operations also needs to understand how to value different types of revenue stream opportunities for planning, quota setting and forecasting, especially if the company will be offering perpetual and recurring revenue offerings. Each type of revenue stream opportunity should be valued differently, Dana noted:
- Valuing perpetual opportunities. Opportunity amount calculations are basic, because the prices are fixed and non-recurring. Add the as-quoted value (or estimated value of lower-stage opportunities) of products and one-time services.
- Valuing recurring-term opportunities. Contracts are valid for an agreed-upon time period, and prices are predetermined. Dana explained that companies can use one of three methods to calculate opportunity value: committed/total contract value (CCV/TCV) – multiply scheduled monthly billing by the term; annual contract value (ACV) – for annual contracts, the ACV and TCV are the same, but for multi-year contracts, the TCV equals the sum of billings per month for the entire contract, while the ACV is determined by the amount billed for the first year or the average annual billing over the term of the contract; monthly recurring revenue (MRR) – this is based on a single monthly billing cycle, regardless of term, so when billing amounts are fixed for the contract term, use that amount to value the opportunity.
- Valuing recurring-usage opportunities. Because opportunity value isn’t known until usage is calculated in arrears, and usage changes month to month, record activation fees in one field, then estimate the MRR or ACV value using historical amounts realized for similar accounts.
For more on making the transformation to recurring revenue, join us November 7-9 at the Hyatt Regency in New Orleans for TechX, where Jeff Clark and Robert Muñoz will present on the transformation’s implications on the sales and marketing tech stacks.