There is a phenomenon I have observed time after time with mature companies receiving![\"\"](\"https:\/\/berkonomics.com\/wp-content\/uploads\/2018\/04\/Oil-car-300x275.jpg\")
over 75% of their revenues from recurring sources.\u00a0 Management undertakes a simple exercise of calculating the increased profitability of shutting down all R&D, sales and subordinate operations, and universally notes with shock the high net profit that results \u2013 from shutting down all operations except customer service to recurring customers (as in software support operations.)<\/p>\n
Legacy system recurring revenues<\/strong><\/p>\n Depending upon the type of business, customers are loyal often because they are creatures of habit, enjoying the existing relationship and service, not wanting to disrupt a working resource.\u00a0 In fact, I am involved with one such company whose customer base extends back to the 1980\u2019s when first purchasing their systems, still paying a regular quarterly maintenance fee to a company that services them well but has no remaining sales staff or R&D functions. The customers are happy and the company profitable.\u00a0 What\u2019s not to like?<\/p>\n The result of \u201cprofit only\u201d thinking<\/strong><\/p>\n [Email readers, continue here…]\u00a0 \u00a0<\/em><\/span> \u00a0Well, there are two problems here. The company dooms itself to a slow death over the passage of time as customers desert to newer products.\u00a0 So, the decision to \u201cgo into maintenance mode\u201d is known as \u201cmilking the cash cow\u201d for a reason.\u00a0 And second, there is no excitement in such a company to retain employees looking for advancement.\u00a0 Employees who leave are replaced with people who are likely not \u201cA\u201d players, often causing future levels of customer service to decline.<\/p>\n The enterprise value of recurring revenue-based companies<\/strong><\/p>\n And yet, there are many companies where the cost of product renewal and R&D are just too high to keep up with competition.\u00a0 Companies in this predicament often can be sold for their recurring revenue stream, but the multiples they command are not high.\u00a0 In such a case, milking the cash cow may well be the best decision for management rather than selling the company.<\/p>\n An exception: SaaS companies<\/strong><\/p>\n The conclusion:<\/strong><\/p>\n Recurring revenues are oil for companies growing, reinvesting in R&D and expanded sales efforts. Those same revenues are glue to those choosing the alternative route of milking the cash cow.\u00a0 In those cases, they are attractive slow, sticky streams of glue, slowing a company until it ultimately dies of old age.<\/p>\n","protected":false},"excerpt":{"rendered":" Some types of businesses generate more and more recurring revenues over time, often growing to a size where recurring revenues pay all of the overhead of the company \u2013 an enviable position. The surprising recurring revenue trap There is a … Continue reading ![\"\"](\"https:\/\/berkonomics.com\/wp-content\/uploads\/2018\/02\/Banking2-300x155.jpg\")
We started this conversation looking at legacy companies with recurring revenue. \u00a0Companies that have built their revenue streams upon software, hardware, or other products delivered as a cloud service are a more recent phenomenon \u2013 saving capital outlays for their customers and delivering services more inexpensively using cloud-based systems. \u00a0These companies have the same R&D issues and cash cow tendencies as legacy businesses, but there are two exceptions: \u00a0new sales fall right to the bottom line in most cases, making these businesses more profitable than most capital expenditure propositions \u2013 attracting more customers without the need for financing or large up-front costs. \u00a0And the enterprise value of these businesses at the M&A or IPO stage is almost always much higher than other types of businesses because of this.<\/p>\n