Business Model

The ROM Business Model

The Model

Recurring revenue businesses can have a range of different business models, operating on an arc between two extremes: the ‘pay upfront’ model on the far left side, to consumption-based business models on the far right side. Each model along this arc has distinct implications for the sales cycle, win rate, level of risk, and go to market model.

Key Elements

Business Models on a Continuum

With the term ‘recurring revenue’, most people typically think of software sold on monthly, quarterly, or annual contracts, yet recurring revenue models actually exist across a much wider continuum. There are three types of models along this continuum:

  • Ownership: The most extreme example in this category is where a company is selling on-premise hardware, where the buyer pays upfront (e.g., perpetual software license).
  • Subscription: Most typical SaaS businesses fall in this category, often with monthly, quarterly, or annual contracts paid upfront.
  • Consumption: This includes various forms of usage-based pricing; an example of this is pay-as-you-go cloud computing resources. (Footnote 1)

Businesses can move from left to right, as well as from right to left, along this arc; doing so changes how the business should price their product, as well as how they sell it. It is crucial to be aware of these necessary changes, and the impact they have on the company's revenue operation.

Key Impacts of the Selected Business Model

Moving along the arc of this Business Model continuum from left to right results in the following key impacts:

  • The sales cycle has accelerated. The length of the sales cycle tends to shorten as we move from a value-based proposal with an upfront payment, to impact-based performance with payment at the time of consumption. A conventional B2B software sales cycle for perpetual software license is typically 9-18 months, while the sales cycle of a SaaS contract with an annual contract value of around $50,000 is typically around 20-90 days. With consumption models, the sales cycle is practically instantaneous, with accounts often charged shortly after usage occurs.
  • Win rates have fallen. Win rates for upfront contracts are typically quite high, as the buyer has generally already secured the budget internally; therefore, the win rate is about 1:3. With shorter SaaS contracts, the win rate is more often 1:5 or 1:6, because companies can usually test the product with minimal commitment required. Finally, in a freemium business model, the win rate is more like 1:8 or even less, because the commitment required from the buyer is even less, resulting in more unqualified buyers and higher churn.
  • The seller bears more of the risk. In a pay upfront model, the buyer bears the majority of the risk, as it's much harder for them to return the product and realign their organization around a new solution. As we move further toward subscription and consumption models, the seller instead carries the majority of the risk: their company has made a large investment in developing the software, while there is very little risk to the customer for changing their mind.


Trends in Business Model Transitions

Some growing trends of how businesses are shifting their business models are: ‍

(i) Launching a SaaS product
A common trend among enterprises with a pay upfront model is to launch a new SaaS service that is aimed at capturing more market share and a more predictable stream. This often happens in the SMB segment, but may also happen in an enterprise business; one example is a hardware business that begins to sell a recurring support contract for the first time.

(ii) Selling to the Enterprise
In this scenario, an existing SaaS company that sells platform software to SMB and mid-market size companies will shift to selling multi-year contracts. This is typically due to the fact that their customer acquisition and retention costs are taking longer to recoup, and therefore a shift to longer-term customer commitments is necessary. This scenario typically occurs in large enterprises and educational institutions.

(iii) Accelerate with Usage / Impact
Instead of selling a platform to corporations, the model shifts to a monthly subscription/usage model sold to end users. This can increase the velocity of the sales cycle, but it may take 1-2 years to ramp up the ability to connect with a large volume of end users.

‍

SaaS is not the only type of recurring revenue model;
virtually any business can be a recurring revenue business.

Findings

  1. Recurring revenue is not exclusive to SaaS companies. The principles of recurring revenue apply to any business where they do not make a profit on the customer's first purchase, and therefore need to continue to sell and provide recurring impact to the customer over time.
  2. Businesses can successfully utilize multiple business models at the same time. Businesses typically are successful when they rely on one model until around $10-20M in revenue, at which point they often expand and deploy additional business models to drive additional revenue streams.
  3. The chosen business model has an effect on the sales cycle. As you move from perpetual to subscription to consumption, the sales cycle typically decreases from years (as in perpetual hardware contracts) to merely hours (customers paying as they go for cloud compute resources).
  4. The chosen business model has an effect on the win rate. The win rate of qualified leads decreases moving from left to right in the business model. This is a result of the level of commitment that the customer needs to make in each scenario. This makes leads for a freemium business model the hardest to convert, because the customer needs to make very low level of commitment in order to engage with you.
  5. The chosen business model has an effect on the level of risk. There are radical implications for the level of risk borne by the seller versus the buyer as you move across the spectrum of recurring revenue business models. As we move toward a usage model, the risk for the seller continues to increase, and the risk for the buyer becomes less and less.

The Model in Action

Ownership, Subscription & Consumption

All of the examples depicted here are recurring revenue models, and a business can successfully employ more than one model at the same time.

Visualization of the ROM Business Model in action

Terminology Used

Perpetual contract. A perpetual license that authorizes an individual or company to use a product or service indefinitely.
Subscription contract. The type of contract used by software-as-a-service companies (or SaaS), where a customer pays for access to software on a monthly, quarterly, or annual commitment.
Consumption model. A type of software model where cost is based on consumption; users are typically charged at the end of a billing cycle based on how much they have used the product.
Freemium model. A business model where a product or service is provided free of charge, but customers are charged for access to additional features or services that go beyond the functionality of the free version.

References

Source 1. van der Kooij, J.J. (2018) The SaaS Sales Method: Sales as a Science.
Source 2. David Skok. SaaS Metrics 2.0.
Source 3. Bob Tinker and Tae Hea Nahm. (2018) Survival to Thrival: Building the Enterprise Startup.
Source 4. Mark Roberge. (2015) The Sales Acceleration Formula: Using Data, Technology, and Inbound Selling to go from $0 to $100 Million.
Source 5. SaaS makes it easier for big projects to get approved. Just kidding. Blogpost by Steve Banker

Footnotes

Note 1. The freemium model is a type of consumption model when considered on this model, where customers are able to sign up for a free version and determine on their own if they want to upgrade to a paid version.
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