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June 30, 2022

As a business owner, it’s important to keep your customers satisfied and coming back for more. One way to do this is through subscription revenue. But what is subscription revenue? Keep reading to find out!

What is Subscription Revenue?

What is subscription revenue? Subscription revenue is a type of revenue that is generated when a customer pays for a subscription to a service. This type of revenue is recurring, which means that it is received regularly.

With subscription models, you bill your customers on a recurring basis––typically monthly or annually.

When you initially start charging for subscriptions, your cost will go up. But don’t worry, your revenues will go down.

Customer acquisition costs money, but it’s essential if you want your product to succeed. You must listen to your customers’ feedback and implement it into your products.

Retaining customers is the ultimate goal.

After you’ve put so much effort into making your customers happy, they start returning. The hard work you put into engineering pays off.

You begin upselling and cross-selling to your customers.

And just like that, your revenues go up.

Money!

Money!

Yes, that is the sweet sound of recurring revenue from subscriptions. You can put your feet up, relax, and listen to the soothing sounds of that cash on a continuous, regular basis.

The subscription revenue model is a great way to earn predictable revenue while providing your customers with flexibility and value.

Types of Subscription Revenue Pricing Models

There are three common types of recurring revenue streams.

1. Flat-rate pricing

Flat-rate pricing is when you offer every customer the same product or service, regardless of their unique needs.

You can charge your clients on weekly, bi-weekly, or monthly payments.

2. Tiered pricing model

The tier-based pricing model allows you to offer different packages based on which features or users are included. This can benefit small businesses by allowing you to customize your offering to each customer.

The cheapest plan would best serve startups and small companies. As these companies grow, they can upgrade to higher plans without changing companies.

Because they’ve already been on a journey with you, they’re more likely to become partners.

The tiers range from 2-5.

3. Usage-based pricing 

You can charge your clients either a flat monthly or annual rate, or you can forgo the subscription fee and charge a fee for the amount of time you use.

Factors affecting your usage-based pricing model could include the number of API calls, emails, or transactions made.

How to Create a Reliable Subscription Revenue Model?

In a transactional business, money goes from Marketing to Sales and then Finance. But in a subscription-based model, you have RevOps, which is short for Revenue Operations.

Remember when we talked about how to provide value to your clients? The best way to do that would be to engage with them throughout the customer lifecycle consistently.

To maximize profits, you need to focus on customer retention. It costs 5 times more to acquire a new customer than to retain an existing one.

And so, we change this sales funnel into a sales cycle.

what is subscription revenue (Source)

The flywheel is the key to a successful subscription revenue workflow. It ensures that all of the revenue-driving functions work harmoniously to maximize your potential.

To build a reliable subscription revenue workflow, you must focus on four key areas: acquisition, sustenance, growth, and customer experience. Focusing on these key areas ensures that your business brings in revenue consistently and reliably.

How To Calculate Subscription Revenue

There are two ways to calculate subscription revenue: Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR).

MRR

You can calculate your Monthly Recurring Revenue by considering all the active and recurring subscriptions. There are two methods to do this:

To calculate your company’s monthly recurring revenue, you can consider all the active subscriptions. There are two ways to do this: by taking the sum of the monthly recurring charges of all paying customers or by taking the average revenue per user and multiplying it by the number of paid customers.

ARR

There is a slight variation in the ARR formula based on the billings (you’ll learn about billings in the next sub-heading). However, the basic ARR formula is the sum of all yearly recurring charges for all paying customers.

1. If you charge your clients monthly, you can calculate the 12-month (or annual) Recurring Revenue (or ARR) as:

(Annual Contract Value) multiplied by (12/duration of annual contracts in months).

2. If you charge your clients yearly, you can calculate the ARR as:

(Total Contracted Revenue) /(Number of years the contract is for).

It is important to calculate both the ARR and MRR metrics. The ARR metric will give you insights into the long-term health of your business, while the MRR metric will provide insights into the short-term health of your business.

How Subscription Revenue Accounting Works

The Subscription Accounting Journey has three parts: Booking, Billing, and Revenue.

Bookings

What if we told you that you could get our product for a $500 monthly fee? You would only have to sign a contract for two years, and we would bill you monthly.

This contract, where there is a promise of service and payment, is called a booking of $12,000.

Bookings are a helpful indicator of future cash flow and give you insights into the sales process.

And since bookings aren’t considered revenue (yet), this will help the finance team mark them as ‘committed money’ and avoid inaccurate MRR and ARR calculations.

Billings

Billings would be the invoices sent to your customers. It is where you’d collect the money monthly or yearly.

Subscription billings provide insight into a subscription business’s health because it’s the money you’re owed.

Revenue

And finally, we have our revenue. Under the GAAP rules, you can only recognize the income if you’ve provided the services to the customer––and if the other conditions laid out by ASC 606 are met.

And if you’ve collected the customer’s payment but haven’t yet provided the services, the amount will be termed ‘deferred revenue.’

Growth

With subscriptions, companies have a predictable stream of revenue that makes forecasting easy and enables growth.

If a company has an annual recurring revenue of $10 million, 80% of which is recurring revenue, it knows that it will begin the next year with a revenue base of $8 million. This provides a solid foundation on which to grow and invest.

No wonder, SaaS-based solutions are expected to grow from $102 billion in 2019 to $ 140 billion in 2022, according to Gartner estimates. This kind of growth is no longer restricted to the software business.

Customer Satisfaction

Subscription businesses know that the key to customer satisfaction is engagement. Subscription businesses can create lasting customer relationships and improve retention by constantly interacting with customers. According to a CitiBank study, 76% of businesses are now looking at subscription models to achieve these goals.

Conclusion

So, what is subscription revenue? Subscription revenue is a type of revenue that is generated when a customer pays for a subscription to a service. This type of revenue is recurring, which means that it is received regularly.

If you’re not already incorporating subscription revenue into your business model, I highly recommend doing so. It’s a great way to ensure a steady income and show your customers that you’re providing them the value they can depend on. This helps improve customer retention hence more revenue.

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