The 6 Rungs on the Recurring Revenue Ladder

A rock-solid recurring revenue model is one of the most valuable assets you can show a hesitant buyer.

But, not all revenue streams are created equal, especially in the eye of buyers.

Typically, a business will offer some combination of six different recurring revenue models, each one more valuable than the last.

Let’s dive into these six forms in order from least valuable to most:

Simple Consumables:

A simple consumable is anything a business sells that is “one and done.” For example, once a clothing store sells a t-shirt, there is no guarantee that the customer will do business with you again just because they purchased your product.

While good marketing and a quality good can create some brand loyalty, this form of revenue is the most prone to seasonal shifts in consumer behavior and changes in current trends.

Example: The Grocery Store

Consider your local grocery store. Customers visit, select the needed items, pay for them, and leave. 

In this case, the revenue is generated from the sale of goods—these are simple consumables. 

The grocery store’s profitability depends heavily on repeat purchases, customer loyalty, pricing, product quality, and customer service.

Opportunities:

• High customer traffic can lead to substantial revenues.
• The option to diversify products or services offered.
• Flexibility to adjust prices to respond to market demands or cost fluctuations.

Challenges:

• High dependence on customer loyalty and repeat purchases.
• Price and product competition can be intense.
• Requires effective inventory management to balance supply and demand.

Sunk Money Consumables:

Brands like Keurig really have the sunk money consumables concept down to a science.

Once a consumer has invested in a product, such as a coffee machine that only takes a particular type of “pod,” they will continue to buy the product to make their investment worth the money.

So, once a consumer buys the more expensive machine, the recurring revenue comes in the form of brand-specific products that the machine must have to function. 

Example: The Home Printer

One classic example is the printer and ink scenario. 

When you buy a printer, you’re also committing, to some extent, to purchasing a specific type of ink cartridge. Your printer (the initial sunk cost) requires continuous refilling with these cartridges (the consumables). 

This model allows the company to generate predictable, recurring revenue.

Opportunities:

• Recurring revenue generated from consumable refills.
• The initial sunk cost can create a barrier to exit for customers.
• Potential for a higher lifetime value per customer.

Challenges:

• The need to balance the cost of the initial product and consumables to retain customers.
• Dependence on the continued use of the initial product.
• Risk of negative perception if customers feel locked into buying consumables.

Subscriptions

With the rise of monthly boxes of curated products, subscription services have made a big splash lately.

Everything from makeup samples to children’s crafts is regularly delivered to a consumer’s mailbox until they cancel the subscription.

This recurring revenue model is especially valuable when annual discounts are offered, wherein a new subscriber pays less when purchasing multiple months of the product at once. 

This approach assures that the customer will stick around for at least the amount of time paid in advance. 

Example: Streaming Services

Consider a streaming service like Netflix. Subscribers pay a monthly fee to gain access to Netflix’s vast library of films and TV shows. 

This form of revenue is predictable, recurring, and allows small businesses to scale effectively. 

However, it also requires continuous value delivery—Netflix must consistently offer engaging new content to retain subscribers.

Opportunities:

• Recurring revenue stream that aids financial planning.
• Opportunities to upsell or cross-sell other products/services.
• Potential for high customer lifetime value.

Challenges:

• The need for continuous delivery of high-value content or services to retain subscribers.
• Potential high churn rate if customers don’t perceive ongoing value.
• Requires strategies to handle customer cancellations or payment failures.

Sunk Money Subscriptions

Sunk money subscriptions are a twist on standard subscriptions, combining the concept of “sinking money” into a machine, then subscribing to an ongoing service that accompanies that machine.

For example, purchasing an iPad through a phone provider, then paying a monthly fee for internet access is a sunk money subscription.

Often the subscription comes in the form of a digital service that pairs with a particular device, but not always.

Example: Home Coffee Maker

Take, for instance, a high-end espresso machine that uses proprietary coffee pods. 

The device is the initial sunk cost, and the coffee pods are purchased through a subscription service. 

This model can establish a strong tie between customers and the product while providing the company with an upfront payment and recurring revenue.

Opportunities:

• The double revenue stream from the initial purchase and ongoing subscription.
• The sunk cost can increase customer commitment and reduce churn.
• Potential for high customer lifetime value.

Challenges:

• High upfront costs may deter potential customers.
• Requires strategies for managing subscriptions and delivering ongoing value.
• Potential backlash if customers feel “locked in” to the subscription.

Auto-Renewal Subscriptions

Many digital services are auto-renewal subscriptions, which continue to charge a consumer every month until the consumer says otherwise. 

Video streaming services like Netflix and Hulu are auto-renewal subscription services and very successful ones at that. 

Other examples include cloud storage service providers and gym memberships. This revenue is evergreen and a precious commodity for a small business. 

Example: Software-as-a-Service (SaaS)

Many software-as-a-service (SaaS) platforms, like Adobe Creative Cloud or Microsoft Office 365, utilize this model. 

Subscribers gain access to these platforms for a recurring fee, which is auto-renewed at the end of each subscription period. 

This model can generate passive income and customer loyalty but requires clear and upfront communication to avoid potential dissatisfaction.

Opportunities:

• Produces a double revenue stream from the initial purchase and ongoing subscription.
• The sunk cost can increase customer commitment and reduce churn.
• Potential for high customer lifetime value.

Challenges:

• High upfront costs may deter potential customers.
• Requires strategies for managing subscriptions and delivering lasting value.
• Potential backlash if customers feel “locked in” to the subscription.

Contract Revenue:

The most valuable type of revenue is contract revenue and is most often seen in B2B industries. This recurring revenue model ensures that the revenue is legally obligated to continue due to the contract terms.

Backing out of a contract is often more expensive than simply following through with it, and it offers the consumer assurances that the business will provide a specific set of goods or services that are also legally binding.

This recurring revenue model is very attractive to those looking to buy a business because it is the most reliable form of recurring revenue. 

Example: Managed IT Services

A managed IT services provider might enter into a contract with a business to provide a certain level of service for a set monthly fee over the next three years.

This recurring revenue model provides both parties with revenue and cost predictability but requires the provider to meet specified service levels or face penalties.

Opportunities:

• Long-term, predictable recurring revenue model.
• Opportunities for upselling or cross-selling throughout the relationship.
• Establishes long-term client relationships.

Challenges:

• Longer sales cycles and complex negotiations.
• Risk of penalties for non-compliance with service level agreements.
• Dependence on renewals for sustained revenue.

Final Thoughts

As a business owner and eventual seller, your goal is to move down the recurring revenue ladder. 

If you are currently only selling consumables, finding ways to sell sunk money consumables is your next step, and so on.

The farther you are along the ladder, the more attractive your business will be.