As mentioned before, there are two main types of revenue for most businesses — recurring or steady income, and one-time purchases or transactions.
Most companies rely heavily on the second type of revenue to survive!
We’ve discussed how important it is to have both types of revenue in your business model, but what about which kind of company makes the most money?
It seems like every entrepreneur I talk to believes that their competitors are more likely to go after the other type of business model. This article will prove them wrong!
There are three major reasons why this theory is false.
Transactions typically occur around holidays or at times when people are spending money, such as during a sale or season. This is why most big sellers have a lot of exposure throughout the year; they spend enough to make it up in cost per individual item.
Businesses that rely heavily on sales for their income produce steady flow of cash, which allows them to invest in more expensive marketing strategies and other areas of the business. These businesses can also afford to keep operating costs down since there’s not much overhead due to no managerial staff.
For example, Amazon has an internal system where it calculates how much money it will earn each month with its various products and services. It then allocates appropriate resources (people and equipment) to maximize those earnings. This way, even if one product line does poorly, everything else doesn’t suffer too badly because there aren’t many employees working on it.
Recurring revenues don’t depend on any specific event, so investing in advertising or changing your pricing isn’t quite as important. However, you still want to be efficient with what you do, just because you’ve already paid for it!
Many small businesses begin life relying exclusively on transactional revenue before giving away coupons, offering discounts, or creating additional service lines. They soon find themselves struggling to stay afloat.
By adding recurring expenses, you balance out these losses by getting some of this revenue back later.
This may sound obvious, but it’s important to understand why this is the case. Let’s look at an example!
Say you own a restaurant that does lots of business during the week, but which is closed for two weeks every summer due to weather conditions. During these times, your restaurant makes zero income.
This is a problem because without money coming in, it becomes difficult to maintain and grow the company. You would run out of money if we were talking about the average small business owner, or even most large businesses with less severe budget constraints.
So how do you stay afloat? By raising prices, of course! A common tactic is to raise your prices by 20% just before the break and then lower them back down after the break. (Remember, transaction costs are what we pay to have something done, so adding more to make a purchase can include things like buying online instead of going into a store, traveling extra distance for the same price, etc.)
By doing this, you create new transactions where people will spend the exact same amount of money as they did last year while also spending more since you raised your price. This creates a steady stream of revenue when the business opens again!
Now let’s compare this situation to one where the hotel has regular guests who come back time and time again. They are willing to pay their normal room rate each visit because they know they will get value from the experience.
While some believe that transaction-based business models are better than those with recurring revenues, this is false! It depends on what you want to achieve from your company and how much capital you have to invest in it.
If you are just looking to make money then the choice does not matter too much. You will get the same amount of income no matter which model you use.
However, if you want to build long term success for your business, then having recurrent revenue is the way to go. This gives you time to spend more on investing in your business since you don’t need to worry about finding new customers every month.
You can instead focus on developing relationships with your current clients so that they keep coming back. This helps strengthen the bond between you and them as well as creating additional opportunities for sales down the line.
It also allows you to retain your loyal customers longer due to the ease of access to their spending habits. There are many ways to manage recurring payments outside of Shopify, but the best software for ecommerce stores makes it easy to do so within Shopify itself.
For some companies, such as Netflix or Starbucks, their model is totally dependent upon recurring revenue. They make most of their money through subscription services or monthly purchases, so they do not really have a direct sale for every item.
For those businesses, the death of the traditional brick-and-mortar store does not matter too much because they still get paid every month!
With that being said, however, this type of business can be very expensive to run if you don’t have enough people buying their products or subscribers using them.
The thing about having only one sale per product is that if nobody buys it, then the company loses money. So, these types of businesses need lots of growth in order to stay profitable.
They also need to be able to produce more of the goods or services to satisfy hungry customers, which can cost money. This is why there are sometimes rumors that Netflix could eventually offer its service free.
If they did, though, what would they put up as advertisements? A message telling people to stop spending money on their subscriptions? That probably wouldn’t go over well.
While most businesses rely heavily on recurring revenue, not all companies are able to survive solely off of that source of income. This is because many industries depend more heavily on transaction-based revenue, such as for restaurants or shopping.
Recurring revenue is what keeps your business afloat when times are good, but it eventually swings in favor of the opposite during slow periods. When this happens, you will need other sources of income to keep up with bills.
Many entrepreneurs make the mistake thinking that they can transition away from one source of income without suffering significant losses. This isn’t always the case though, which is why it’s important to be prepared!
It’s great to have an idea that makes money passively, but no matter how well you manage your expenses, you won’t be able to completely shift your reliance onto that source of income. At some point, you’ll run out of cash!
Fortunately, there are ways to prepare your business for when that time comes. By investing in certain products and services, you’ll be better equipped to stay competitive.
So what are transaction revenue and recurring revenue? Let’s look at a few examples!
Transaction or one time income comes from something you sell, like buying a car for sale. A restaurant that offers discounts to students will earn some transaction income as students flock in to eat food they discount heavily.
Recurring income is similar to the example of the restaurant, but it is continuous over an extended period of time. This can be done through monthly subscriptions, yearly memberships, or even lifetime memberships such as to a fitness program.
A great way to understand this distinction is to think about how much money each type of business makes. If a company only earns enough money once, then it would run out eventually, and it would have to close down permanently!
Businesses that rely mostly on one-time income typically run out of money quickly due to cost overruns or shortages in funding. This is why most companies don’t stay in business very long – heh.
While some believe that only one type of business model is better than another, it is not true! It is totally acceptable to run both types of businesses under the same rules. What makes which style of business more efficient or effective in your situation depends largely on your resources and how much revenue you want to reap from each model.
There are many companies out there that rely almost exclusively on recurring revenues for their income. This includes things like Netflix, where you pay monthly fees to use their services, or software programs such as Photoshop or Excel where you are continually charged to use them.
By having these recurring payments every month or yearly, the company has set up an automatic financial stream of income that they can count on. These kinds of businesses have very steady incomes, because even if people don’t purchase anything new at all, they will still get paid what they were before.
However, this doesn’t always make money. If people stop using a product or service completely, then the company loses its income. They may also be investing in additional equipment or technology that does not work well with the product anymore, adding to their overhead cost.
While both transaction-based income and recurring income can be very lucrative for your business, one type of income is much more stable than the other. This fact was clearly seen in the run up to and aftermath of the recent recession.
Income that comes in large amounts frequently may appeal to some consumers, but it can also create a sense of false security for you as an entrepreneur. It may even contribute to overextending yourself financially.
Recurring revenue is typically less dramatic than transaction-based income, making it more sustainable long term. Because it comes in smaller chunks, you are not as likely to overspend due to the influence of a big sale or event.
This stability is what makes recurring revenues ideal for most entrepreneurs. Even if there is no special occasion, like Christmas or someone’s birthday, you have known about this money coming in all year. You have prepared for it by investing in resources and marketing strategies.
There is never a time when you are not actively promoting your services, so you do not need to worry about putting in the effort to generate that income at times when you are not planning on having it.