by Bill Vinck, Excendio Advisors
When is a dollar worth more than a dollar?
Overview
The premise of this article is that while all businesses like revenue not all forms of revenue are equally valuable. Revenue types differ in important respects and there is a hierarchy among types. A “subscription” dollar can be seen as more valuable than a “product” dollar. The topic of revenue types and their relative values comes up frequently in M&A conversations.
We will consider the topic from several related perspectives beginning with the revenue types typically found in IT businesses. We’ll continue with a discussion of other revenue characteristics and some associated metrics including margin and scalability.
These ideas are arrayed in a matrix which summarizes them in a fashion potentially useful to a management team for planning purposes as well as facilitating business analysis discussions in an M&A situation.
Revenue Types:
Subscription: Revenue is generated when a client executes a contract of a year or longer to receive access to the firm’s technology. SaaS is an example.
Subscription Add-Ons: Some firms provide add-on products for a fee to subscription product clients.
Service Annuity: Revenue is generated when a client executes a contract for a year or longer for a specific service. Maintenance contracts are an example.
Project: Revenue is generated when a client executes a contract for a specific service described in the project scope of work and the service is completed. This type has no ARR but may have historical repeat revenue from certain clients.
Product: Revenue is generated when a 3rd party product is sold, and the client takes title.
Revenue Metrics:
ARR: Annual recurring revenue amounts. Specified in the contracts.
Margin: Current margin percentage.
Scalability: Ease with which new clients can be added without significant incremental expense.
Rate of Growth: Percentage annual increase for this type of revenue.
Contract Duration: Average duration of contract.
Churn: Percentage of clients who leave or downgrade this service.
Growth Initiatives: Roster of projects conducted internally with the specific intention of improving the revenue characteristic under consideration.
Expected Impact: Expected result of each initiative.
Summary
Management Matrix
| Revenue Type/Metrics | Subscription/+ | Service Annuity | Project | Product |
| ARR | $ | $ | $ History | $ History |
| Margin | % | % | % | % |
| Scalability | Degre of difficulty & Cost | Degree of difficulty & Cost | NA | NA |
| Rate of Growth | % | % | % | % |
| Contract Duration | Average # years | Average # years | NA | NA |
| Churn | % | % | NA | NA |
| Growth Initiatives | Description & Target | Description & Target | Description & Target | NA |
| Expected Impact | % change | % change | Volume and margin impact | NA |
| % Total | % | % | % | % |
Conclusion
By developing and maintaining a matrix like this, a management team has a simple tool at their disposal to see current discrete revenue trends. It displays a key view of the current revenue picture. Further it can plan and track revenue characteristic enhancement projects.
For a firm anticipating transition, the matrix is a simple tool to begin business analysis and valuation.