I’ve been thinking a little about non-recurring revenue businesses. Particularly, businesses where transactions are large, but infrequent. I’m coming to the belief that these are under-appreciated categories of investment, especially since the gospel of recurring revenue, subscription commerce, and SaaS has been preached in recent years.
The basic downsides of these sorts of businesses vs. recurring revenue businesses are
- Less predictability: There are two issues with the unpredictability of non-recurring businesses. The first is practical and real – it’s hard to forecast and plan expenses when revenue might swing significantly. That is not good. The second is some version of “it helps you, your employees, and your shareholders sleep better at night.”
- Lower multiples: Buyers and investors don’t like the lack of predictability, and punish the company for it. There is more risk of looking like an idiot as the head of M&A or as someone who buys the stock, so that risk is priced into the asset
- Higher potential LTV: The argument that over time, you’ll be able to extract more value from a customer than you would have if they paid it all up front. The assumption here is that that increased value is NPV positive based on other potential uses of the capital that you could have gotten up front
These issues are true, and make non-recurring businesses sound pretty shitty. But here’s the case for them:
- Non-recurring revenue businesses can grow much faster. Because you accumulate revenue in bigger chunks, you can generate really explosive growth in a shorter amount of time. Sure, your revenue can also fall off a cliff more quickly too, but that’s just the nature of these businesses.
- Non-recurring revenue businesses might consume less cash to grow. Because you recover your marketing and sales expenses up front, this allows you to start generating cash much more quickly, whereas recurring revenue businesses often consume cash to grow and recover that marketing investment over time. The exception are recurring revenue businesses with an amazingly viral free product that very effectively get consumers to subscribe without needing significant marketing and sales expenses.
- The lower multiples are probably justified, but don’t make these businesses categorically bad. You probably should take a haircut in valuation for the unpredictability, but there should be a pretty healthy market for these businesses. Also, your top line will be greater and your growth greater as well, so you’ll be taking a valuation haircut on a larger base.
- Some categories just are this way. It’s the cost of participating in these markets, and some of these markets can be pretty enormous with lots of margin. Who cares if you are not a recurring revenue business if there are lots and lots of customers and you are generating huge margins on each sale up front? Some companies might kill to half the dollars of contribution margin over 12 months that a non-recurring business gets on its first transaction. And investors should kill to be a major investor in the market leader in some of these enormous categories of non-recurring purchases.
- Some non-recurring businesses end up being more recurring than you’d think for a couple reasons. First, these purchases tend to be highly referral based. So even if a consumer is only making one purchase every few years, that one person may end up influencing multiple consumers. So you acquire 1 customer, but that may actually drive 4-5 purchases. Second, the non-recurring purchase may be a gateway to related, perhaps more frequent purchases. Cars are a good example of this. You don’t buy a car that often, but there are a lot of related costs and services around financing, insurance, maintenance, and the buying/selling of used inventory that end up generating meaningful additional revenue streams at scale.
The point here is NOT that recurring revenue businesses are overrated, or that non-recurring businesses are better or worse. They are just different, and I think some of the biggest and most exciting categories have gone relatively untouched because they don’t fit the mold of recurring revenue.