The golden rule of recurring revenue businesses – “The Rule of 78”

All successful owners or managers of small businesses that I know have one thing in common. They all have a good grasp of “the numbers”. They all understand the important moving parts of their P&L. They all also have a couple of key metrics in their heads that they watch like hawks. I need to sign x number of customers to break even or I need to sign y customers a month to be profitable this year.

Understanding your numbers is important – but if you run a recurring revenue business, there is one set of numbers that is more important than anything – I call it “The Rule of 78”.

A quick definition – a recurring revenue business is one where you win a customer – usually in a services business - and they spend money every month. For example if you are on a mobile phone contract you are a recurring revenue customer. You spend £20 a month for your phone package every month. For obvious reasons business owners crave it and investors love it. But here is something that a lot of people don’t always appreciate – how you can fall foul of the “Rule of 78”. So what is it?

A simple example – imagine you run a services business and you win one new customer each month and your customers spend exactly £1,000 a month each, every month for the foreseeable future. Let’s look at how your sales in the year build. You win your first customer in January and they bill £1,000 every month in the year – in other words you bill them 12 times - £12,000.

You win your second customer in February and you bill them for the rest of the year – i.e. 11 times. You win the next one in March and bill them 10 times in the year and so on.

If you roll that model on throughout the year you will end up with 12 customers and you will send out 78 bills – hence the name “Rule of 78”. You will bill £78,000. But here’s the really important bit. Of your 78 “billing opportunities” 33 of them – or 42% - come as a result of business you won in January, February and March. In other words almost half of your year’s revenue comes as result of performance in the first quarter. By the half year it’s all over bar the shouting unless you do something really special in the second half. Why? Because in the final two quarters you only have 17 billing opportunities – or 21% of the total.

So what do you do with this information? Well I’ll tell you what I do as the Manager of a recurring revenue business. First and foremost we build some real incentives around performance in the first three months. The last thing a salesman can afford is a blank month between January and March. The second thing we do is we spend a lot of time around September of each year doing some marketing and focused sales activity in order to build a pipeline to set up the upcoming first quarter of the following year.

I am glad to say that with this Q1 just behind us, we hit or exceeded our sales numbers in January, February and March and in doing so have set ourselves up for a very good year. We still need to deliver the remainder but having done the hard bit, we have a good shot.

Those who haven’t appreciated the immutable laws of the Rule of 78 and who have exited Q1 with little sales success are now facing a long uphill climb during which they will be constantly behind the numbers. And with each passing month the chances of closing the gap gets smaller and smaller - literally.

If you run a recurring revenue business, your mantra must be: Recurring revenue businesses are all about first quarter performance.