Missing link in real portfolio management

Innovation business cases and recurring revenues

In a recent review of a financial education program about business cases, I was struck by the lack of attention for recurring revenues. When I checked further literature on this topic as well as example business cases, I found confirmation that this gap seems omnipresent.

This is a real gap; our track record in business cases shows that the vast majority of these cases create a signficant part of their value from recurring revenues (as opposed to initial revenues).

 

What do cell phones and slot machines have in common?

The following examples show the omnipresence of the phenomenon:

  • cell phones, where the initial product – the phone – is (almost) free and all of the value is in the subscription and/or call fees over its lifetime;
    which are converging with
  • personal navigation devices (satnavs), with the recurring revenue streams of map updates, real-time traffic information streams;
    which are increasingly being integrated in
  • cars, for which the business case of the dealers builds to a large extent on the recurring maintenance fees;
    all the way to the home:
  • mortgage and rent business cases share this typical recurring pattern
    and in the kitchen:
  • with coffee makers linking to specific coffee cups, pads, pouches etc.
    to the game room:
  • game consoles, with recurring revenues from online subscriptions, game sales, and peripherals, and
  • entertainment and slot machines, that are being installed free of charge for a share of the so-called cashbox content (the net profit the machine generates).

This last example triggers me to write a blog soon about Monte Carlo simulation for portfolio management, but that is a completely different topic.

How to include usage in the portfolio?

In all these cases, the usage patterns of the product over its lifetime contributes significantly to revenues, and to costs. In a good portfolio management process, these product usage characteristics are an inherent part of the information, and they must be included in the analysis. Ignoring their value or their costs is potentially misleading, and opens the process to erroneous portfolio decisions.

Do you think this is more than a technicality? For me, it seems one of the difficulties in developing new business models. The decision-makers involved may have an implicit bias for judging cases on their initial revenues only. However, models where users pay as they go can build a much more sustainable and profitable case.

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