Business Value Intelligencer: Revenue by Design

This is the first of my deep dives into a single driver of value. I begin where the Cash Flow force begins: with the revenue itself. Not how much of it there is, but how it is built.

Most owners think about revenue as a number to grow. Asset Architects think about revenue as a structure to design. Two businesses can post the same top line and be worth very different multiples, because a dollar of predictable, recurring, contracted revenue is worth far more than a dollar you must win again every month. Revenue Design is the discipline of deliberately shaping pricing, recurring nature, and mix so that the income you produce is the highest quality available to you.

Recall the definition from Issue #2: Revenue Design is the intentional structuring of pricing, recurring nature, and mix to maximize the quality of income. Each lever is a choice.

Pricing

Not the number on the invoice, but the architecture of how you charge: one-time versus ongoing, fixed versus usage-based, list versus negotiated. The same service sold as a monthly retainer instead of a project fee produces higher-quality income at the same annual total, because it is more predictable.

Recurring Nature

The single largest lever. Ask it of every revenue line: does this come back on its own, or do I have to go get it again? Contracts, subscriptions, maintenance agreements, and retainers convert “go get it again” revenue into “comes back on its own” revenue. That conversion is the heart of Revenue Design. Without it, every period starts partway back down the mountain you are trying to climb.

Mix

The blend of customers, products, and channels behind the total. One customer at sixty percent of revenue is lower-quality income than the same total spread across two hundred accounts, before anything goes wrong. Designing mix means deliberately shaping concentration and the balance of new versus repeat.

The above design choices are valuation inputs. Higher-quality revenue lowers the perceived risk of the cash flows, which lowers the discount rate and raises the multiple a buyer will pay. Revenue Design improves both sides of the valuation equation at once: it can accelerate the growth of cash flow and reduce the risk attached to it.

Adobe and the re-architecting of revenue

For most of its history, Adobe Inc. sold its software as a one-time transaction. A customer bought Creative Suite once and might return years later for the next version. The revenue was large but episodic: every product cycle began near zero and had to be rebuilt through a fresh wave of upgrade sales.

Beginning in 2012 and 2013, Adobe redesigned its revenue. It did not change the product. It changed the structure of the income, moving customers off perpetual licenses and onto Creative Cloud subscriptions. The same software now produced recurring revenue that renewed on its own.

The transition was not costless, and that is the honest part of the pivot. Replacing large one-time payments with smaller monthly ones depressed near-term profitability. Adobe’s EBITDA fell from about $1.31B to a trough near $0.76B. A business watching only its earnings would have concluded it was destroying value.

It was doing the opposite.

Look at the middle column. While EBITDA sat at its lowest point, the multiple had already climbed from 11x to 32x and enterprise value had risen from $14.7B to $24.2B. The market repriced the revenue before the earnings recovered.

By FY2015, EBITDA was back near where it started, about five percent lower than in 2010. Yet the multiple reached 36x and enterprise value hit $44.8B. Earnings were flat. Value roughly tripled.

That gap is the entire lesson. The value did not come from more profit. It came from the market re-rating the quality of the revenue. Recurring income is easier to underwrite than episodic sales, so a dollar of it earns a higher multiple. The lesson is not “software should be a subscription.” It is that income structure is a choice, and that choice is priced.

What revenue design opportunities are available to you?

You are not Adobe, and you do not need to be. The transferable idea is smaller and more practical: almost every business has some slice of transactional revenue that could be redesigned into recurring revenue, and most owners have never deliberately looked for it. The dollar figures are a technology giant’s; the mechanism is available to smaller businesses.

Consider where this hides in a typical owner-operated business:

My suggestion to business owners looking to create business value starts from the top. Sort every revenue dollar into two piles: comes back on its own, and has to be won again. Most owners have never drawn that line, and are surprised how much sits in the second pile. The design question follows: which of those dollars could move to the first pile with a change in structure, not product?

That is Revenue Design in practice. A structural move, not a growth tactic. The buyer of a business is not buying last year’s revenue; they are buying confidence in next year’s. Revenue Design builds that confidence into the income itself.

This closes the Cash Flow force for now. Next month, I move to Growth drivers, the first being Commercial Beachhead: how a business seizes and secures new ground, and how to tell durable expansion from a lucky year.

Value creation is not an accident. It is an architecture.

Best,
Jeremy
Principal, Sawtooth Value Advisory