HealthTech's Recurring Problem: How to define Annually Recurring Revenue

The recurring problem in healthtech around defining Annual Recurring Revenue (ARR) stems from the complexities of the healthcare revenue cycle and the diversity of business models, which often go beyond the simple subscription model of traditional SaaS.

While the general definition of ARR is the predictable, recurring revenue a company expects to receive annually from its customers, healthtech companies face specific challenges:

1. Hybrid Business Models

Many healthtech companies are not pure Software-as-a-Service (SaaS). They are often Tech-Enabled Services or a hybrid, where recurring revenue is tied to: 

Usage or Consumption: Revenue based on the volume of transactions, claims processed, or per-patient engagement, which can fluctuate and be less predictable than a flat subscription.

Capitation/Per Member Per Month (PMPM) Fees: Payments received from payers (insurers) or employers on a per-member basis, which may have variable enrollment or utilization rates.

Service Components: Blending software subscriptions with professional services (e.g., clinical support, implementation, data analytics), where only the truly recurring software/platform fee should be counted as ARR.

The Problem: Distinguishing between truly recurring revenue (ARR) and variable or one-time service revenue can be difficult. Misclassifying these can artificially inflate the ARR figure, misleading investors about the company's financial health and predictability.

2. Implementation and One-Time Fees

Healthtech deals, especially with large hospital systems or payers, often include significant one-time fees for:

Implementation/Integration: Connecting the tech solution to Electronic Health Records (EHRs) and other legacy systems.

Customisation: Tailoring the platform to specific clinical or administrative workflows.

The Problem: These one-time fees can be large and make up a significant portion of the initial contract value. Including them in ARR is a common mistake, as they do not recur annually. ARR must strictly exclude these non-recurring charges.

3. Long Sales Cycles and Contract Lag

Healthcare sales cycles are notoriously long, and contracts often include phased rollouts or terms that delay the start of paid subscription usage.

The Problem: There can be a significant lag between signing a contract and the revenue "going live." This creates a distinction between:

Committed ARR (CARR): The total value of recurring revenue that has been contractually signed but not yet fully realized or live.

Realised ARR: The revenue that is currently being collected based on active users or members. 
 
For accurate forecasting and reporting, companies must clearly delineate between these two, as investors prioritise the predictable, realized revenue stream.

4. Regulatory and Payment Complexity

Unlike generic SaaS, healthtech revenue is highly dependent on complex regulations (like HIPAA) and the intricate healthcare payment landscape (payers, providers, patients).

The Problem: Revenue can be subject to:

Prior Authorizations and Denials: Technology that helps with the revenue cycle (RCM) may have a recurring fee tied to success metrics, which are influenced by external denial rates.

Reimbursement Changes: New billing codes or payer policies can instantly impact the value of a tech solution, making the "annual" value of the recurring fee less stable.

In short, the problem is defining a clear, clean, and consistent metric for predictable annual revenue when the core business models and revenue streams are inherently complex, service-heavy, and influenced by external regulatory and payment factors unique to the healthcare industry.

To discuss how Nelson Advisors can help your HealthTech, MedTech or Digital Health company, please email [email protected]