By David Zwick, Flexera Software
With technology companies, business success, growth and profitability depend on how products are marketed and monetized. Technology companies, providing software and Internet of Things (IoT) devices, are looking for the most efficient ways to innovate, grow into new markets and secure valuable revenue streams.
Recurring earnings, which are worth significantly more than one-time earnings, are one of the most important ways to grow a company’s earnings and overall valuation. As CFOs work to increase profitability and enable long-term investments, securing recurring revenue streams is a top goal. Making the quote-to-cash (QTC) process – the entire sales cycle – seamless and automated is key to the goal and relies on offering customer-centric products that can drive customer retention and recurring revenue recognition for the supplier .
Financial leaders must build their “digital acumen” to support their strategic initiatives – “use technology and tools to focus on solving problems versus collecting and reporting data.” Embracing the right tools can drive innovation and success. Today, that means focusing on the deployment and monetization models that deliver the best results for both suppliers and customers. This may require moving on-premises offerings to software-as-a-service (SaaS) deployments, while moving from selling one-time, perpetual licenses to recurring revenue models. CFOs need to understand how these approaches can benefit the bottom line.
The value of linking SaaS and subscription
The SaaS deployment model is rapidly gaining popularity and is expected to account for 58% of total software revenue by 2025, according to IDC. With SaaS, the software supplier provides the complete solution, hosting and management, and delivers this as a service to the end customer. The “SaaSification” of products helps the supplier and facilitates a recurring revenue stream along with scalable implementations. The customer benefits by being able to use the software, without costs for hosting, maintenance or updates.
When moving to SaaS, the software vendor must have a recurring revenue stream to maintain the service. The subscription monetization model, which is different from perpetual licenses, is ideal. The combination of these two industry-leading models – subscription monetization coupled with SaaS deployment – benefits both the supplier and the customer.
Subscription (also referred to as a “term license”) is the leading model for monetizing software, as found in the Revenera Monetization Monitor: Monetization Models and Strategies report. It provides a steady recurring revenue stream, usually billed annually in prepayments. The industry standard in B2B scenarios is often a three-year contract; it may be shorter in consumer use cases. Longer-term contracts already have sequential renewal built in, making the recurring revenue stream even more powerful.
Subscription is a simpler model than other monetization models with recurring revenue, such as outcome (billed based on measurable customer value) or usage-based (based on actual use of the software). As suppliers, technology companies benefit from a stable and predictable revenue stream, which supports the company’s valuation and the company’s ability to invest in its product. SaaS deployments also make it easier to measure and track customer adoption and engagement trends, allowing vendors to proactively support and strengthen customer relationships for ongoing subscription renewals.
Subscriptions are also attractive to buyers because it lowers the barrier to entry for a product. Customers have the advantage of being able to try out the technology (and adapt purchases to changing usage needs) without a huge upfront investment, and by buying SaaS as an OpEx, not CapEx (as is often the case with perpetual licenses), spending . Meeting the needs of customers is an extremely important way to strengthen customer loyalty – one of the most important requirements for ensuring that customers renew their subscriptions and that the revenue is truly recurring.
Ease the transition to SaaS and subscription
The transition to SaaS and subscriptions requires efforts across the organization not only to improve the entire end-to-end QTC process, but also to secure recurring revenue. CFOs must take an active role—working with other senior finance staff, account management, billing and accounts receivable, fulfillment, product management, and sales teams—to have a clear understanding of the financial implications, benefits, and functionality of this hybrid approach.
To do this:
- Follow the stats to support the transition: To move away (in whole or in part) from perpetual licenses (where revenues are pre-recorded), you need to track several metrics. Annual recurring revenue (ARR), the sum of all subscription revenue in a year, is the most critical measure of subscriptions. Annual contract value (ACV), invoices, customer acquisition cost (CAC), customer lifetime value (LTV), and revenue retention are also critical.
- Prioritize customer focus: To ensure that LTV is always greater than CAC, CFOs must help align all roles across the organization by emphasizing customer focus. Provisioning, onboarding, analysis of account status and renewal risks, and renewals and upselling all need to be viewed from a customer’s point of view to ensure they see your SaaS as a genuine and valuable service.
- Focus on retention: Renewal rates and gross retention rates are the best indicators of customer health. Evaluate the retention rate by type of software or by product line and then in total for the entire company. Retention can be measured in several ways, including gross revenue retention rates and renewal rates (a measure of contracts that need to be renewed). Gross retention rates above 90% generally indicate healthy products and customer success.
- Align back office systems to support the process: Ensure that systems across the organization including the accounting system, customer relationship management (CRM), entitlement management, usage management, and compliance management system work together to function smoothly from a business process perspective.
A successful quote-to-money process depends on delivering value to customers through continuous product improvement. As the pressure to secure recurring revenue streams continues, the transition to SaaS deployment and subscription monetization can provide the flexibility required to meet the goals of all parties. CFOs can help drive this beneficial change by understanding and embracing the tools at their disposal.
About the author
David Zwick is financial director at Flexera Software.