By David Zwick, Flexera Software
At technology companies, business success, growth, and profitability depend on how products are taken to market and monetized. Technology companies, delivering 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 revenue—worth significantly more than one-time revenue—is one of the top ways to grow the revenue and overall valuation of a business. As CFOs work to drive profitability and enable long-term investment, securing recurring revenue streams is a top goal. Keeping the quote-to-cash (QTC) process—the full sales cycle—moving seamlessly and in an automated manner is key to the goal and relies on offering customer-centric products that can drive customer retention and recurring revenue recognition for the supplier.
Finance leaders must build their “digital acumen” to support their strategic initiatives—“leveraging technology and tools to focus on problem solving versus data gathering and reporting.” Embracing the right tools can drive innovation and success. Today, that entails turning to the deployment and monetization models that deliver the best results for suppliers and customers, alike. This may require transitioning on-premises offerings to software-as-a-service (SaaS) deployments while moving away from the sale of one-time perpetual licenses to recurring revenue models. CFOs must understand how these approaches can benefit the bottom line.
The Value Of Pairing SaaS And Subscription
The SaaS deployment model is rapidly gaining popularity and is projected to account for 58% of total software revenue by 2025, according to IDC. With SaaS, the software supplier provides the full solution, hosting and managing it, providing it as a service to the end customer. The “SaaSification” of products aids the supplier, facilitating a recurring revenue stream, along with scalable deployments. The customer benefits by being able to use the software, without expenses related to hosting, maintenance, or updates.
When moving to SaaS, the software supplier must have a recurring revenue stream to maintain the service. The subscription monetization model, which moves away from perpetual licenses, is ideal. The combination of these two leading models—subscription monetization paired with SaaS deployment—benefits both the supplier and the customer.
Subscription (also referred to as “term licensing”) is today’s leading software monetization model, as found in the Revenera Monetization Monitor: Monetization Models and Strategies report. It delivers a steady recurring revenue stream, usually billed annually in up-front installments. The industry standard in B2B scenarios is often a three-year contract; it might be shorter in consumer use cases. Contracts with longer run times already build in the renewal for consecutive terms, making the recurring revenue stream even more powerful.
Subscription is a more straightforward model than other recurring revenue monetization models, such as outcome (billed based on measurable customer value) or usage-based (based on actual usage of the software). As suppliers, technology companies have the advantage of a stable and predictable revenue stream, which supports the company’s valuation and buttresses the company’s ability to invest in its product. SaaS deployments also make it easier to measure and monitor customer adoption and engagement trends, allowing suppliers to proactively support and strengthen the customer relationship for ongoing subscription renewals.
Subscription also appeals to buyers, as it lowers the barrier to entry for a product. Customers have the advantage of being able to try the technology (and adjust purchases to meet evolving usage needs) without a massive up-front investment, and by being able to buy SaaS as an OpEx, not CapEx (as is often the case with perpetual licenses), expenditure. Meeting customers’ needs is a critically important way to strengthen customer loyalty—one of the most important requirements for ensuring that customers will renew their subscriptions and that revenue will truly be recurring.
Ease The Move To SaaS And Subscription
The transition to SaaS and subscription requires organization-wide effort, not only to improve the full end-to-end QTC process but to secure recurring revenue. CFOs must take an active role—partnering 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 so:
- Track the metrics to support the transition: To move away (entirely or in part) from perpetual licensing (with revenue recorded up front), be sure to track several metrics. Annual recurring revenue (ARR), the sum of all subscription revenue in a year, is the most critical metric for subscriptions. Annual contract value (ACV), billings, customer acquisition cost (CAC), lifetime value of the customer (LTV), and revenue retention are also critical.
- Prioritize customer centricity: To ensure that LTV is always larger than CAC, CFOs must help align all roles organization-wide by emphasizing customer centricity. Provisioning, onboarding, analysis of account health and renewal risk, and renewals and upselling must all be considered from a customer’s point of view to ensure that they see your SaaS as a true and valuable service.
- Focus on retention: Renewal rates and gross retention rates are the best indicators of customer health. Evaluate retention rate by type of software or by product line, then in aggregate for the entire company. Retention may be measured in multiple ways, including gross revenue retention rates and the renewal rate percentage (a measure of contracts that are up for renewal). Gross retention rates greater than 90% generally indicate healthy products and customer success.
- Align back office systems to support the process: Make sure 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-cash process hinges on delivering value to customers through continuous improvement of products. As the pressure to secure recurring revenue streams continues, transitioning to SaaS deployment and subscription monetization may provide the requisite flexibility 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 chief financial officer at Flexera Software.