Topics of Interest Archives: Recurring Revenue

From Algebra to Calculus: Financial Planning in the XaaS Economy

Recurring Revenue and EPM: Time for Change. Source: Pixabay.comThe pace of change in ‘new economy’ companies is accelerating. When it comes to cloud-based anything-as-a-service (XaaS) businesses, the types of planning, budgeting, and forecasting strategies that have worked for more traditional product-focused enterprises just don’t fit. From long-term strategic plans to annual budgets, the reality of recurring revenue businesses calls for a different—and more agile—approach to these processes. With this blog, we’re hoping to add some momentum to this much-needed discussion in the market.

While SaaS companies tend to get most of the press in the recurring revenue arena, they’re not the only ones working through these issues. Any business that augments its asset sales models to include asset rental (or lease) needs to adjust their PBF practices. So too does any organization that features usage-based pricing such as per-sheet fees for photocopiers, per-gigabyte bandwidth fees for website hosting, or per-processor core hour fees for cloud computing. In all of these models, customers forego longer-term asset ownership to reap short-term savings. The result, however, is that the cycle time for contract expiration—and potential customer churn—is accelerated. It’s all a function of time, and shows how a compression of the customer lifecycle forces us to readjust our PBF processes to respond in turn.

Doing the Math: Algebra vs. Calculus
Why do we think things are so different now? At base, it all has to do with business velocity. Here’s what we mean: in the older, product-centric environment, you think about your business in annual cycles, with starting periods adjusted to smooth out any predictable seasonality in your particular industry. You look at growth linearly, plotting out FY ’12, ’13, and ’14 and finding that line of best fit to predict what ’15 will look like. The best analogy we’ve come up with is that traditional planning is like algebra – plotting some points, and finding the old school y = mx + b slope to understand what’s coming down the line.1

Recurring revenue business planning, in contrast, is like calculus. With business viewed on the basis of Monthly Recurring Revenue (MRR), the relevant time periods for analysis are much, much shorter. We look at those recurring revenues, new customer acquisition velocity, and churn rates to paint a picture of the rate of change at a given point in time. In this environment, this September’s expected revenue pays a lot more attention to August’s base, new acquisitions, and churn than it does to last September’s numbers with a reasonable growth factor applied. It’s a fundamental difference: that of moving from a static representation of what the business is to a dynamic, constantly-changing understanding of what it will be.

Less Sizzle, More Steak
Those first few paragraphs were, admittedly, a bit heavy on the analyst-speak. Let’s be a bit more practical from here on out. Your planning process focuses on setting realistic goals and tactics for attaining them. Budgeting picks up to allocate internal investments to support those plans. Forecasting provides—in the best-case scenario—a reality check on where the business is headed from a results perspective.

Planning. When constructing our 1-year operational plan, we’d traditionally have our eye on the popular metrics like gross income, net income, earnings per share (for publicly-held companies), and EBITDA. Our growth projection is based on a linear projection of earnings. That’s what we’d feed into the budgeting process: expecting a 5% increase in sales, derived from a corresponding 5% increase in units shipped (assuming we maintain pricing). But in a subscription-based world, we care much more about the activity associated with customer acquisition, customer churn, and utilization in understanding what will happen in the future.

Budgeting. With that 5% expectation in mind, our functional heads provide their bottom-up budgets for what it will take to achieve the goal. In its most charitable form, it’s an exercise in allocating resources, deciding how many dollars are necessary to provide some required amount of capacity. In its least charitable form, budgeting is an exercise in expanding fiefdoms, with managers seeking to grow their spheres of influence – and ensuring, over the course of time, that those budgets are exhausted to prevent them from being cut in the next round. But in a more subscriber driver-driven world, budget is based on the expectations of utilization and activity. As CapEx flip-flops from being the majority of budgeted costs to a category subservient to OpEx and activity-dependent spend, budgeting changes from a fixed cost to a variable percentage of revenues that may be gated or altered at various levels of commercial activity.

Forecasting. Rather than looking at goals, now we switch to actuals. We’re most likely exporting some historical balance sheet and income statement lines to Excel and looking for trends. One million widgets shipped in ’12, 1.1m in ’13, 1.21m in ’14, so we’re expecting 1.33m this year. We see ten-percent bumps in past periods and expect similar results. In some industries we might have a bit more nuance, recognizing that our sales track with some industry-wide metric, like doorbell sales tracking to economy-wide new housing starts. There, still, we’d look at annual changes in the underlying driver, expecting what has come before to continue — absent more informed economic guidance to the contrary. Not only is it important to forecast based on corporate, microeconomic, and macroeconomic drivers, but based on solution adoption, upselling, and expectations for service and product updates either to stay ahead of the pack or maintain parity with competitors.

Getting to the Point
So what does all of this mean? It means that we have a lot more work to do – and more quickly. Planning metrics for recurring revenue businesses look a lot like those for traditional companies, with lifetime customer value, customer acquisition cost, upsell velocity, cross-sell growth, and things like seat-based or usage-based utilization measures loaded on top. To properly budget for operations in a dynamic environment, we need accurate financials as a starting point. That means being able to run through consolidation and close in days, not weeks. That’s the only way to accurately plan resource allocation and ensure adequate capacity to support a business whose growth can look a lot more like our mythical hockey stick than a straight line.

In traditional environments, we may expect to sell one million widgets, and we can plan backwards from there to ensure adequate logistics support, manufacturing capacity, and raw materials inventory. In a recurring revenue business where the number of seats required, processing cores utilized, or transactions processed can grow exponentially, we don’t have the luxury of planning technology infrastructure, sales headcount, or support capacity on an annual basis. We need to not only have visibility into performance close to real-time, we need to have planning and budgeting processes that operate in this accelerated timeframe as well. This is why companies across all industries need to think about their subscription billing strategy in context of existing financial planning and financial accounting tools. Without a subscription strategy, companies will be left unable to effectively bill and manage a new business environment dependent on complex and recurring revenue transactions.

In this context, Blue Hill looks forward to seeing how financial software solutions and financial modules will continue to partner with the likes of Aria, goTransverse, MetraTech, Monexa, Recurly, Vindicia, and Zuora to integrate the future XaaS world into existing corporate finance operations and bridge the gaps to the future of conducting and managing customer and service-centric business.

 

- Scott and Hyoun

 

1. Pun only 63.5% intended, but 100% forecastable based on knowledge of analyst psyche.

Posted in Blog, Executive Management, Finance & Accounting, Financial Operations, General Industry, General Management, IT & Infrastructure, Research | Tagged , , | Leave a comment

Zuora Subscribed '15: Bold Vision and a Rising Tide

Focus on Relationships. Source: Pixabay.comLast week in San Francisco, Zuora’s fifth annual Subscribed event presented a bold view of the future of subscription-based business. As their “Relationship Business Management” moniker shows, they’re taking the conversation far beyond the billing component where it began. It’s a vision that seems to resonate, both with customers and investors. I’m not quite as bullish on the inevitable dominance of subscriptions over traditional asset ownership, but I appreciate Zuora’s conviction and believe that their enthusiasm in bringing that conversation to the market will help everyone involved. Here’s why:

If we only thought about subscription billing, its value would be judged mostly in terms of facilitating transactions. That doesn’t adequately draw attention to what’s required from the business side in rethinking how we design products and services, engage customers, and intelligently measure business performance. That’s a broader discussion that focuses on different concerns and involves different participants that wouldn’t usually be involved in the traditional quote-to-cash process for products or project-oriented services. So even if you’re not a current or potential Zuora client—or even if you’re a competitor—it’s beneficial for everyone to have someone championing this dialogue.

Farewell, ERP?
So let’s start with an idea that certainly deserves to be labeled “bold.” It wasn’t a focus of the main-stage presentations, but the idea of having a customer relationship-centric application supplant ERP as the main enterprise system of record was certainly present. In this environment, ERP is relegated to a home for the GL, rather than as the foundational system into which everything else must integrate. The system that manages customer relationships assumes that central role. To be honest, prior to the event, I hadn’t realized exactly how ambitious RBM really was.

That’s just crazy, right?
No, I don’t think so. ERP’s origins came out of a specific need tied to production. What began as Material Requirements Planning (MRP) grew and evolved over time to become what we know today as ERP. Its core, at least for the larger players in the space, remains dedicated to the making of things and all that entails. Newer entrants like NetSuite, Unit4, and FinancialForce are more in tune with the professional services world, which is certainly different than product manufacturing, but still isn’t naturally attuned to the pricing complexity, provisioning, and alternative financial metrics that subscription business requires. With that background, I don’t think it’s out of the realm of possibility for something like RBM to form the core of a new system which follows the same path of evolution and expansion over time.

But it’s at least a little bit crazy.
For new businesses who focus on subscription-based services (i.e. those who are starting from scratch technology-wise) the storyline makes sense. For young businesses who have reached the limits of QuickBooks and would need to transition anyway, it’s not a stretch. But for established businesses that are already up-and-running on an ERP, the transition is more difficult and seems less likely. The same goes for businesses who are not exclusively subscription-oriented. For whatever portion of their portfolio requires manufacturing, warehousing, inventory management, logistics, etc., traditional ERP systems will win out. I don’t think this is a huge loss, or a sign of weakness for the model, however. You don’t need 100% penetration to be a wildly successful business.

A Counterpoint from a Grumpy Old Man
The belief that anything and everything will evolve to be subscription-based requires a pretty big assumption: that individuals and businesses will be perfectly happy in a rental economy.1 That’s what we’re really talking about. A move towards subscriptions means a move away from ownership. It makes all the sense in the world for the sell-side of the equation: they’re willing to potentially lose money on customer acquisition because they more than make up for it in the long run. Buyers, however, lose control. Let’s use a simple example: purchasing a car.

To keep the numbers easy, let’s say we purchase a $36,000 car at 0.0% APR and a three-year term. We’ll pay $1,000 per month and own it outright in three years. We could have leased the same car for $500 per month, or $6,000 per year.  At the end of Year 3, the lease looks like a good deal: we had the same amount of car usage for half the price. At the end of Year 6, assuming we picked up another lease with the same terms, we’re all tied up (ignoring inflation). But what happens next? Every year thereafter, the car owner drives for free, while the lessee pays another $6,000. Let’s say we get to the end of Year 10, and the owner needs a new car. They’ve gotten ten years of car usage for $24,000 less than the lessee.

Now, we all make choices. In this example, we could choose to own or we could choose to lease. It was up to us to figure out what option was best. In the “new world order” of aggressive subscription-ization, we don’t get to choose. We’re forced to pay that extra $24,000. For businesses, that is a demonstrable negative change in their Total Cost of Ownership for any investment. This is exactly what we’ve seen with the early-movers like Adobe (with the Creative Cloud) and Microsoft (with Office 365). Some folks are perfectly happy to accept less-than-cutting-edge functionality in order to extend the life of products they’ve bought in perpetuity. Those options are gone… for now.

Three Cheers for Economics and Michael Porter
The good news is that one of two main things will happen as the subscription pendulum swings a bit too far: either customer discontent will force providers to offer ownership options, or someone else will bring a competitive offering to market that does. If there’s an underserved market for perpetual licenses, someone will fill that competitive gap. Either that, or the FTC and DOJ will be very busy looking for signs of an underlying agreement to limit competition and force the subscription-only model on consumers and business customers.

This All Came Up at Subscribed?
Well, no. Subscribed was a great catalyst for these types of discussions, however. What did come up were a series of product updates and announcements that built out Zuora’s RBM vision. The two biggest (to me, at least) are the introduction of RBM Connect and the acquisition of Frontleaf, which is the foundation of the new Z-Insights product. With RBM Connect, Zuora introduced a new app marketplace that gives customers a one-stop shop to find and acquire supplemental solutions to add new functionality to their subscription management process. It’s a smart move, as it adds value (and stickiness) and cements Zuora’s position as the central hub for RBM. Z-Insights expands their portfolio with a customer intelligence solution capable of integrating multiple data sources to compile a holistic view of the customer – to better understand their experiences and needs, and to better tailor outreach and offers to reduce churn and facilitate cross-sell and up-sell opportunities. Not too shabby.

One of their recently-announced partnerships also underscores how the subscription business market is maturing. By bringing Tidemark into the fold, they enable the application of strong enterprise planning, budgeting, and forecasting in the subscription arena. Even in traditional companies, this is a process that all-too-typically is still run via spreadsheet – and all-too-often simply extrapolates from historical numbers rather than applying analytics to understand and model business drivers. Adding this level of functionality by means of the partnership helps to elevate the discussion, and positions it as truly within the realm of subscription business rather than just subscription billing.

(De)Parting Thought
As I head back from San Francisco and think about everything I’ve heard this week (both at Subscribed and IBM Vision, which is the subject of another publication), I’m encouraged with where this market is headed. While I may be a bit more reserved in my expectations for (or, actually, adamantly opposed to) subscriptions being applied to everything in the economy, I think there a huge number of areas where they can make sense. Right at the top of that list is the data, and data-enabled, services that we’re seeing evolve in the Internet of Things space. There is a huge opportunity here for product and services companies, and an equally large opportunity for providers who can help them understand, plan, and successfully execute subscription business strategies. Even if you don’t end up choosing or evaluating Zuora in that context, it would be tough not to thank them for helping to push this important conversation forward.
-Scott

 

1. There’s another, related concern to keep in mind as well: a lot of data-oriented services and customer analytics solutions rely on the existence and accessibility of large customer datasets to mine for behavioral information. These services’ and solutions’ potential will be compromised if there is a societal/political push-back against ubiquitous data collection and exploitation. When we’re simply talking about integrating weather data to better understand its impact on retail sales, no one will object all too much. When we pivot to retailers or financial institutions analyzing your spending behavior to predict what life events you’re planning (new house, new car, new marriage, etc.), it starts to feel much more invasive. Big Data is all fun and games until you realize you’re being targeted as a “Segment of One.” But that’s a grumpy old man discussion for another time.

Posted in Blog, Executive Management, Finance & Accounting, Financial Operations, General Industry, General Management, Research | Tagged , , | Leave a comment

How to Make Money with the Internet of Things

Money and IoT - Source: Pixabay.comThere seems to be a consensus that the Internet of Things is going to change the world.  We’ll be connecting up our homes, our cars, and all manner of personal and medical devices. It will change the nature of work… and the nature of business. That’s what we’ve been hearing, and it’s certainly a worthy—if lofty—goal. What we don’t hear quite as much about is how it actually works, and what is actually required to get these things up and running. Thankfully, this practical conversation is beginning to emerge as well.

If you look out in the market, you’ll probably see two main camps: one highlighting all of the great outcomes that IoT will bring, and another focused on the technical details of sensors, communications protocols, security, and data management. For the most part, you won’t see them actually come together. The good news is that this exact thing happened right here in Boston earlier this month. Over the course of a few days downtown, PTC LiveWorx brought together the technical and financial, both in terms of topics discussed and technology partners in attendance.

Taking “the edge” to the bank
The topic of monetizing IoT is pretty complex, but can be illustrated fairly quickly: somewhere out in the world is a sensor. That sensor lives at “the edge” and collects information. That information is stored on a device. That device communicates back to a central location, which is collecting information from a bunch of other devices. At this point, one of three things happens: (1) that data is used to monitor and improve the performance of a specific asset, improving reliability and/or productivity; (2) that data is sold to other people who can use it to make better decisions; or (3) that data is made available for analysis, and that analytics capability is made available as a service, for a price. Application #1 helps save the asset-owner money, and may also help the asset-manufacturer sell more. Applications #2 and #3 create new data-derived revenue streams for the folks collecting that information.1

Why PTC?
I think it’s quite interesting that the hub for this conversation was at an event run by someone who those of us on the financial side of the fence wouldn’t normally expect. PTC is big for engineers and designers. They’re one of the companies you go to for computer-aided design (CAD) and for product lifecycle management (PLM). So, at least in the beginning, they were the folks who helped you design the physical product. Then they acquired ThingWorx, which provides a platform upon which you can develop applications deployed on those physical products. And they acquired Axeda, which gives you a secure communications stack to connect those devices. This year, they announced the acquisition of ColdLight,2 which provides analytics technology that you can embed on those devices. Put all of that together, and you can see why they’re involved: they’re touching smart connected devices across the entire hardware and software design phases, including the much-needed analytics and communications layers.

Fair enough. But what about the monetization part? That’s where their growing partner network comes in. One notable attendee, who will be facilitating more of these types of discussions at their own Subscribed event this week, is Zuora. They’re a ThingWorx partner and provide a good example of where the financial connections happen. PTC helps with the design of smart, connected products, and Zuora provides pre- and post-sale process management for handling orders, subscriptions, and billing. So if you’re selling subscriptions to sensor-captured data streams, or if you’re offering analytics services on a per-processor or per-gigabyte basis, that’s where the tie-in comes.

Who Else Is Getting Involved?
While I think PTC LiveWorx did a great job making these connections, I’d be dropping the ball if I didn’t mention others who are getting in on the game. Alongside Zuora at LiveWorx was MetraTech (now part of Ericsson), who are very keen on participating in all things IoT. And at the same time that show was going on in Boston, SAP was announcing its HANA Cloud Platform for the IoT and its related partnerships with Siemens and Intel down in Orlando at Sapphire. And there was NetSuite’s messaging at SuiteWorld. And Informatica. And I would expect to hear a thing or two this week at both IBM Vision and Zuora Subscribed. And that’s just what’s going on in the span of two or three weeks in May. You shouldn’t even need to keep an eye out for further developments – I’m fairly certain they’ll be coming to the front page of news and media sites near you in the not-too-distant future.

Why Should I Care?
I think those of us who comment on the space still owe you a good explanation of why you should be paying attention – other than IoT being the latest “shiny object” in the business world. Here’s my pitch: if you currently sell products that collect some sort of data (or could be retrofitted to do so) and there is someone out in the world who would find that data valuable, IoT is a new revenue source for you. If you sell physical products that degrade or need to be serviced, IoT means you can offer remote monitoring services, or preventative maintenance services – new revenue streams. In the alternative, you can increase the attractiveness (and value) of those products by giving customers the ability to conduct that monitoring and maintenance themselves. If you sell services that could be expanded if you only had access to more data, it’s new money. And if you sell technology to help sense conditions, facilitate secure communications, conduct analysis, manage service provisioning and billing, or forecast and plan revenue – this market is going to need you.

If none of that matters to you, there’s still one very good reason to pay attention: it’s simply a fascinating topic of which we’re just beginning to scratch the surface. No one knows exactly how it will all play out – but it is going to be something special.

 

-Scott

 

1. That’s just a quick example of one way that it can work. In some scenarios, there’s analytics happening on the end device itself. In others, there are different layers of data gathering – say, a localized server that gathers information for one geographic location (like a building or farm), and a secondary location that aggregates ecosystem-wide information from all geographies (or all buildings you own / manage, or individual farms within a collective).

2. That link is to my colleague Tony Rizzo’s Market Alert on the acquisition. It provides the full context for the deal and is a great read on where IoT is headed.

Posted in Blog, Executive Management, Finance & Accounting, Financial Operations, General Industry, General Management, Research | Tagged , , | 1 Comment

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