There are only two software companies out there right now – subscription based and wannabe. Those looking to migrate to recurring income have a tough road ahead of them. It requires executives to manage costs to serve, transition revenue and manage customer expectations during the transition. Overcoming these challenges can be very rewarding: companies become dependent on innovation for growth, and the enterprise value of recurring revenue companies is several times higher. However, executives should consider all of their options to ensure that subscription is the best choice for their organization and their customers.
Weighing the choices
Costs to serve: Is the cost of serving a customer spread over time or is it front-loaded? If the former, a strong case can be made for the subscription price; If it’s the latter, it’s a tough pill to swallow for software companies with few customers to spread those costs.
Customer Value: Is the value customers get from the software higher when installed? Does it remain stable? Does it decrease over time? The longer the price of the software increases, the more sense a subscription model makes.
Evaluating the path of migration
Migrating to a subscription (or SaaS) model requires a company to address three key challenges.
cash flow and income; Perpetual licensing models allow developers to recognize all software revenue and receive upfront funds when a contract is signed. The move to subscriptions spreads revenue over the entire contract period, a big change for companies that report revenue down the road or make cash in the near term.
Maintenance and support (M&S): In the sustainable model, increased software sales typically do not increase support demand proportionally, so M&S is seen as a source of profit. Moving to a subscription model can introduce two challenges:
1. Objection from a profit center organization and
2. Costs may increase as the burden of hosting, maintenance, software updates and fixes is shifted to the developer.
Product development and innovation; Enduring software contracts monetize innovation through additional module sales or customer upgrades. However, with a subscription model, innovation is often monetized. Long-term customer value Through contract renewals, changing the business case and the product development/innovation equation.
What migration/what? not at all to migrate
Because paying customers expect to get value over time, some software doesn’t sell well as a subscription. This includes software focused primarily on compliance or infrastructure (eg workflow management, transaction processing, compliance reporting). This type of software is static and solves known challenges, suggesting that a perpetual license is an appropriate model.
SaaS does not necessarily mean cloud-hosted.
For companies considering a subscription model but don’t want to move to a software-as-a-service (SaaS) deployment model, there’s some good news – SaaS Business model, is not a deployment framework. So just because a company has an on-premises deployment model doesn’t mean it can’t consider a subscription model. For example, in a subscription model, Citrix supports on-premises deployment or Citrix Cloud. SaaS means customers pay over time, typically through a subscription model.
Although this type of software is typically deployed through the cloud, SaaS can be deployed on-premises.
Just because your software hasn’t moved to the cloud doesn’t mean you can’t change your business model. “Cloud” and “On-Prem” are the deployment models. “SaaS” is a business model decision that pays over time instead of selling permanent licenses. Many on-prem solutions have subscription revenue models (although cloud-based perpetual software is rare).
On the other hand, software that solves new challenges or increases in complexity over time is ideal for subscription models. If new modules are introduced frequently to keep up with the business challenge or competitors’ offerings, a subscription model makes good sense. This includes solutions such as evolving sales, re-use of manufacturing processes, or business processes where the type and volume of data is constantly changing.
To successfully transition from perpetual to subscription pricing, a product must provide constant or increasing value over time. It also requires an agile development framework to slowly and consistently introduce new and better functionality, rather than the traditional pitfalls of waterfall development processes and periodic but massive version updates.
How do we migrate?
A sudden switch from fixed to subscription software pricing can increase known costs and reduce a company’s revenue. Since EBITDA drives bonuses for many executives, this can be a career-ending move! But stay with the process – while the switch may be challenging, there are steps software leaders can take to minimize the short-term impact and position themselves for future success.
- A subscription model should be introduced gradually, not suddenly.. The best option for developers is to use maintenance and support, part of the contract is already recurring revenue. To do this, leaders need to increase the maintenance cost to access upgrade protection and additional features. Changing the maintenance contract has two effects. It lures customers into continuous renewal, and ensures an increase in the price of the maintenance contract. This step allows both the customer and the software developer to gradually transition to subscription pricing, increasing the recurring revenue in the perpetual subscription.
- Software, maintenance and support, and installation services should be included in the budget. How does accounting change facilitate business model migration? Because it deals with the marginal conflict between software, service and M&S, each team has an incentive to optimize their profit center, often to the detriment of the total. Aligning incentives with a profit objective allows executives to mobilize resources to support the new model without worrying about organizational politics. Put another way; if so A service or support line exists only because the software exists, then it should be part of a software P&L.
- Promote software backlog as a key business metric. High software backlog Future income is the goal. and drives enterprise value. While some short-term revenue loss is inevitable, the overall value of the business depends on a reliable future revenue stream. This is best measured by backlog, which is more important than current annual recurring revenue (ARR).
Positioning for future success
Driving sustainable revenue is critical to any business. Subscription pricing allows software developers to set themselves up to build a significant book of future revenue. But it doesn’t come without its challenges. Those who take action for the right reasons and execute effectively will be well positioned for success.
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