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The subscription-based business model is becoming hugely attractive to investors.
What do Netflix, the Financial Times, Birchbox, and Zipcar have in common? They're all using subscriptions to develop smarter customer relationships.
We're in the middle of an unprecedented global shift in business models, as companies move away from selling products and toward offering subscriptions for services. Consumers now value access over ownership. Subscription plans are thriving for connected cars, smart home services, air travel, industrial equipment, household consumer products, luxury goods - the list goes on.
With its Relationship Business Management software, Zuora is leading the charge in the new Subscription Economy. They're helping companies like Box, Zendesk, Qualcomm, and Honeywell reinvent their businesses from pay-and-leave transactions to forward-looking subscriptions.
While Box's recent IPO shows us that Wall Street has taken notice of this trend towards recurring revenue models, for many companies, the transition isn't always swift. Shifting revenue models can be challenging, but here are three reasons that an increasingly sophisticated investment community values subscriptions.
1. Investors value predictability.
To investors, the biggest perk of having a recurring revenue model is the value of predictable revenue. A $20 million company with 80% recurring revenue can count on $16 million at the beginning of every year. That figure is stable and predictable, and management can plan and invest accordingly.
But the same can't be said for a $20 million company that doesn't have recurring revenue. Instead, a one-time transaction-based company is forced to start every year at zero. Although it can base some predictions on past performance, the business will have no contractually obligated revenue stream around which to base ambitious expansion plans.
In addition, a healthy subscription-based business benefits from excellent customer retention and visibility into how consumers are using its services. Subscriptions allow companies to interact with consumers on a regular basis, determine what services they're using, and, most importantly, be able to predict their customers' needs. This data can then be used for further cross-selling or marketing.
2. Investors value growth.
Having a predictable revenue stream allows subscription-based businesses to invest aggressively in growth, particularly in competitive market conditions with multiple players. All companies, even the established ones, are vulnerable to disruption - especially in an industry like IT, where a majority of the top 25 enterprise companies are not expected to be around 20 years from now.
That said, legacy product vendors have a resource advantage: customers and partners. It takes an aggressive approach to capture customers. Subscription-based businesses can offer lower upfront costs, greater flexibility, intuitive delivery mechanisms, and a keen sense of their customers' needs and wants. That's why the median growth for SaaS subscription companies such as Adobe, Box, Zendesk, and Workday is more than three times that of traditional enterprise software companies.
3. Investors value new metrics.
The metrics that matter most to subscription businesses don't show up on traditional public income statements. Product metrics such as units, margins, and inventory are replaced by relationship metrics like renewals, upsells, and churn.
Fortunately, Wall Street now understands how to assess subscription finances beyond simple income statements. Investors are starting to look at the future revenue stream not included in GAAP statements to assess the financial prospects of subscription vendors.
According to Zuora, there are three metrics that subscription-based businesses should be concerned with:
- Retention rate. The percentage of customers that businesses lose annually through attrition.
- Annual recurring revenue. The difference between recurring revenues and recurring costs.
- Growth efficiency index. How much new recurring revenue a company gets from a given investment in sales and marketing.
These metrics allow businesses to measure current progress, project future revenue, and plan future expansions. Given this unique visibility, investors can better predict how stable a business will be a year from now, rather than being forced to "wait it out" until the end of the year with traditional one-time transaction models.
For all these reasons, we can expect to see subscription models continue to be popular with investors.
To learn more about how the subscription-based revenue model could help improve your business, download Zuora's Subscription Finance Success Kit.
This post is based on an article originally published on Zuora.
This post is sponsored by Zuora.
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