Today, there are only two software companies—those that sell on a subscription basis and those that want them to. For those looking to migrate to recurring income, the road ahead is tough. It requires executives to manage service costs, incrementally change revenue and manage customer expectations during the transition. Overcoming these challenges is well worth it: companies become less reliant on upgrades for growth, and recurring revenue companies have enterprise values that are several times higher. However, executives must consider all of their options to ensure a subscription is the best option for their company and their customers.
weighing options
service fee: Are the costs of serving customers amortized over time, or are they preloaded? If it’s the former, it makes a strong case for subscription pricing; if it’s the latter, it’s a tough pill to swallow for a software company with few customers to spread those costs.
value of customer: Does the customer get a lot of value from the software at the time of installation? Is it stable? Will it go down over time? The greater the long-term value of the software, the more meaningful the subscription model will be.
Assess the migration path
Migrating to a subscription-based (or SaaS) model requires companies to face three key challenges:
Cash Flow and Income: The perpetual licensing model allows developers to recognize all software revenue and receive the associated cash up front when a contract is signed. The move to subscriptions to distribute revenue over the life of a contract is a sizable shift for companies where reporting earnings to the street or short-term cash is an operational issue.
Maintenance and Support (M&S): In a perpetual model, increasing software sales typically does not proportionally increase the need for support, so M&S has always been seen as a source of profit. Transitioning to a subscription model can present two challenges:
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2. Costs may increase as the burden of hosting, maintenance, software updates, and patches shifts to developers.
Product Development and Innovation: Perpetual software contracts monetize innovation through additional module sales or customer upgrades.However, in a subscription model, innovation is often long-term customer value Through renewals, changing business cases and the product development/innovation equation.
Migrate what/what no migrate
Because customers who pay over time expect value, some software is unlikely to sell well as a subscription. This includes software primarily oriented towards compliance or infrastructure (eg, workflow management, transaction processing, compliance reporting). This type of software addresses static and well-known challenges, suggesting that upfront perpetual licensing is an appropriate model.
SaaS doesn’t mean cloud hosting
There’s some good news for companies considering a subscription model but don’t want to move to a software-as-a-service (SaaS) deployment model — SaaS is business model, not the deployment framework. So just because a company has an on-premises model doesn’t mean it can’t consider a subscription model. For example, in a subscription model, Citrix supports on-premises or Citrix Cloud. SaaS means that customers pay by time, usually on a subscription model.
While such software is typically deployed through the cloud, SaaS can also be deployed on-premises.
The fact that your software hasn’t moved to the cloud doesn’t mean you can’t change your business model. “Cloud” vs “On-premises” is the deployment model. “SaaS” is a business model decision to pay by time instead of selling perpetual licenses. Many On-Prem solutions have a subscription revenue model (although cloud-based perpetual software is very rare).
On the other hand, software that addresses new challenges or increases in complexity over time is ideal for a subscription model. A subscription model makes sense if new modules are frequently introduced to keep up with business challenges or competitor offerings. This includes evolving business processes such as sales, manufacturing process solutions with frequent tool changes, or data management systems with changing types and volumes of data.
Products must provide stable or growing value over time to successfully transition from perpetual to subscription pricing. It also requires an agile development structure to introduce new and better features incrementally and consistently, rather than the traditional trauma of waterfall development processes and periodic but massive version upgrades.
How do we migrate?
A sudden shift from perpetual pricing to subscription software pricing could reduce the company’s revenue while increasing recognized costs. Because EBITDA drives bonuses for many executives, it could be career-ending! But stay the course—while transformation is challenging, there are steps software leaders can take to reduce short-term impact and set them up for future success:
- The subscription model should be introduced gradually rather than suddenly. The best option for developers is to take advantage of maintenance and support, contract elements that already generate recurring revenue. To that end, leaders should increase the value of maintenance, including upgrade protection and access to additional features. Changing the maintenance contract will have two effects: It will entice customers to keep renewing and justify the price increase for maintenance contracts. The move increases recurring revenue in the perpetual subscription base, allowing both customers and software developers to gradually transition to subscription pricing.
- Software, maintenance and support, and installation services should be financially combined. How will accounting changes facilitate business model migration? Because it resolves the profit tug-of-war between software, services, and M&S in which each team has an incentive to optimize its profit center, often to the detriment of the overall interest. Combining incentives with a single profit goal allows executives to divert resources to support the new model without worrying about organizational politics.Another way; if A service or support line exists only because the software exists, then it should be part of a software income statement.
- Introduce software backlog as a key business metric. High software backlog Committed future income is the goal and drive enterprise value. While some short-term revenue loss is inevitable, the overall value of the business is based on a secure 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 for any business. Subscription pricing enables software developers to position themselves to build a sizable future revenue book. But it’s not without challenges. Those who act for the right reasons and execute effectively will be well positioned to succeed.
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