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CAPEX Called into Question

A Discussion with Dean Jonathan Levin of the Stanford Graduate School of Business

Tien Tzuo
CEO, Zuora

Welcome to the second part of my interview with Jonathan Levin, the Philip H. Knight Professor and Dean of Stanford Graduate School of Business. This week Jonathan and I discuss the implications of recurring revenue models on traditional accounting and income statements,  how Stanford GSB is thinking about subscription models in terms of subject matter, and the potential effects of subscription models on business schools in general.   


TIEN: Subscription models are really different when it comes to accounting, because you don’t really capitalize R&D. Your sales and marketing costs aren’t really capitalized either, because all those costs happen in the past.  In a traditional business, the cost of sales reflects how much I spent to get that dollar of revenue.  But in a subscription business, sales and marketing expenses are matched to future revenue. So from a financial standpoint, if you stopped investing in R&D, and you stopped investing in acquiring new customers, what you’d have left is a pure gross margin business with a recurring revenue stream.

JONATHAN: So then it’s a question of what your fundamental cost structure looks like to provide the service, right?

TIEN: Exactly. COGS, R&D and G&A are all associated with servicing the recurring revenue, so they are recurring costs. So it’s really just thinking about the income statement in a very different way. Whereas a traditional statement says “you made this much revenue in the past quarter,” a subscription business financial statement says “you are starting the quarter with this much recurring revenue.” It’s looking forward, not backward. 

JONATHAN: The whole concept of CAPEX gets called into question in these models. 

TIEN: Yes! Because traditionally you buy physical factories and you capitalize them so you can spread those costs over unit sales. But where are those unit sales now? There are no unit sales, there are just customers. It’s all about servicing your ARR. 

JONATHAN: And going back to the point about GDP and measurement, we’re probably mismeasuring investment at a national level because some of these things that aren’t formally counted as investments are actually investments in a digital economy. That’s sort of the aggregated national perspective on this; we don’t necessarily pick up all the true forms of investment that the digital economy companies are making. Nobody builds their own server farms anymore, for example.


TIEN: How are you guys thinking about these models in terms of research and study? Are you talking about subscription models in business school

JONATHAN: Yes, certainly. For example, we have marketing faculty who have looked at the value of loyalty programs. That makes you think about customer acquisition from a long-term value perspective, as opposed to just selling your product. We also see students interested in entrepreneurship often looking at innovation from a business model perspective, and secondly from a digital economy perspective. Subscription models are often a big part of that discussion.

TIEN: What about the influence of subscription models on an industry you’re very familiar with, education?

JONATHAN: Oh, certainly. One of the big trends we’ve seen in business education is an increased desire and demand for learning throughout people’s careers. And that naturally leads on to think about providing opportunities for people to learn at different points and through different modalities, in addition to having traditional programs that are centered around an incredibly deep and intense and immersive in-person experience. And that has interesting implications for how you think about providing lifelong education.

TIEN: The thirty-year MBA.

JONATHAN: Yes, something like that. There was actually a study at Stanford a few years ago which proposed a model of education where you essentially get a lifelong pass, and you could keep cycling back for more education when and where you need it. It was very provocative and interesting.

TIEN: Right. So instead of chasing down alumni for donations every year, you provide them with access to a set of services: educational services, counseling services, networking services. It’s the same dynamic that applies to all subscription models:  How do you build a business model where your customers are using your service? Hopefully they’re using it for life, so what’s the margin structure to support that?

JONATHAN: One thing we’ve seen during the pandemic is that moving to a virtual environment can enable new approaches to lifelong connection, because in addition to traditional campus reunions every five years — which are great of course — you can have one-hour sessions where people participate from all over the world. Even once we emerge from the Covid pandemic, we will have learned new ways to create ongoing connections.

TIEN: Ongoing connection is what it’s all about. Thanks for the chat, Jon!

JONATHAN: Thanks, Tien! Any time. 

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