When things go bad in finance departments, they go really bad. Biblically bad. I’m not talking about war, pestilence or famine, of course, but I am talking about earnings restatements, plummeting stocks, and in the case of bad actors, orange jumpsuits.
Which brings me to the topic of revenue recognition. In subscription companies, revenue is recorded and “recognized” as a service is delivered, not when cash is received. In theory this gives companies better insight into the true revenue that they’ve earned, but in practice it can be a nightmare to get right.
Let me explain why.
The holy grail for any kind of business is a repeat customer. In the words of management consultant legend Peter Drucker, “The purpose of business is to create and keep a customer.” (Emphasis mine). It’s much easier to sell to someone who’s already done business with you than someone who walks in off the street.
We’re all familiar by now with the stats. Acquiring a new customer is anywhere from five to twenty five times more expensive than retaining an existing one. According to Frederick Reichheld of Bain & Company (the inventor of the net promoter score), increasing customer retention rates by just 5% can increase your profits by a staggering 25% to 95%. That’s why we’re all drowning in loyalty programs and retail apps.
But here’s the thing. In a traditional, transactional model, each one of those repeat sales exists independently: you give your cash to the person behind the counter, who rings you up (ka ching!), and you walk out the door. Hopefully tomorrow or next week you’ll come back (for example, to earn some more Starbuck Stars), but that’s a whole new decision. When most businesses talk about encouraging loyalty, they’re really just talking about lining up a string of discrete transactions.
Subscription companies, however, think differently about this stuff. Instead of hoping for the best with a bunch of punch cards and promotional offers, they formalize that loyalty into an ongoing relationship — a relationship that can flex up or flex down in value and volume according to the needs and wants of the subscriber.
That’s great for the business. That’s great for the customer. It’s not so great for the finance department, however. Why? Because now all of those nice, neat discrete transactions are inextricably chained together. From a subscription revenue recognition perspective, if you make an adjustment to one of them, you make an adjustment to all of them.
It’s like the difference between classical physics and quantum mechanics. Instead of dealing with a nice neat linear sequence of revenue events (ka ching!), suddenly your finance team is trying to capture, amortize and report on a dizzying cloud of revenue nanoparticles as they buzz around and affect one another’s energy and angular momentum.
It gets worse.
A few years ago, a new set of accounting rules were introduced. In the US, they’re called “ASC-606” (appropriately enough for this article, I’ve also heard finance departments jokingly call it “ASC-666”). ASC 606 introduces the concept of a “revenue contract.” One of the benefits of the subscription model, of course, is that it gives subscribers the agency to make all sorts of changes: accept, activate, upgrade, downgrade, pause, extend, cancel, or simply consume. Trying to measure and aggregate all of those revenue events into a single revenue contract can easily turn hellish. Imagine spreadsheets multiplying like tribbles.
Cue the four horsemen.
I’m not going to name names, but I know for a fact that right now there are large, publicly traded companies who are trying to do this stuff in spreadsheets, drowning in tens of millions of dollars’ worth of human error, and basically flirting with financial apocalypse. They’re about to break the seventh seal, when all hell breaks loose. Here are four ways things can go truly south if you don’t address this issue with a revenue automation platform specifically designed for subscription businesses:
You break the law. Too many error-prone manual processes mean higher amounts of external resources required to deal with complex revenue processes. Without automation, you greatly increase the risk of running afoul of audit and compliance regulations. You can lose your job, or worse.
You need to restate your earnings. No one wants to hear those words, but it can easily happen as a result of human error in critical revenue accounting processes. This means lower stock prices and decreasing confidence from investors. It’s the ultimate nightmare, short of a prison sentence.
You can’t grow. As companies grow internationally, change business models or acquire new business units, they also take on completely different revenue processes. These require integration and can’t be managed manually; you won’t be able to scale and you’ll stall out.
You need to delay your IPO or other exit. Companies not using automated revenue solutions will struggle with the amount of analysis, reporting, forecasting and disclosures necessary to deal with bankers, investors and others interested in helping a company grow or plan exits. You’ll lose trust with your investors, and you’ll be left behind.
So what’s the solution? Automation. The good news is there are lots of tools out there that can help (full disclosure, Zuora, the company I run, offers one of these tools, it’s the reason I’ve learned so much about ASC-606!) But ultimately, particularly in an industry guided by ever-evolving standards, the only way to keep the horseman at bay is to automate your subscription revenue.