Because they can’t afford not to.
As Deloitte spells out: “As more and more customers demand more flexible payment models, the continued viability of many companies, and even entire industries, is being threatened. Those that fail to at least explore consumption-based offerings may end up on the path to obsolescence.”
Here are three key drivers that lead software companies to transform their businesses.
It comes down to a couple of core metrics.
o Customer lifetime value (LTV or CLV). Customer lifetime value is a stand-in for how much value a customer can create for shareholders. With a subscription model, LTV is considerably larger over time because your customers are now recurring customers. With the right land and expand strategy, you can also build in growth for future years.
o Average revenue per unit (ARPU). With a subscription model, your objective is always to drive up ARPU year over year. Whenever you’re looking at a deal, you’re always taking a long-term view: what happens in year two or three or four of the contract? How can you continue to increase average revenue per subscriber over the customer lifespan?
While companies that shift to a recurring revenue model may see an initial downturn in gross margins, over time the increase to shareholder value is huge as investors gain confidence in the predictability and increased revenue growth opportunities of a recurring revenue model.
For example, look at software giant PTC. When PTC announced a broad, systemic shift from perpetual licenses to cloud-based subscriptions, they predicted that this would rekindle growth, expand margins, and maximize long-term shareholder value. And they were right! As of today, their stock is up 85% year-over-year (from March 2016) and they’ve added more than $3 billion dollars in shareholder value. Their perpetual revenues got impacted, but it’s made up for in recurring revenues—and the stock price reflects this.
The pivot to the cloud throughout the software industry has created new competitors and increased customer expectations. SaaS businesses can quickly out-compete via new business models that enable improved experience (price, quality, and/or speed).
As a result, software perpetual license and maintenance revenues are slowing or in decline. Gone are the days when customers want to buy software in a box. Customers now expect a software-as-a-service experience that provides ongoing and increasing value throughout their time as a customer.
Symantec provides a great example of a software business that chose to be the disruptor…rather than get disrupted by new, up-and-coming, mid-sized and small-sized cybersecurity software vendors. In late 2015, they dove into the threat market with a new security-as-a-service offering leveraging other solutions from the Symantec portfolio to create a single integrated solution that competing product just can’t measure up against.
Buyers are demanding it, as PTC discovered through their own due diligence: according to PTC CFO, Andy Miller, “In our research, we found that up to 90% of current and potential customers want more flexible pricing options.”
Customers prefer subscriptions because:
o Customer-centric experience. Before SaaS, the notion of a customer success organization didn’t even exist in the software industry. Now subscriptions offer a fundamentally new way for customers to do business with software companies. This requires software vendors to invest in customer success and deliver constant innovation in order to retain existing customers and attract new ones. It’s about increased accountability and customer success as a function.
o Lower upfront cost and greater flexibility. The traditional software business model required big upfront purchases and lots of integration and customization to get up and running. These long and complex implementations are anti-SaaS. Customers prefer to align costs with usage, buying what they need and growing over time. For that reason, software companies now focus on OPEX instead of CAPEX, which offers predictable costs and yields budgetary benefits, freeing up cash to drive growth.
o Access to innovation. With SaaS, product development cycles are much shorter. This means that customers have the ability to influence product development and have access to the latest innovation faster.
