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Managing New Revenue Streams: Think SaaS
By Robert O'Connor, President and CEO, Softrax
Innovation is still the key to growth in the high tech business, but it has broader implications than in the past. Today some of the most important innovations are about the business model - how technology is being sold and delivered. Offering Software as a Service (SaaS) via subscription or utility models is reshaping key customer relationships for high tech companies. Along with the technical challenges, there are significant operational issues software executives must fully understand to successfully manage these new business models.
SaaS Makes Sense
Customers are looking for an easier way to acquire technology. Instead of large payments up front and on delivery, customers increasingly want to mortgage the cost of the technology over a series of monthly payments or simply rent capacity. This takes a huge burden off capital budgets. It also provides a much more flexible and more appropriate financial arrangement for customers.
Fees can be determined not only by the technology itself but by how it is used, which is what really matters to the customer. The base monthly payment can be adjusted by usage levels so the relationship is much easier to scale up and down according to business requirements. Budgeting, paying bills, and controlling the technology are all substantially easier for the customer. In addition, because of the more attractive financing, ROI can often be achieved more quickly.
Even though we're primarily talking about B to B relationships, the economic gap between SaaS and traditional models makes it a very powerful market force. For a good lesson on what is happening in software industry today, look no further than the telecom industry. Innovation and market share are a matter of how services are sold. Rollover minutes, off peak pricing, free weekends, family and friends plans, these offerings are all simple for customers to understand because they are based on how the service is used. Bringing them to market required a financial infrastructure capable of supporting new billing and revenue requirements. Companies that made the transitions first got the biggest market share advantages.
Finance Operations are Critical to Success
In the long run these new models will smooth out the revenue curve for software vendors, but the transition can be tough. There are a lot of things that must be in place in order to be successful. Sales, marketing, development and support must all work together to define offerings, but some of the key management issues occur in the finance department. Billing, renewals, cash flow, and revenue management practices must change dramatically from those associated with traditional product licensing.
When you sell software as a service you are essentially bundling a whole set of products and services with support and other customer entitlements into a single financial arrangement. Contracts become more intricate with tiered pricing strategies that differ by customer, product and consumption levels. This triggers a number of technical accounting rules that make revenue accounting very complex.
Billing capabilities must also become more sophisticated. Services have to be added to the bill upon completion, support has to be tracked against the commitment level. Usage items must be billed in arrears while subscriptions are billed in advance - on the same invoice. Making sure revenue is being optimized while all this is going on requires the ability to monitor vast amounts of transaction activity and quickly find meaningful insights.
The crux of the issue is integrating contract terms into all the downstream financial workflows from order entry to billing, metering, renewals, revenue and expense accounting, and financial forecasting. Many existing financial systems are not equipped to support these demands and there is a risk of having spreadsheets crop up like weeds around the core system. This is one of the key things CEOs are concerned about today - how many spreadsheets did it take to produce the financial data they are being asked to sign off on? Ideally the answer is none. While regulations like Sarbanes-Oxley have forced the issue, software as service models also demand more timely and detailed financial data.
How these new demands are met depends on your approach to SaaS. There are essentially two choices: subscription and utility models. Each has nuances that require an in-depth understanding of various accounting guidelines.
The Subscription Model
The Subscription model is increasingly being applied to many different types of offerings in the high tech business. A subscription service sold as part of an arrangement will need to be revalued in line with the Security and Exchange Commissions" Staff Accounting Bulletin (SAB) 101, and Vendor Specified Objective Evidence (VSOE) will need to be established where necessary in accordance with the AICPA's Statement of Position (SOP) 97-2. This requires the ability to track the following financial attributes over the lifecycle of the relationship, including:
Product Activation: The driver for activation of the product must be identified. Subscription services are often sold as part of an offering. However, the activation for revenue purposes can be dependent on many factors.
Subscription Term: The term and value associated with the term will dictate the appropriate spreading of revenue. Any additional optional terms that are included need to be included in the revenue calculations. The situation is often complicated since subscription services may be offered as part of a hardware agreement (e.g. cellular phone companies). Many subscription services also include right to cancel clauses that place a limit on the cancellation penalty or remediation terms. In most cases the revenue is spread over the term. More recently the conservative approach has been encouraged that either recognizes revenue on a pro-rated day basis or defers any revenue until the accounting period that follows booking of the revenue.