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| Home - Industry Article - Dec 05 Issue |
Managing New Revenue Streams: Think SaaS
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Extension Impact: Subscription contracts are often extended at the discretion of customer care as an effective means of retaining customers. This must be captured and evaluated to determine if additional treatment is necessary or a change of policy is required. At a minimum it is required that reporting information is available to the revenue management system to assess the materiality of the amounts.
The Utility Model
Utility arrangements are based on the delivery of product measured in a transaction or usage-based manner. Utility arrangements that bill the customer based on usage or transactions are common in software models that involve ecommerce. Key financial capabilities for the successful launch and management of a utility model include tracking the following key attributes over the lifecycle of the relationship:
Transaction Value: The value of each transaction must typically be determined against a pricing schedule (by volume, type, etc.). In some cases it is necessary to establish the average value over the contract lifetime. The transaction model can be complicated when the pricing model is also time dependent.
Transactional Volume: The transactional volume may dictate bucketing revenue and summarizing revenue amounts. In many cases the high volume of similar transactions is captured into revenue "buckets." Any exceptions to the process or cancellations and adjustments are then made in a detailed manner. The transactions are always captured within the system allowing for audit tracking (i.e. the revenue buckets can be associated with the transactions). This approach can effectively handle very large transaction volume, and still maintain a detailed audit trail of exceptions and revenue schedules that get changed.
Time-based Commitments: Commitment to deliver certain levels of transactions must be identified. This allows portions of revenue to be recognized independent of additional transactional volume.
Prepayment and Scheduled Payment Options: To correctly account for revenue and backlog it is necessary to apply payment amounts to the transactions for which they are intended. This can be one of the most complex arrears for which to determine correct booking of receivables.
True-up Processing: Payments made in advance for transactional volume need to be reconciled with actual usage. The actual usage must be captured for true-up processing to occur. This is typically the case where a minimum payment is made each month. At the end of each month the actual usage is compared to the minimum. The complication is that the payment at the beginning of the period is continually being apportioned between deferred revenue and revenue at the end of the period. To complicate this further, this true up may also affect the future month billing.
Minimum Commitments: These can permit revenue to be recognized ahead of the transactional usage. The minimum commitments may cross product and agreement boundaries. In general, these relationships must be captured within the VSOE pricing mechanism to associate fair value across product boundaries. In many cases this is alleviated since minimum commitments are only booked in arrears.
End-of-term Processing: Any residual transactional amounts that remain after the contract has expired must be accommodated. The process for this can vary based on the revenue policy; however there are strict accounting guidelines that cover this process (e.g. EITF 01-09). This is often referred to as "salvage" or "Es-cheat" and is common with gift cards, etc. It is important that these amounts are removed from the deferred revenue "buckets" and handled appropriately so that the amount of deferred revenue is not inflated.
Future Revenue - the New Performance Metric
The financial infrastructure has to be adapted to accurately capture, track, and forecast these new revenue streams. Once the initial infrastructure readiness is accomplished, the demands for performance monitoring are also very different. In order to really understand how well the business model is working, CEOs are asking for more detailed and timely answers to performance metrics by product, region, and customer segment, even down to the account level. Revenue and profit contributions are key issues. But the most critical issue for assessing the performance of a SaaS business model is future revenue.
In order to better forecast future performance CEOs are asking for more details on the whole revenue chain from bookings to backlogs, billing, and revenue recognition. Some financial reporting capabilities that will be essential to success include:
- Reporting and comparing bookings and revenue growth
- Tracking renewal rates
- Matching expenses (especially commissions) against revenue
- Understanding how add-on sales to existing customers contribute to bookings and revenue goals
- Having instant insight into revenue growth by new and existing customers
- Improving visibility into how deferred revenue will be recognized over time
Reporting in all of these areas is required to measure the success of your SaaS initiative and to support the ongoing strategic decisions that will need to be made. In particular, analyzing how efficiently revenue goes from deferred accounts onto financial statements is emerging as an effective tool for finding operational problems as well as keeping revenue recognition practices in compliance with complicated accounting rules. Not only will these reporting capabilities help you manage for success, these are the metrics your board and financial analysts will be looking for to evaluate your SaaS business.
The Complexity Tradeoff
The complexity involved in all of this is a zero sum game. Making it all look simple and easy at the front end for the customer requires some very sophisticated capabilities at the back end. This is particularly true when hardware and software components are involved, or when you are required to track consumption or usage - as in some ecommerce businesses - and bill based on a sliding scale.
The relationship between billing and revenue becomes completely separated. In order to provide meaningful performance information to executives, the system must be as automated as possible. Contract data, metering feeds, and pricing tables must independently drive both billing and revenue recognition. Otherwise revenue will fall through the cracks and the risk of reporting irregularities greatly increases.
This is no small undertaking for most companies, especially if separate systems for contracts, orders, billing, and accounting are entrenched, or if spreadsheets have proliferated. The key thing for CEOs to keep in mind is not to underestimate the operational issues that the addition of a SaaS model is going to demand, particularly in the finance department.
Robert O'Connor is President and Chief Executive Officer of Softrax. With over 20 years of experience in executive management of software companies, he has proven expertise in finance, sales and marketing. Robert's leadership has helped Softrax evolve into a better, more successful company. For article feedback, he can be contacted by email at roconnor@softrax.com or you can visit www.softrax.com
 
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