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| Home - Industry Article - Oct 06 Issue |
Vendors, Not All Revenue is Equal
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Looking at each type of revenue:
| Maintenance |
In terms of both cost of sales and odds-to-close, this is the easiest revenue that a software company can get. For the vast majority of customers, no sales expense and only a small amount of administrative expense are incurred. For the industry, approximately 90-95% retention is considered a good performance. Some natural or organic erosion is to be expected (5-8%) due to consolidation, M&A activity, going out of business, etc.
A customer's maintenance decision is based on its perception of the risk of not having maintenance, the value it received in the last 12 months, and its needs for the next 12 months or longer.
For most software companies, maintenance revenue is highly profitable. As the install base becomes larger, economies of scale make increases in profitability a possibility.
Obtaining maintenance revenue should be a high priority as it is the lowest cost revenue with the highest odds-to-close and should carry very good margins. Since the erosion of this revenue source is cumulative, any loss in one year will have a long-term revenue impact.
REMEMBER - Every dollar realized from maintenance revenue means one less dollar to be derived from higher cost and lower odds-to-close revenue sources. |
| Add-on modules |
Selling additional modules and seats into the current customer base is proving very successful for most application software companies. The vendors who are doing best are using mass marketing techniques to address major segments of their base. These techniques often include packaging the product, education and services into one offering with options for the customers to participate in generalized, multi-client education, and services opportunities.
Customer segments to be targeted are selected from a census of the customer base. A decision must be made on what module to push, with a trade-off between selecting modules that already have a wide acceptance (with proof of value) and those modules with greater potential (low acceptance). An additional criterion for selecting a module is the ease of installation, leveraging the implementation work done to date. A competitor for this revenue is the existing method used by the customer to accomplish the objectives addressed by the module. Often the campaign features success stories from one or more customers for increased credibility.
The period between launching a campaign and gaining revenue is typically 90 to 120 days. |
| New site in existing account |
Since this revenue source is opportunity driven, you should be in on-going contact with those accounts with the potential to launch new sites. Once an opportunity is identified, these deals should be high priority because they offer a higher odds-to-close and a lower cost of sales than new accounts. |
| New account - first time user |
Although these transactions represent a large chunk of revenue, this revenue source is the most competitive, has a long sales cycle, and has the lowest odds-to-close. The cost of sales is high due to the extensive effort it takes to cultivate a new account plus the fact that not all deals close.
In today's market, we see functionality in many markets approaching a commodity state. Often, trust and a low risk offer is what wins the deal. Note that price is often not a major determinant of who wins the deal.
The sales cycles for a new account averages 6 to 12 months. |
| Replacement |
Many analysts predict this as an important source of revenue in the future. However, experience has proven that these are difficult sales campaigns.
Potential replacement systems will be compared with the existing system. Problem areas in the existing system are held under a spotlight, prolonging the sales cycle and driving up the cost of sales. Existing functionality becomes a "must have" as performing a function in the same way as the existing system is often considered the best fit.
The value of the replacement will be marginal. How much better is the new system than the old?
The existing system is often seen as a great system once discussions on a replacement begin. |
Types of Revenue and Business Strategy
Business strategy must consider the real potential and cost of the various types of revenue. Experience shows that many management teams have a blind spot for realistically predicting their potential. A company should explore each revenue source and craft a strategy that yields both the best short term (current revenue) and long term (on-going revenue and growth) results.
The most common error is to focus on new accounts or replacements, where the potential revenue is low and the cost high. This strategy is often a continuation of the pre-Y2K market where analysts and investors were focused on new accounts as the key measure of success. In many markets, for example ERP, new account opportunities are limited due to market saturation and the commodity nature of many products.
Newer markets, Product Life Cycle Management or Performance Measurement for example, have significant new account potential. Companies in these markets should be focused on new account production.
Companies with larger install bases have significant opportunity in marketing to that base. Although not as exciting as selling new accounts, robust revenue streams and predictable profitability can be crafted from the relationship with the base.
Summary
Very few companies, if any, can be good at everything. Although many executives see that "all dollars are green" (at least in the US), the reality is that different types of revenue come at different costs. Be realistic on what is possible, how much you can afford to spend to get revenue, the timing of the expense versus the revenue and how much risk you are willing to accept. All revenue is green, but sometimes your revenue strategy can make your bottom line red.
Olin Thompson is Principal of Process ERP Partner. He has over 25 years' experience as an executive in the software industry with roles in general management, sales, marketing, and business development. Olin advises software companies on strategy and tactics in business strategy, sales, and marketing. He is a frequent author and an award-winning speaker on topics of interest to both software industry and end-user companies. For article feedback, contact Olin at OT@olinthompson.com
 
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