By Tyler Sloat, CFO
The face of business and the job of the CFO are shifting as subscriptions are replacing the traditional product sales models. I’ve gone through this transformation myself, and I know that CFOs long accustomed to product-centric single-purchase transactions need to get smart on the shift to long-term recurring revenue relationships. These relationships and the impact they have on business are the hallmark of the 21st century.
The shift is clear – you can see the movement across multiple industries: ZipCar in automotive, Netflix in entertainment, Adobe in software, Amazon in memberships, HP and Dell in IT and more. At Zuora, we call this phenomenon the Subscription Economy.
The Subscription Economy is taking hold for a variety of reasons. Customers today are demanding a more flexible, more convenient consumption model. On the business side, General Managers have the flexibility to test pricing, bringing new functionality to customers faster. Executives see that this allows for longer lasting relationships with customers and more overall value. And investors recognize that, if executed well, subscription companies have fantastic revenue and return models.
As a finance professional, if you haven’t already participated in the shift to subscription, you will soon. When you do, you need to be aware that finance as you know it is broken. Traditional, double-entry bookkeeping can’t capture the dynamic, ongoing revenue relationships that are the foundation for the subscription business model.
Subscription finance is fundamentally different. As a CFO of a recurring revenue company, I have seen that the most meaningful metrics for my business aren’t addressed by GAAP standards. For example:
- One-time revenue is valued differently than recurring revenue
- Your business should be measured across multiple dimensions of time – not just the past, but the future as well
- Churn is a fundamental metric for a Subscription Economy company, yet there is no common definition across all companies.
- Complex customer changes can impact downstream results, such as mid-month subscription cancellations that can result in credits or refunds thereby impacting revenue recognition
Every accounting system in existence today, including the large ERP systems, were built around the rules of double-entry bookkeeping. That means your accounting system is still great as a general ledger, but will not meet your subscription business needs. In the new business model, the back-office needs to change so subscriptions don’t wreak havoc on your business.
I have talked with lots of CFOs in recurring revenue businesses who struggle with traditional finance systems they have in place. It takes longer for them and their teams to close the books. My revenue team, like so many, used to be drowning in spreadsheets.
In a subscription business, your CEO and board are demanding more and more insight into forward-looking metrics like ARR, churn, upsell and ACV. At Zuora, we rely on non-GAAP off-balance sheet accounts to really show our success. Most investors now get it, but still do not have a common lens to evaluate these companies, which is why Wall Street often varies dramatically when estimating results for subscription businesses.
I understand what it means to go through this transition, and believe me: if it’s done right, it’s well worth the work. The recurring revenue business model delivers more financial predictability, more insight and more flexibility to respond to customers’ evolving needs. Upsells, cross-sells and upgrades are entirely new revenue streams.
You should recognize, however, if you haven’t chosen to make the shift, the Subscription Economy is here to stay, and you will soon need to adapt. Customers want more control over their relationships with your business, and with the proliferation of mobile devices and social networks, customers are taking charge across the board. They want you to serve them how, where and when they want. Are you ready?