Time for a New GAAP

By Aarthi Rayapura June 22, 2016

By Matthew Darrow, VP & GM at Zuora

Today, almost 90 percent of the S&P 500 currently disclose earnings report figures that are not based on Generally Accepted Accounting Principles (GAAP). Let’s take a look at one notable example: Apple.

Earlier this year, their CFO Luca Maestri published a non-GAAP supplement noting that services are becoming an important part of its revenue base, constituting roughly 13 percent of its total annual revenues of $234 billion.

Now why would Apple go and do such a thing? Because GAAP is really bad at illustrating the value of service revenue.
At the most basic level, revenue is simply the money your company makes from its business activities—the income from sales or services. Under GAAP revenue recognition standards, organizations count revenue when it is earned. This stipulates the discrete, finite delivery of a service or a product.

Needless to say, there are no discrete, finite deliveries in the Subscription Economy. The delivery is ongoing, and, as a result, revenue can’t be all recognized up front. Subscription companies have all sorts of revenue that they can count on but can’t formally recognize, and if you throw upgrades and bundling into the mix, these revenue figures quickly start diverging from standard GAAP metrics.

This is a particular problem with SaaS companies, but I would argue that it isn’t just a SaaS problem anymore, it’s a business problem. Value is shifting from ownership to access. Today’s economy isn’t just about shipping units anymore. It’s about growing and monetizing a dedicated customer base. GAAP works great if you’re selling CDs, but the rest of us have moved on to Spotify.

An increasingly sophisticated investor community is also starting to move beyond GAAP in search of accurate growth signals. Note that non-GAAP metrics can give, but they can also take away. Take a look at Herbalife. Last March their stock price fell more than seven percent after the company acknowledged that they misstated their customer growth numbers, even though their GAAP reporting remained fundamentally the same. Keep in mind that this is a growth number that the company only started reporting on a year ago!

As analyst Tomasz Tunguz notes, “If you sift through the 40+ public SaaS businesses, you won’t find mention of annual recurring revenue, churn, account expansion, or cash collection cycles in most of them – even though these are the metrics the management teams employ to evaluate and steer their businesses.”

So kudos to companies like ServiceNow, who are respectfully surfacing relevant Subscription Economy metrics in their earnings reports, in an effort to show investors how their business actually works. And kudos to Apple, for highlighting their pursuit of recurring-revenue based services.

For forward-thinking companies who are serious about digital transformation, GAAP is a past-tense framework. It’s time to start building paths where people are walking.

Continue reading success stories from the Subscription Economy in the latest issue of Subscribed Magazine!