Sage CFO on Shift from Product Sales to Subscriptions

By Erika Malzberg November 29, 2016

Originally published in Diginomica.

SUMMARY:Small business software giant Sage’s CFO gives six valuable insights into the culture change that comes in the switch from product sales to subscriptions.

What are the challenges when a conventional, product-centric business shifts from its traditional sales ethos to a subscription relationship with its customers? UK-based business software giant Sage has a 30-year history of selling traditional software licenses and maintenance contracts to a customer base of small and medium-size businesses (SMBs) that’s grown to 3 million.

The £1.4 billion ($1.75bn) revenue company has only recently begun the shift to a subscription business model. Its CFO Steve Hare spoke about the cultural challenges of making that change last week at an event hosted by subscription billing vendor Zuora, which Sage uses to manage its subscriptions.

Hare said Sage had been slow to start offering its products from the cloud, and slow therefore to adopt the subscription model. While that has now changed, it still has many customers that don’t want to move to the cloud and therefore it also offers a range of hybrid products.

“It’s very disruptive to an existing business model to move away from your traditional way of doing things. Fortunately now we’ve accelerated in the last two to three years, we now have a full suite of cloud products for accounting, payroll and payments. But at the same time we have a lot of existing customers who are still on-premise and are not ready to move. They’re not ready to disrupt what they’re doing.”

In an on-stage conversation with Zuora CEO Tien Tzuo, Hare shared six insights into the culture change from product sales to subscriptions and the impact it is having on its engagement with customers, partners and investors.

1. Q1’s a lot more important than Q4

When a business revolves around product sales, the selling accelerates towards the end of the quarter or the year-end. The subscription model turns that on its head, explains Hare.

“If you book a 12-month subscription contract in the last month of the financial year versus the first month, it’s very different. The last month, I only get one twelfth of the revenue. You book it in the first month, I get the full year.”

That generates what Hare and his colleagues call the ‘rule of 78’. A subscription sold in the first month of the financial year allows you to recognize 12 months of revenue, but as each month passes, it dwindles to 11, then 10, and so on. Across the full year, those numbers add up to 78, with each successive quarter contributing less and less — sales in Q1 make up more than 40% of the total, while Q4 provides less than 8%. As Hare points out, that’s a complete reversal of how the software industry used to look at sales:

“Those of you who’ve bought licenses from software companies, typically what you do is go to the sales guy on the last day of the quarter, preferably in the afternoon when they’re a bit short of their target, and you get the deal of the century. Now the best deal’s available on the first day of the financial year.”

2. Subscription is a continuum

Instead of occasionally speaking to customers when it’s time to sell them a new package, the subscription relationship puts the focus on providing a continuous service. For an organization that was historically very product-centric, this has meant a shift in the way sales and marketing teams engage with customers, says Hare.

“Ultimately, the customer doesn’t really care about the product. They care about functionality, they care about what is this doing for me?

I’m not selling you an accounting product, I’m selling you a solution to your back-office needs. I’m trying to simplify your business for you. You don’t need to worry about your accounting, your payroll, your payments integration, we’ll provide that for you, and we’ll bundle it together so you pay that monthly or quarterly or whatever it is …

Once you’re on a subscription model, it’s a continuum. So [you’re] getting the sales teams focused on this continual touchpoint, creating a different relationship with customers. It’s not even selling software, it’s selling features, it’s selling services, and talking to customers about their needs.”

3. Customers want mobility

In Sage’s market, it turns out that what people want is to access their finance system from their mobile device. It means they can get things done faster and have better access to useful information. That means a lot more to an entrepreneur than having their accounts in order, says Hare.

“For most small to medium-size businesses, which is who we serve, what they really want is mobility. It’s being able to access on your device.

Historically an entrepreneur would have very little management information because accounting is not real time. Invoices get typed up five weeks after they do the work. Now with in-application functionality, you can be issuing e-invoices as you’re doing the work.”

A plumber, for example, can email an invoice as soon as they’ve finished a job — and then have the customer pay instantly from a payment link embedded in the electronic invoice.

4. Who needs accounts?

Much of the record-keeping that accounting software focuses on can be automated through smartphones working alongside artificial intelligence says Hare. For example, users can speak instructions to chatbots instead of filling in screens, or they can take an image of a bill with their smartphone camera, and AI in the cloud will scan it for transaction data.

All this automation will mean the accounting function becomes almost irrelevant for SMBs, Hare suggested:

“Unless you’re an accountant, you don’t go into business to do accounts. You just want that to happen behind the scenes … Accounting really for a small to medium-size business should be obsolete, because it’s all about the interface … It’s all logic. Why does it need somebody to input an entry?”

5. Look out for your partners

The same culture change that has to happen internally also needs to take place across the partner ecosystem, because they’re equally impacted by the change in business model. Sage was slow to realize this, Hare admits.

“Internally, we put a huge amount of effort into communication and engagement and getting people on-side with what we were trying to do. We were a little slow to do that with partners, and then we wondered why we were getting resistance.

We didn’t put enough effort into thinking through how the incentive schemes worked. Suddenly a partner was going from getting a big cut of the perpetual license, and we were shifting to the payments being spread out over a longer period of time. We didn’t take enough care over that. Hopefully we’re now recovering that.”

As well as communicating the financial impact of the changes, it’s important to encourage partners to adopt a more continuous relationship that’s focused on outcomes, he says.

6. Investors may not understand

As a public company, Sage has to continue to report quarterly numbers throughout this fundamental shift in its business model. It can be a challenge to ensure that investors understand what’s going on as growing numbers of customers transition to a subscription relationship in place of their historic buying pattern. Hare says:

“We’ve had very significant substitution. At the moment, our overall revenue growth is around 6%. Our recurring revenue growth is around 10%, but our subscription growth is 32%.

Getting investors, and particularly analysts, to understand the constituent parts of that and how the dynamics work is not straightforward.”

There’s a lot going on behind the 6% topline growth rate that Sage has committed to, explains Hare.

“Behind the scenes, our software sold on license is declining about 20% per annum. Go back to the ‘rule of 78’, obviously the subscription doesn’t replace that at quite the same rate.”

To make up that shortfall, Sage needs to acquire new customers — but that’s not something the company has historically done very well. Its past growth came mostly through acquisitions of companies that brought an existing customer base with them. Now Sage has to learn to how to sign up new customers, says Hare:

“The big challenge for Sage is, we’re doing a pretty good job migrating our existing customers — we actually have over a million subscription contracts now. But what we have to do is organically acquire a lot more new customers.

Historically that’s the thing that we’ve not done at scale, because we’ve always resorted to getting the checkbook out and going acquiring companies with customers already, rather than doing it ourselves.

Doing that digitally and making sure that we’re really engaged with the digital channel is something that is starting to work, but it isn’t firing on cylinders yet.”

My take

I recall Sage giving the subscription model a spin in 2000, which didn’t end well. Once bitten, twice shy — but at least the company is now finally making the move.

Hare’s account is a classic summary of the big challenges companies face when shifting from conventional sales to subscription. We’ve seen it a lot in the software industry, but enterprise leaders need to be aware that the spread of servitization and the subscription payment models that go along with it are coming to every other industry. So there’s much to learn from the experiences of companies like Sage.

Learn more about shifting from products to services in our free guide: How to Shift an Enterprise Towards a Subscription Business.