Why the subscription economy is the future of business

By Erika Malzberg March 14, 2017

Originally published in CIO.com by John Gallant.

Zuora CEO Tien Tzuo says subscription-based companies are growing nine times faster than product companies and explains why ‘subscription relationship management’ platforms will replace existing ERP and CRM systems.

Zuora aims to win the next IT stack war – but it’s probably not the stack war that’s comes most readily to your mind. Tien Tzuo, CEO and co-founder of Zuora, wants to own the application stack that drives your subscription business and he believes that virtually every company will be a subscription business before long.

Speaking with Chief Content Officer John Gallant in this installment of the IDG CEO Interview Series, Tzuo describes Zuora’s “subscription relationship management” platform and talks about why this software stack is better suited to disrupt new business models than existing ERP and CRM systems.

Don’t believe your company could be a player in the emerging subscription economy? You might want to rethink that after learning from Tzuo about how traditional economy giants like Caterpillar are changing their industries with subscription-based offerings. According to Tzuo, who was steeped in this new model of business as one of the earliest executives at salesforce.com, subscription-based companies are growing nine times faster than product companies. And Zuora aims to be the platform that drives that growth for the future.

 

The Origins of Zuora

CIO.com: Talk about the origin of Zuora. Why did you start the company and what were you setting out to do?

Tzuo: In 2007, when the shift of the software industry to subscriptions was still a couple years away, we could see the handwriting on the wall. This is when I was at Salesforce.com and my co-founders were at WebEx, two of the biggest SaaS companies at the time. Most people thought of the shift to the cloud as a technology shift in how software would be delivered. Just as important, and people talked less about it, was the business model shift.

Marc Benioff [founder of Salesforce.com] talks about two new models. One is the technology model, but he goes right into this subscription-based business model, the pay-as-you-go business model, and how profound that was in enabling Salesforce to disrupt the enterprise software industry. Now, in 2017, all software is delivered like this. Oracle talks about their cloud revenues, SAP talks about their cloud revenues, Microsoft talks about their cloud revenues. Adobe did a 100 percent shift. PTC stock is up 2x because their shift to subscriptions is accelerating. That’s just the way the world works today.

What we asked was, is this shift from a traditional way of selling to a subscription model of selling only limited to the technology industry or is it something more universal? We found it was universal. We saw examples like Zipcar where we envisioned that one day you won’t have to own a car, you can simply walk up to a car service, punch in your ID and get transportation services. There was no Uber at the time, there was no Lyft, there was no city bike share. The whole idea of transportation as a service wasn’t there yet but we could see it in the early days of Zipcar.

We saw it in Netflix. In 2007, Netflix was mailing out DVDs but we could see there’s no reason you should buy movies if you could subscribe to a service to get any movie you want. Then streaming came along and Apple Music and Spotify and this is how the world has evolved. We saw early on there was going to be a world where people wouldn’t have to buy stuff, they would subscribe to things, and this new generation of companies would need an infrastructure stack to launch, grow and manage these new subscription-based businesses – a stack similar to what we had built at Salesforce, similar to what Netflix had to build themselves. That’s what inspired us to start our company.

What *Is* the Subscription Economy

 

CIO.com: I think people get this at a high level but can you drill into what you really mean by the subscription economy?

Tzuo: We think the model of selling people products is actually a broken model. This is not the natural way of things. Does it really work for companies to say their fundamental purpose is to ship and sell more cars, more pens, more laptops, conspicuous consumption, planned obsolescence, all this stuff just sits in the landfill? People don’t want that. People just want an outcome. People want a service. People want to know the vendor, the brand, the person on the other end that’s providing that service in a trusted relationship. This is what we discovered when we launched Salesforce.com, that it was about this trusted relationship that we had with our customers.

The business model caused us to care about that relationship because we needed that relationship to continue in order grow and make money. That is just a much better way of building businesses today and that’s what the subscription economy is about. As consumers, we’re freed from the shackles of having to worry about product ownership. I don’t have to worry about the day-to-day, the hardware, all that stuff that sounds common sense now.

If I have Uber I don’t have to worry about whether my car has gas, where it’s parked, when is the garage going to close, do I have my insurance card. The whole idea is not having to worry about the assets and just having the trusted vendor provide this service — and knowing that if you don’t like the service there’s a different service down the street you can go to. That creates a much better environment for doing business and for the economy at large.

CIO.com: When you use examples like Salesforce, Netflix or Uber, people get that, but then they say: Well, we’re not that kind of company. I’m, let’s say, a manufacturer or consumer packaged goods company. How is this applicable to my company?

Tzuo: If you look at our customer base today, we have companies like General Motors, Ford, Caterpillar. Why is that? Because technology is driving this. Today, every manufacturing company can put sensors on their products, connected to the internet. These are all becoming smart devices. They’re still physical products but if the car drives itself, why do I want to buy it? Why don’t I just use it as a service?

Schneider Electric sells energy management equipment. This is industrial stuff in commercial buildings and they’re realizing: All our devices have sensors, they’re all connected to the internet. We can manage this stuff in a remote location. We can do a better job providing energy management. We can turn up the thermostat, turn down the thermostat, turn up the light, turn down the light based on historical patterns of where people are. They all go to the cafeteria at lunch so let’s dial down this temperature. They’re all coming back from lunch, let’s dial up the temperature. We could do a better job of it and we could even price this service in a way that’s win/win. We’ll price the service based on how much energy we save you so you don’t have to think about it. Manufacturing companies are all going this way.

You talk about CPG [consumer packaged goods], Unilever just bought Dollar Shave Club for a billion dollars. Why? Because Dollar Shave Club didn’t think of themselves as simply selling shavers. They have subscribers and their goal was to own the bathroom, if you will. We’ll start with the shaver, we’ll move to wipes, etc., but we see what we do as a service for our customers.

The last example I’ll throw out there in the retail space is Stitch Fix. They’re fundamentally transforming retail. The retail model as it stands is broken. In the product economy, you had to go to the store to pick up a product but now companies like Stitch Fix will just ship things to you. They’ll know what you want based on their relationship with you, based on historical data, based on what other people like you have done in the past. We’ll ship you these articles of clothing, you pick what you want and you ship the rest back. That completely transforms the whole retail CPG experience. That’s where the world is going.

Overcoming Challenges to Making the Shift to Subscriptions

 

CIO.com: As companies make that transition, what kinds of issues or challenges do they run into and how do you help them overcome those issues?

Tzuo: In conversations with our customers, we often show a picture where on the left is a traditional business. You come up with a product; you feed it into multiple channels. A channel could be a store, your salespeople, partners, it could be an app on an iPhone or a song on iTunes. You know there are customers on the other side and sometimes you don’t even know who they are because it’s the distribution channel that engages with them. All you know is you shipped a product. Then you flip.

On the right side is a picture that starts with the customer. The customer is spending time in all these different places — on their phone, in the store, talking to your customer service reps, in their offices talking to your salespeople, with your partners and resellers – and you want to make sure wherever they are there are innovations in experience tied to your brand that give them the outcomes that they want. You have to start with the customer and then build things around the customer, and you have to have a direct relationship with the customer. That doesn’t mean that you can’t use resellers. You certainly can. But you need an ID. Amazon has an Amazon ID for all their customers. You have an Amazon ID and all your interactions with Amazon go back to that Amazon ID and the history of the relationship is built against that ID. One hundred million people walk into Walmart every two weeks — in the U.S., that’s a third of the population — but there’s no relationship. You pick stuff off the shelves, you check out and you leave. There’s no history, there’s no relationship, there’s no foundation for that relationship to get better and there’s no foundation for that relationship to grow into streaming movies or home delivery or little devices with AI in-room like Amazon has. You will have a whole set of relationships with vendors that provide services that give you the outcomes that you want for your life.

The second thing is around the systems. There’s a war coming. The last war was about this whole idea of on-premise vs. cloud. That’s pretty much over. People get it. It’s all going to go in the cloud. Infrastructure is going in the cloud, applications are going in the cloud. But there’s another war brewing that’s tied to the business model shift. These old ERP systems from Oracle, from SAP, work great when the fundamental goal of your company is to ship a product. Those systems don’t work when you have a subscription-based business model, when you’re trying to wrap your whole business model around your customer and turn your customers into subscribers.

There’s a whole new stack of applications that has to happen. We recognized this back in 2007. We said: It’s going to take a long time to build this stack but let’s get going. We built the world’s first subscription relationship management hub, if you will, that sits alongside of CRM and alongside the financials to run these types of businesses. This is the system that gives them all the access to subscriber information, all the pricing and packaging flexibility, all the financial metrics — these new recurring financial metrics that they need — and it drives operational efficiencies as companies scale these businesses. Today, we have the world’s largest set of subscription-based companies — diversified, international, across multiple industries — on the system. We’ve been gearing up for the war and the war is coming.

Who Drives the Transition to a Subscription-Based Model

CIO.com: Who within the organization is driving this transition to a subscription-based model? Who do you sell to?

Tzuo: The short answer is we sell to the CEO and we sell to everyone. Why is that? What the CEOs are struggling with is that in the old product world these functional departmental siloes worked. You go figure out what it is that the market wants, you manufacture the stuff, sell this stuff, provide aftermarket services, support, maintenance, whatever. You over there in finance, just make sure it’s all accounted for.

But now these organizations are wrapped around the customer. Everyone has to be wrapped around the customer. Everyone has to know everything about the customer, so you go from these siloed organizations with handoffs between every silo to everybody cross-functionally wrapped around the customer. The customer is interacting with your finance department from a collections or billing standpoint. The customer is interacting with your sales department. The customer is interacting with engineering service. We help break down those siloes into an integrated system that wraps the whole customer around. The finance guys are plugged into our hub to send out invoices, track collections, close the books. The salespeople are plugged into our systems to do quotes and orders and so forth. The engineers and the manufacturing guys are plugged into the system because they need to know what I need to provision, to fulfill. Here’s all the usage information about how the customer is consuming the service so you can go build for it.

We wrap the whole company around this brand-new infrastructure, the subscription relationship management hub, if you will, to help you build these true customer-centric businesses. We sell to the CFO, we sell to the CIO, we sell to the head of engineering or product innovation but ultimately the CEO gets involved in every one of our engagement.

Impact on the IT Organization

CIO.com: Let’s talk specifically about the IT organization. If the decision is made to go ahead and implement this, what kind of work is involved there? What has to be integrated? What has to be set up? What’s the end-to-end process here?

Tzuo: IT has invested tens of millions, hundreds of millions of dollars building an architecture and infrastructure that worked in the old world. It helped them scale these product-based businesses. There’s a general sense that monolithic ERP applications have outlasted their lives. They’re slowing things down, they’re not agile.

People are breaking up ERP systems and there’s a movement into the cloud. There are two choices for IT; one is to say: My company is launching these new innovations so let me build an innovation platform built around a subscription management hub and we’ll put all our new innovations on there — our new connected car services, our new home automation services and new services launched in a cloud offering where I have a recurring revenue model tied to that product. That works well. A company like General Motors or Caterpillar will likely do that because they’re still going to sell lots of tractors or cars in the short term even though all the research says future revenue growth is going to come from these new services.

The second model, if you’re a software company, this shift to subscriptions is going to happen much faster in the next two or three years. I’m going to go from 10 percent of my business being subscriptions to 90 percent subscriptions. These companies are coming in saying: We’re going to do an entire quote-to-cash transformation. We’re going to build a brand-new platform, migrate all our customers onto it and start ripping out Oracle, ripping out SAP.

The cost savings we get from ripping out Oracle or SAP will more than fund the build-out of this new cloud-based subscription relationship management platform. In fact, we’ll save money in many cases, both in technology and in head count. It all depends on how fast your industry is moving to this world and whether you’re launching these new things on the side or going through a massive transformation because of your industry and your company.

Data Consistency

 

CIO.com: One of the things that comes up in a lot of my conversations around digital transformation, specifically about using analytics or big data, is inconsistency in data across systems and not having that single view of the customer that you talked about earlier. Is that something you do for the customer of your product or is that work that they’re required to do to take advantage of your product?

Tzuo: We will massively simplify that. Look at where the product record sits. Some of our customers say: We standardized our financials on an ERP system, we’ve put in Salesforce or another CRM application so for the first time we have a single list of our customers. We did the data cleanup process in our CRM, but [what about] that stuff in between CRM and ERP, these quote-to-cash systems, including quoting, ordering, fulfillment, collections, ecommerce.

Some of these guys have 42 of these quote-to-cash systems. I saw one architecture diagram from a software company that had JDE, Siebel, an old version of Oracle, because these things got cobbled together over time as they launched new products, acquired companies, went into new geographies. This is what’s holding up their agility. When you put a subscription relationship management hub in, it winds up being a central record. We want to be the system of record for pricing, sometimes for product as well but sometimes there’s another system that has the building materials and all the physical aspects of the product. We typically hold the pricing of how people buy the product.

We’ve become what I’ll call the subscription record, which didn’t exist before. Think about your Verizon plan. You have a subscription record that defines which plan you’re on. Are you on the 20 GB plan, the 10 GB plan, did you add text messaging, where does your monthly bill cycle start, and all the history associated with that. When you log into Salesforce, they know you’re on professional edition, you have 60 seats. This is the subscription record. We’re the system of record for that. We’re the system of record for everything that’s generated out of that; the invoices, the questions, the revenue recognition schedules, all the financial transactions that basically document your relationship with your customers. Then you start wrapping everything around your hub. You plug in your quoting system, your revenue recognition system, your collection system, dunning system, provisioning system. It’s a much more rational way to do it.

There is one industry that operates like this today, which is the telecom industry. This is the architecture that they use. They have these big systems that they call BSS/OSS [business support system/operations support system] that serve as their subscription relationship management hub. This is the architecture that all companies are going to move to as they shift their business models to the subscription economy.

The Zuora Platform

 

CIO.com: You’ve talked a little bit about the product but let’s go into that in a little bit more depth. Can you give us a quick overview of what’s at the heart of it and what are the capabilities you wrap around that?

Tzuo: There is a dynamic pricing engine. In this new world, there are all sorts of ways of pricing. You want to price by the user, by the gigabyte, by the month. You have peak pricing like Uber does or the telephone companies sometimes do. Do you want to price it by the month? Do you want to price it by the year? There is a dynamic, event-based rating engine. What’s that? In the old world invoices are based on units. I buy 5,000 units, each unit was a dollar, here’s an invoice for that. This new world has to be an event-based model because invoicing, or how much they owe you, is based on a whole bunch of events. Did the customer sign up? Did they suspend their service? Did two days pass? Did they just consume ten units of service? These things all have impact and so we have an event-based model where ERP systems have an order-based model. That’s the second big differentiator.

The third big differentiator is metrics. We calculate things like churn and renewal rates and customer lifetime value, all these things, because our data model supports it. Again, in a traditional ERP system there’s no sense of that. The fourth thing is we are a sub ledger in accounting terms but our subledgers are time based. You understand a dollar that recurs and a dollar that doesn’t recur. Again, you have to have this in these types of systems but traditional accounting-based ERP systems don’t have that capability. The fifth thing is this whole subscription record. We track the whole subscriber lifecycle. It’s a core piece of what’s driving everything else in the system and a really important piece of the system. These are the core differentiators that you have to have in this engine.

Then what we have is modules around it. We have a quoting module that’s plugged into it but it supports the most important third-party quoting modules, [Salesforce] SteelBrick, [Oracle] Big Machines, PROS, whatever it happens to be. We have a collections module, but we’ll support third-party collections modules. We have a tax system but we’ll support third-party tax systems from Avalara or Vertex. The key thing is the hub. The hub has six core engines and the application modules that people use are wrapped around the hub. That’s the architecture that will win the war, the IT stack war, if you will, in this subscription economy.

Zuora Insights</h4

CIO.com: In November, you launched a set of capabilities called Insights. Can you talk a little bit about what Insights does for customers?

Tzuo: Reporting and analytics is a space that’s going to be completely reinvented and we want to make sure we are ahead. We do all the standard stuff: Billings, bookings, churn, the collections schedule, all your standard financial reports. But today’s world is about predictive [analytics] so we built our entire product on a big data stack. Our customers are now starting to give us all their usage data, customer behavior data, how many times they log in, how many reports they run, how many drives they take, how many phone calls they make, how much storage they use, what features of the application are they using on a day-to-day basis? We can take all that big data and we can correlate it to what we already see in our financials.

Now, for example, we can see that this customer has an 80 percent probability of churning in the next year. This customer has a 20 percent probability of churning. This customer should be targeted with these types of upsells. You can now sort customers by potentiality to buy this add-on product and then target your marketing campaigns or your sales team on those opportunities. If they needed to predict churn rate, most companies will say: Historically, our customers churn 10 percent a year, just plug in 10 percent. We don’t have to do that. We can bring a predicted churn rate down to the specific customer and we plug that into a customer lifetime value.

You can book a deal where you can know the predicted lifetime value of the customer and incorporate that into your decision of how you want to discount and what types of deals you want to offer. Modern day reporting in 2017, with all the stuff that you hear around predictive and AI, must have these capabilities. We’ve been working on that for the last 15-18 months or so and that’s what we launched back in November.

CIO.com: Since you’re on a cloud platform, do customers benefit from the learnings that you glean from other customers? Do they get better at subscriptions because you can look at trends and patterns across the entire customer base?

Tzuo: That’s exactly right. After seven or eight years, we’ve amassed the world’s biggest list of subscription economy companies and so our customers are starting to ask these questions. Obviously, their data is their data and so we have to make sure things are anonymized and they’re opted in. As an example, we just published our first report just to give people a sense of things. We asked: How fast are these subscription revenue businesses growing? We went back for about four or five years and we tracked the quarter-to-quarter growth of these businesses normalizing for outlier behavior. We ignore the first year because oftentimes there’s a data migration ramp and we ignore the top five percent and the bottom five percent outliers.

What we found was that subscription businesses are growing at nine times the rate of the S&P 500. That was really exciting for us. Just looking at our own industry, the software industry, subscription-based software, SaaS, is growing at 30-40 percent a year and traditional perpetual software licenses, what’s left of them, are growing at three to four percent. You’ve seen a 10x difference already just in our own sector but we see this across all sectors; transportation, publishing, media, music, all these different things.

Then we can drill in to the next level. How much of that growth on a quarter-to-quarter basis is coming from acquiring more customers and how much is coming from growing your value for a customer? We’ll be able to graph those things over time. We’ll be releasing more and more of these insights. Our goal is to provide more of the insights so people can ask ‘how am I doing against companies like me and where are the areas I should be optimizing in my business’?

Traditional Companies Making the Shift

 

CIO.com: Would you give us an example of a more traditional company — one that most people wouldn’t think of as being subscription oriented in its business — that is a customer of yours? I’m looking for a great example of a more traditional company making this transition.

Tzuo: I’ll give you two examples. One is Surf Air. We all know how the airline industry works. You buy your ticket, you go to the airport, you pass the TSA security and it’s not a very pleasant process. Surf Air’s CEO was the head of Frontier Airlines way back and then he managed a membership organization like a vacation club. He said: What if I marry these two things? With Surf Air, you pay a monthly fee and you can fly anywhere they fly. You take out your phone, you find the next few flights, you grab a seat. It’s a private terminal so there’s no TSA and, because you’re prescreened, because you’re a member, you just walk onto the plane. You can take as many rides as you want. It completely transforms the transportation experience. For people in my company who go up and down California all the time, it’s been transformational for them.

The other story I’ll share is the Caterpillar story because it really raises eyebrows. It’s an internet of things (IoT) story. We’ve put sensors in so many of our assets. These could be tractors, these could be engines. They’ve been collecting all this data for years and now they’re realizing that they can build all these additional applications. They can go from a simple one where they know, based on sound waves and vibrations, that you should be servicing this asset. These things are in situations in companies where if the engine stops running for two hours, it’s worth millions of dollars. Then imagine self-managed farms with self-driving tractors? When you hear these stories, you can just see the world is about to change yet again with these smart, connected devices driven by IoT.

The Future of the Subscription Economy

 

CIO.com: Where do you take things from here? What’s ahead for the company?

Tzuo: This is the early innings of this shift. We’re incredibly excited knowing that subscription-based businesses are growing nine times faster than traditional businesses. But the percentage of the economy that’s on a subscription-based business model [is still low]. Caterpillar is a $50 billion company. Even if they billed $1 billion in subscription business, that’s still just two percent of the company. The same thing with cars; McKinsey predicts there will be $1.5 trillion of value created by connected devices, connected car services, and that’s where all the growth is over the next 10-15 years. That’s still less than 10 percent of the entire car industry.

There is a lot more innovation, a lot more assistance that companies want in terms of helping them figure out how to do this type of transition. Our goal continues to be to grow, to bulk up, to build the best technology. We see ourselves as having a chance to be a platform that drives the growth and success of all companies in the subscription economy and that’s what we’re focused on doing.

The Subscribed Academy

 

CIO.com: Is there anything that I didn’t ask you about that’s critical to people’s understanding of the company?

Tzuo: One thing for your readers to know is that we have a Subscribed Academy that is all about guides and best practices around pricing, packaging, go-to-market strategies, financial metrics. I have my BA from a business school. The concepts that you’re taught are anchored on the product economy and people are hungry for these new ways of thinking to drive these new economy ideas. Subscribed Academy has become the premier site for learning about these concepts and I encourage your readers to go there and check it out.

Learn more about how to succeed within the Subscription Economy from The Subscription Economy® Leader with our free ebook: The 9 Keys to Building Success in the Subscription Economy.