How Revenue Recognition Impacts Pricing Strategy

By Jayne Scuncio November 27, 2017

This op-ed was originally published at CFO.com and written by Monika Saha, Zuora’s VP and GM of the Finance Product Line. You can also listen to a webinar on this topic here.

 

The new revenue recognition rules demand tight teamwork between pricing and revenue teams.

In today’s customer-centric subscription economy, pricing and packaging can provide a winning edge. Companies using the subscription business model are using this key customer-touching aspect to differentiate their offerings. The more successful ones tend to offer plenty of flexible pricing and payment options.

These companies think of pricing and packaging in the same way that they think about product development: It’s in a constant state of evolution. It’s never 100% done.

Indeed, as market pressures grow, pricing teams are often expected to rejigger their offerings overnight. But pricing decisions are almost always based on (and iterated upon) looking at the potential rise in subscribers and upward-trending growth charts, without considering the downstream implications to the back office.

Wait. Don’t more customers = more revenue = happy revenue teams? Not always.

Accountants are happiest when the math adds up. But the new accounting standards ASC 606 and IFRS 15, which go into effect for 2018 years, are forcing companies to re-evaluate when and how they account for their revenue, and in the process threatening to upend finance-team harmony.

The new rules are based on one overarching principle: companies must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered at that point.

So, what does pricing have to do with revenue recognition? Let me explain.

In a world where a plethora of new monetization models are now possible, the new rules dramatically multiply the complexities of revenue recognition. Look at a sample of recent headlines: Uber, Amazon and Microsoft brace for accounting shake-upAmazon says new accounting rule will change when it recognizes sales of its devicesBoeing and other big defense companies face special challenge in new revenue rulesTech Teams Rush to Catch Up as New Accounting Rule Looms.

Let’s look at Amazon, for instance. The retail giant sells in so many ways — subscriptions (example: Prime); direct to consumer (example: direct purchase of Amazon Echo); via retailers (example: purchasing Amazon Echo through a different retailer); gift cards, etc.

Under the new guidelines, pricing and deal structures are interpreted differently. Amazon pointed out the impact in its July SEC filing, stating that it won’t be able to account for revenues the way it has been doing.

The changes particularly impact Amazon-branded electronic devices sold through retailers, the company said. Revenue from such sales will be recognized upon sale to the retailer rather than to end customers.

Also greatly affected will be the unredeemed portion of Amazon’s gift cards, which the company will begin to recognize over the expected customer redemption period, which is substantially within nine months. Under the existing rules, Amazon does not recognize revenue until gift cards expire or when the likelihood of redemption becomes remote, generally two years from the date of issuance. At the end of 2016, Amazon’s liability for unredeemed gift cards was $2.4 billion.

That’s just one example. Boeing has told investors and the SEC that the new standards will have a material impact on its income statement and balance sheet. Public companies like Verizon, Hortonworks, and Workday are dealing with  higher costs to meet the guidelines. General Motors estimates that adopting the new standard could reduce its beginning balance of retained earnings by as much as $1 billion. There are many more examples as well.

As companies race to adopt the new accounting standards, this is also a time to look ahead and ensure that such situations are avoided in the future. How to do that? By taking a fresh look at how pricing teams and revenue teams collaborate going forward.

Now more than ever, it is crucial for pricing and revenue teams to collaborate closely to connect the dots between the business’s pricing and packaging needs and the resulting impacts on revenue operations and revenue outcomes.

Revenue teams should always understand the business motivations behind different pricing or packaging models, and pricing teams should always understand the revenue implications of their pricing and packaging decisions.

Without this close alignment and collaboration, finance teams will find themselves living with the revenue nightmares resulting from creative pricing and packaging choices. Or, worse yet, finance teams will begin to push back on certain pricing models because they don’t have the means to automate revenue recognition for these pricing scenarios at scale.

In practical terms, to avoid potential downstream issues, make sure to include revenue-team representatives on the pricing committee and involve them in deal structuring. It’s also a good idea to establish templates and processes to model deals from sales all the way through revenue.

There’s no doubt that pricing teams hold a great deal of responsibility in figuring out how to take products to market and grow the business. But for a business to be truly successful, it must consider all the implications of its pricing decisions before it makes them.