Recurring Revenue Handbook: The 5 Critical Success Factors

Denis Pombriant, author and Managing Principal at Beagle Research, walks through the five critical success factors for recurring revenue models, and the data you need to help your company grow and thrive in the Subscription Economy.

The “Data Problem” of Subscription Businesses

Technological innovations have always spurred huge shifts in the economy. In the 18th and 19th centuries, technological innovation triggered the shift from an agrarian to a manufacturing economy. In the 20th century, manufacturing business models governed by enterprise resource planning (ERP) systems became the norm. In the 21st century, we are undergoing yet another major shift as the product-centric business model gives way to the subscription economy in which customers contract for products and services on a pay-as-you-go basis built on recurring revenue models.

Despite the shift, many companies continue to adhere to a product-centric model, relying on ERP systems to run the business and provide data to support decision making. But. because conventional ERP systems don’t readily accommodate a subscription business, subscription companies are resorting to spreadsheets and other data management approaches that operate outside the ERP system. In short, they have a data problem.

In a product company, the business model and business management systems are built around a core product — the material thing being delivered. But a subscription company orients itself around the whole product, which includes the core product along with its quality, price, availability, delivery, and terms. Each component is part and parcel of the deliverable. Consequently, a subscription management system has more work to do on behalf of the vendor and the customer.

In addition, at the center of a subscription business is the vendor-customer relationship. And, quite naturally, subscription businesses need data and metrics related to the health of this relationship.

Unfortunately, current ERP systems don’t recognize what a modern customer is; they cannot distinguish between a one-time purchase and a transaction that will recur in the next billing cycle. Managing a subscription business isn’t really harder than managing a conventional business but it’s very different. Business executives who will succeed in the subscription economy must keep five critical success factors (CSFs) in mind. All five of them boil down to customer data.

Success Factor #1. Strong Customer Relationships

Key question: Is your business focused on pushing out products or building relationships with customers?

Relationships are the lifeblood of a subscription-based business. Customers interact with all aspects of your business without regard for the internal boundaries between, say, sales and service. Service actually looks a lot like sales to subscription customers because it is typically the more dominant point of interaction.

Robust subscription relationships have three attributes in common:

  1. Faster turns. Customers change their subscription configurations at will to adjust consumption to their current needs. They can reverse those changes just as fast.
  2. Lower margins and revenues. Subscriptions enable customers to buy just what they need for the immediate future. These smaller transactions generate less revenue and smaller margins. Therefore, to make profits, subscription companies have to be operationally excellent while managing more transactions.
  3. Easy severability. The subscription model provides maximum flexibility for customers. If the relationship sours or the customer isn’t deriving the value they expect from the service, the customer is free to disengage.

Fortunately, subscriptions generate a great deal of customer data. Through analysis, you can gain insight into the quality of your customer relationships. Data reveals which customers are actively embracing a solution, which are struggling, and which are giving up.

Customer retention, churn, and renewals are all metrics derived from customer data. Other metrics related to use and frequency — number of users over all, number per unit of time, and products used per customer — can alert you well in advance if a relationship is at risk.

Success Factor #2. Agile, Aligned Business Systems

Key question: Are your business systems aligned to provide flexibility and capture the right data?

Transitioning from making and selling products to making products and selling subscriptions is a big deal. Subscription management requires a steady stream of information about demand, customer acceptance and any drift in satisfaction that could affect the subscription renewal. So as you shift to a subscription model, you’ll need to collect data about repeatable processes that, in a product-based company, are one-time events.

Demand and consumption rates are good examples of metrics that provide visibility into customer satisfaction levels.

Data drives analysis which produces the information companies need to run their businesses. To capture the needed data, a new subscription company needs to modify its business practices and supporting software systems. Subscriptions offer more points of contact between vendors and customers and the relationship is more intimate. Customers see vendors more as partners and rely on them more for their success.

Some of the most important areas of differentiation between a product company and a subscription company include:

  • Configuring deliverables. If customers subscribe to a “wine of the month club,” they agree to purchase many cases of wine. However, they don’t want to take delivery of or pay for all of them up front. So a vendor must scale the deliverables and billing to reflect demand and consumption rates. Monitoring these and other metrics provides visibility into the health of your business.
  • Operational efficiency. Margins on subscription transactions are small and, without operational efficiency, they can be quickly wiped out if rework is needed. Moreover, with subscriptions, vendors can innovate a potentially huge number of new product configurations. These permutations could easily swamp a conventional ERP system. Consequently, any worthwhile subscription management system has to support substantially higher transaction volumes and custom configurations.
  • Terms and conditions. Subscription terms and conditions are tightly interwoven with service delivery. The term might be only a month, but it will automatically renew and it’s subject to editing and cancellation. The term might cover multiple periods, such as when a monthly subscription is paid a year in advance. Business systems must properly account for monies that are collected but not yet applied. These monies present a data opportunity that drives insight into business health. For example, deferred revenues should be growing in a company that is adding new customers and signing them to long-term agreements, as well as in a company that is increasing its footprint within established accounts. Little or no growth of deferred revenue could signal low renewal rates.
  • Sales and service. After the initial purchase, which may happen through an automated Web interface, customers often interact with service agents or through the same Web interface. Changing a configuration, adding capacity and products, and changing the order are all sales interactions with a significant service element. They must be executed correctly and efficiently. ERP systems are typically a poor fit for this type of activity.

Success Factor # 3. Real-Time Access to Customer-Generated Data

Key questions: Are you able to effectively monitor and measure business health and growth?

A product company grows by developing and selling more products. A subscription business grows by adding customers or enlarging its footprint in existing customers and then monetizing them. The data a subscription company generates makes it possible to identify which customers are most profitable, which require a lower (or higher) ratio of onboarding and other services and which are poised for growth.

To acquire that information, subscription businesses gather and analyze customer-generated data for three important sets of parameters:

  1. Uptake and usage. Subscription management system usage statistics can reveal valuable information such as whether customer use is increasing over time or whether uptake varies by season. Armed with this data a vendor can develop key performance indicators (KPIs) that track uptake and show use tolerance ranges. This information is critical to understanding when an account might be in jeopardy.
  2. Churn and annual renewals. A subscription company is more profitable when established customers renew because they don’t require onboarding activities that cut into margins. So measuring churn and renewals can help pinpoint how fast a company is growing and how profitable it is.
  3. Recurring revenue and deferred revenue. As the customer base expands, a growing subscription business generates increasing amounts of recurring revenue. If the company also engages in long-term contracts where the revenue is recognized in small (monthly) increments, the company will have an expanding amount of deferred revenue on its books, which is another measure of growth.

Success Factor #4. End-to-End Business Flow Optimization

Key question: Do you have a seamless flow from order to revenue?

Optimizing a subscription business leverages different processes than optimizing a conventional business. Moreover, conventional ERP systems aren’t built to handle recurring revenue. They have no concept of a repeat customer and they can’t handle the complexity of subscriptions.

Subscription companies have an almost infinite variety of deliverables made possible by the subscription model because it enables recombination of individual products in innovative ways.

Now, imagine administering this huge array of deliverables against an equally large array of customers with differing needs. The only way to cope is with automation. Customers don’t care about the complexity you have to deal with. They expect seamless flow from order to fulfillment and they expect changes to be reflected accurately in their statements. Vendors strive for this flow because it results in less rework and higher margins.

Unfortunately, if you use conventional ERP for a subscription business, you’ll likely have to turn to cumbersome spreadsheets to handle data and operations that have no analog in ERP. To avoid these problems, a subscription management system has to be part of a larger grouping that encompasses customer relationship management, general ledger, your website, payment gateways, and provisioning systems. When these systems work together, customers have great experiences because they are at the center of everything.

And subscription vendors benefit from having an integrated, end-to-end set of process flows that minimize costs, maximize revenue, and optimize customer data generation they can use to run the business efficiently.

Success Factor #5. Actionable, Forward-Looking Metrics

Key question: Are you leveraging data to understand your business and drive key business decisions?

A conventional business person might look at closed deals, revenue, returns and other backward-looking measures. That’s like steering a ship by looking at its wake.

A subscription business person has more operational data, and a greater ability to act on it quickly. KPIs clearly show if customer retention is increasing; they can help determine the most effective discount strategy or show where a vendor is leaving money on the table.

This ability to tap into information can be the difference between success and failure.

Bottom Line: It’s All About the Customer

Subscriptions turn big acquisitions into small purchases that reduce costs and make many products affordable to more customers. The benefits for vendors and customers are compelling. But executives need to manage their subscription companies very differently from traditional product companies. How successful you are will depend on how well you address the five CSFs described in this article.

Understanding the crucial nature of customer relationships is paramount. To gain that understanding, you’ll need to capture and analyze customer-generated data to extract information that enables fact-based decision making and provides insight into business health.

Realigning your business systems will be crucial to getting the right data and establishing a seamless flow from order to fulfillment will be essential to creating a positive customer experience that encourages customers to stay with you month after month.

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