Protik is the Managing Partner at Standav, a system integrator that delivers CRM, Quote-to-Cash and CPQ solutions & Adviser at RevvSales
Subscriptions are now everywhere — be it for streaming movies, ordering your shaving kit or even clothing. Instead of making large upfront payments, the concept of making small, regular payments has caught on with consumers. Referred to as the subscription economy, it has become a popular way of doing business in the consumer sector.
Although it is more widely known in the consumer market, subscription models are also booming in business-to-business (B2B) companies. Increasingly, many B2B companies realize that the subscription model helps them build long-term, profitable and sticky relationships with clients. In the B2B space, companies like Salesforce and Adobe pioneered the model through software as a service.
Many industries in the B2B space are now looking at ways to turn some of their core offerings into subscription-based models. Even companies that sell products that last for a long time are finding ways to offer subscription services. For example, Otis Elevator Company uses IoT and analytics to sell a subscription-based elevator management platform called Otis One. The platform provides real-time insights to predict issues even before they happen and minimize downtime. Otis now generates about 55% of its revenues from services and 45% through new equipment sales.
How do B2B subscription models work?
In traditional “asset” purchase models, customers pay a large amount upfront for the product or service as a perpetual license fee and then pay more for maintenance, support and upgrades. In the subscription business model, customers pay a subscription amount each month or year that is less than the traditional model while getting access to the latest version of the product or service as it is released. As you can imagine, most businesses in the past focused on filling the sales pipeline rather than retaining existing customers. With the subscription model, the primary focus is on boosting customer retention for cross-selling and upselling.
Why do subscription models command a higher valuation?
Every business wants to achieve a higher valuation. There are several benefits of a higher valuation, from the ability to raise funds from investors on better terms to having more negotiation power in a merger or acquisition. Today, a primary appeal for a subscription business is the valuation that it commands. Otherwise, how do you explain that Salesforce commands a higher market valuation than SAP, although SAP has double the Salesforce revenues?
According to John Warrillow, author of The Automatic Customer, a recurring business’s value can be up to eight times that of a similar business with very little recurring revenue. Here are a few reasons subscription businesses make better financial sense:
1. Stable and predictable revenues. Subscription businesses look at a key metric called annual recurring revenue (ARR), the value of the contracted revenue that your business makes through subscriptions normalized to one year. This recurring revenue works as a baseline for expected revenue every year and is a useful way to measure a subscription business’s health. This visibility and predictability of recurring revenues are what Wall Street loves. You just need to maintain your existing customer base by ensuring they do not downgrade or cancel their subscription while winning new customers.
2. Ability to control expenses and reinvest in growth. Because of better visibility and predictability of revenues, you can make better business decisions and manage cash flow to drive business growth. For example, a company with $100 million in revenues, of which 75% is recurring, is assured of $75 million in revenue at the start of the year. You can make forecasts based on real-time customer activity instead of past data and manage spending if the projections are not in line with your expectations. Having a steady revenue base also allows subscription businesses to invest aggressively in growth without taking undue risks.
3. Expand your customer base. Most B2B businesses sell through their direct sales force and tend to focus on medium to large enterprises. However, according to data from the Census Bureau’s Annual Survey of Entrepreneurs (via the SBE Council), “firms with fewer than 500 employees accounted for 99.7%” of businesses. These businesses’ smaller budgets make it unattractive for large companies to engage using their direct sales teams. However, they have a shorter sales cycle and cumulatively present a huge opportunity. The subscription model can make it easier for these long-tail customers to buy from you. Moreover, compared to a one-time purchase, you can get access to your customer’s behavioral, financial and demographic data that is useful for cross-selling or marketing.
Watch out for the common pitfalls.
Many companies valued growth over profit in the race to join the subscription gold rush, resulting in several subscription businesses floundering. Here are some lessons from these consumer businesses that are also applicable for B2B subscription businesses:
• Don’t make the mistake of scaling fast even before having a product or service-market fit.
• Don’t go overboard on acquiring customers by giving away the product/service for free.
• Focus on the right metrics such as churn rate and engagement.
• Instead of focusing excessively on the product or service you offer, focus on the value you deliver to customers.
Additionally, the existing technology systems also pose a challenge in shifting to a subscription-based business because they do not have the flexibility to evolve and handle multiple pricing models as businesses scale. Multiple revenue models can also make recurring billing challenging to manage.
A technology system for a subscription-based business should support service bundles, discounts, support, and additional products and services. Its billing system should handle events like discounts, credits, free trial periods, etc., and should manage failed and multicurrency transactions.
Customers today choose a B2B subscription model because of the promise of convenience and excellent service. It allows businesses to focus on building long-term relationships with their customers rather than filling the sales pipeline. The subscription model can be a great way to achieve predictable cash flow, a stable customer base, higher profitability and, as a result, higher valuation.