Lately I have been blogging about why vendors in high tech, industrial automation, medical equipment and other market sectors are moving rapidly toward subscription-based offers. In the first two blogs of this series based on my infographic,“Navigating the World of Digital Transformation,” I focused on the perspective of the end customer: what they like and what they don’t like about subscriptions. It’s clear from today’s market trends that many customers find compelling reasons to consume technology as a subscription-based service. Sales are growing at a much faster rate than for traditional CapEx offers.

But is this a better model for the vendors? In the next two posts, I will explore this question in more detail starting with the good news about why recurring revenues are such a hot topic in many board rooms.

Why Suppliers Like Recurring Revenue Business Models

What CEO wouldn’t like to wake up on the first day of their new fiscal year knowing exactly where 70-80% of that year’s revenue is coming from? That is the starting point of the beautiful list of benefits of subscriptions. It’s not only beautiful to CEOs, it’s beautiful to financial analysts and investors. Investing in businesses with highly predictable future revenues has become a favorite recommendation of advisors and has resulted in valuation premiums as much as 60% (or more) over companies of the same size who rely on new sales transactions for most or all of their revenue. 

Recurring revenue businesses face far less risk in their forecasts. Since their top line is highly predictable, they can confidently set expense targets that will reliably yield their profit goals.  They can also take advantage of powerful growth levers like investments that reduce customer churn. Even improving subscription renewal rates by a single percentage point can dramatically boost profitability. That is why investors of all types are constantly probing the renewal rates of the subscription companies they track.

Recurring revenue businesses face far less risk in their forecasts. Since their top line is highly predictable, they can confidently set expense targets that will reliably yield their profit goals.

It’s also the case that, over time, customers can end up with higher total spending levels consuming subscriptions than when they purchase assets from that vendor outright. That’s because somewhere in years 4-7 they typically have spent more on the subscription than the raw purchase price of the asset plus the maintenance costs. It’s a fair trade in that the risk to the customer was lower during this time. Had they not enjoyed benefit from the subscription they could have simply not renewed it. Thus, if the vendor was able to win their renewal each year then they have earned the right to additional monetization for assuming risk that the customer used to bare when they took ownership of the asset.

So it is easy to see why management love offers like XaaS and managed services – they lower risk for the business and increase stock prices.  

But That’s Not the End of the Story

Technology subscriptions were made famous by SaaS, but they are not limited to software.  More and more manufacturing companies are releasing as-a-service offers that may combine hardware, software, and services into a single subscription or monetizing them on a pay-per-use basis. GE is famously selling jet engines by the air hour and HP Inc. is now selling PCs and printers to large enterprise customers on a subscription basis per employee.

While it’s financially harder for a manufacturer to embrace subscriptions (versus software companies) due to the need to carry the cost of the asset on their balance sheet during the subscription period, the allure to customers is proving too great to sit on the sidelines. Many are devising creative strategies to move the asset to a third party financial entity so that they can recognize the asset sale up front and still have many of the benefits of residual recurring revenue. In addition, since many managed service and XaaS equipment contracts do not specify that all the equipment must be new, manufacturers are finding new life for used assets.

Not only does the Cloud give [suppliers] vast potential for new and differentiating features, it also gives them far more visibility into the disposition of the assets and the adoption by the customers.

Last but certainly not least, suppliers love modern subscription offers because most all of them are harnessing the power of the Cloud. Not only does the Cloud give them vast potential for new and differentiating features, it also gives them far more visibility into the disposition of the assets and the adoption by the customers. That allows them to reduce downtime, cut service costs, monitor utilization–all things that help make subscription offers profitable and likely to renew.

So that is some of the good news from the supplier perspective. But subscriptions also present new challenges that management must contend with. In my next post, I will define these challenges and talk about how executives are coming to terms with them.

Read more posts in "The Digital Transformation Journey" series:

 
 
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J.B. Wood

About J.B. Wood

J.B. Wood is president and CEO of TSIA. He is a frequent industry speaker and author of the popular books, Complexity Avalanche (2009), Consumption Economics (2011), B4B (2013), and Technology-as-a-Service Playbook: How to Grow a Profitable Subscription Business (2016), and has appeared in leading publications, such as Fortune, The New York Times, and The Wall Street Journal. He works with the world's largest technology companies on strategies to extend their innovation platform beyond the lab and into the customer experience, particularly in the age of cloud and managed services.

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