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Dating back to the Bible story about Jonah getting swallowed by the whale, it’s been generally agreed that being stuck in a fish is bad news. Yet many companies have found themselves stuck in a fish as they make the switch to a subscription sales model. Let’s explain what the XaaS/SaaS fish model is and how you can negotiate your way through the fish as a SaaS/XaaS business.
For years now, we’ve been seeing vendors in technology, software, industrial automation, medical equipment, and other sectors adopt the subscription sales model. There are several factors driving the rise of SaaS/anything as a service:
Despite the popularity and the benefits of the subscription sales model, many companies are reluctant to embrace it. The reason is simple: the switch from a capital asset transaction model to a subscription model necessitates a new financial model.
The new financial model can be a bitter pill for organizational leaders to swallow. Future financial performance will not resemble past financial performance. In fact, financial performance will look worse, at least in the short-term. Nobody wants to explain a financial decline to shareholders and other stakeholders.
Having witnessed many companies make the journey to subscription selling, TSIA discovered clear trends in the financial trajectory for this journey. When TSIA charted this trajectory, it looked like a familiar shape. Voila, the fish model was born. Today the fish model is a reality for many subscription businesses.
The two lines that outline the fish represent revenue and costs. The difference between revenue and costs is, of course, your profits. On the chart, the profits are represented by the white space between the two lines (i.e. the body of the fish).
Most companies will start on the left side of the fish. These are companies that have built their business with a capital asset transaction model. Historically, these business models have been very profitable.
Great, but now the company wants to begin offering subscriptions. The goal is to end up on the right side of the fish. At TSIA, we call this “swallowing the fish.” When the subscription model is fully operational, SaaS/anything as a service companies will reap benefits:
To move from the left side of the fish to the right side (swallowing the fish), however, companies must get through the middle of the chart. This is the difficult part of the journey.
As you can see, the lines of revenue and costs diverge in the middle section of the fish. Costs will go up and revenues will go down. But why is that?
Let’s look at the revenue line. When a company makes the switch from up-front revenue recognition transitions to ratably recognized, multi-year subscriptions, the comparable revenue performance will dip. As the new subscription offer begins to cannibalize your old offer, the comparable revenues will look even worse.
While this is happening, the company will also need to make some necessary investments to ensure the company can handle the new subscription business. To succeed as a SaaS/XaaS business, you will need a Customer Success team, an Analytics team, data centers, and more. These investments are all additional costs.
Expenses are increasing while comparable revenues and profits are decreasing: the middle of the fish is not a great place to be stuck.
In essence, the main problem represented by the fish is a matter of expectations. When a company is accustomed to a certain level of profits, revenue, and costs, stakeholders expect the company to maintain those levels. Any significant fluctuation in those levels upsets expectations.
Unfortunately, the fish is unavoidable. Unless a company was born in the cloud as a subscription business, it will need to navigate the fish to adopt the subscription model. The goal is to get through the middle part of the fish as efficiently as possible and minimize the gap between rising costs and shrinking revenue. You don’t want a fat fish.
The key to swallowing the fish is planning. To help you plan for success, there are a couple of significant issues that you need to know about in advance. These are tactical issues that TSIA has seen many businesses grapple with as they make the transition to the subscription model and swallow the fish.
First of all, you will need to think about how you plan to compensate the team that will be selling your subscriptions. You need to establish a compensation plan that is both effective in incentivizing the sales team and sustainable for your bottom line.
Many companies run into trouble by offering huge incentives to encourage the sales team to prioritize the new subscription offers over the old capital asset offers. While those big incentives are effective encouragement for the sales team, they are simply not sustainable.
As you can imagine, big incentives inflate costs. Increased costs, of course, mean a fatter fish.
Nevertheless, you do need to think about how you will encourage your sales staff to embrace the new subscription model. If you don’t, the sales reps will likely stick to the old offers they know that offer compensation up front.
As you plan to make the switch to subscription sales, give careful thought to how you will get the sales team on board. For the transition to succeed, the sales team must have a vested interest in subscription offers beyond the initial contract.
The other major issue to consider when switching to a subscription model is renewals. The subscription business model is built on renewals, and customer churn rates are the main determinants as to whether a recurring revenue business succeeds or fails.
A subscription-based company with high churn will experience low growth, high costs, and a negative reputation in the marketplace. Conversely, a subscription-based company that enjoys high renewal rates will gain market share and experience growth.
Customer Success is the team that is responsible for ensuring customers fully adopt the product. Adoption leads to renewals and reduces churn. Thus, it is imperative to plan on adding a Customer Success team when moving to a subscription model.
The addition of new personnel will obviously increase costs and further bloat the fish, but the payoff should justify the investment. Once you get to the right side of the fish, the additional Customer Success personnel will be helping to increase revenue.
By committing to a plan to develop a Customer Success team, the cost and revenue lines on the fish chart will cross again. Once revenue begins to outpace costs, you have successfully navigated into the tail of the fish.
The trip through the Anything as a Service/SaaS fish model can be challenging, but it is ultimately worth it. When a company swallows the fish, it will be poised to reap the benefits of the subscription model. More importantly, the company will be poised to reap the benefits of renewals for years to come.
If your business is contemplating a switch to XaaS/SaaS, TSIA can help you do it right. Contact us to learn more about how to plan for subscription success and how to maneuver your way through the fish.
Post Date: April 6, 2021
Thomas Lah is executive director and executive vice president of TSIA. Since 1996, he has used his incisive analysis, strategic thinking, and creative solutions to help some of the world’s largest technology companies improve the efficiency of their daily operations. He has authored several books, including, Bridging the Services Chasm (2009), Consumption Economics (2011), B4B (2013), and Technology-as-a-Service Playbook: How to Grow a Profitable Subscription Business (2016).
The Technology & Services Industry Association (TSIA) is dedicated to helping technology and services organizations large and small grow and advance in the technology industry. Find out how you can achieve success, too. Call us at (858) 674-5491 or we can call you.