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Across the technology industry, product revenue growth rates are flat to declining while services revenues are on the rise. Customers are choosing to consume their tech on a subscription basis as part of new “as-a-service” models, and if you think your traditional product-centric technology company is immune to the rise of as-a-service offers, you’re fooling yourself.
This is why the technology industry’s leading companies have begun changing their business models to focus less on products and be more about services and customer outcomes. TSIA has identified 4 new emerging economic engines, two of which that involve managed services that we highly recommend you model your business after in order to meet this dramatic change and increase your revenues.
The recent industry disruption is forcing a lot of traditional product-centric technology companies to switch their focus on which economic engines, or revenue sources, are going to drive the success of their business.
In his paper, “Emerging Economic Engines of Technology Providers,” TSIA’s executive director, Thomas Lah, goes over the primary sources of revenue for technology companies, including how things were done in the past. Previously, there were 6 ways for technology companies to make money, but the first two are especially important:
Attached to these two primary categories are four revenue stream sub-categories:
From these categories of revenue streams come a few types of economic engines: product providers, product extenders, solution providers, or system providers. But really, most companies could be placed into either the “product provider” or “product extender” buckets. Many companies today are turning into product extenders because services now bring in more revenue than product.
As a result of that shift, there are new business profiles with four new economic engines beginning to take shape within the technology industry. These are especially important for companies thinking about or are currently active in managed services.
But first, here’s are several elements that are used to identify these new profiles:
This is how you start to identify the new profiles. And these are the 4 new economic engine models for companies going forward. If you were making money in one of the 6 ways in the past, you’re going to have to figure out how to play in one of these 4 new models your business is going to fall under.
(Click image to enlarge.)
There are four types of economic engines emerging in the technology industry.
There are four types of economic engines emerging in the technology industry.
These are companies that used to sell their technology as CapEx but now wants to move to OpEx/subscription models but are still incredibly product-centric. HubSpot is an example of a subscription provider, where most of their revenue (95%) comes from product or product-as-a-service, and 5% comes from professional services. They don’t have standalone managed services or support services, as they are already included in the product. Here are the elements that define a subscription provider:
These companies do more than just convert product to “as-a-service”. Born-in-the-Cloud companies can belong in either the subscription provider or subscription provider plus categories. Using Veeva Systems as an example, 80% of their revenues still come to product, but they extend more into services. Elements of a subscription provider plus are:
Most product companies naturally go to subscription provider and subscription provider plus as they start to deploy XaaS offers. However, I should note that while both of these models are growing they are generally not profitable. That’s why TSIA highly recommends that you model your business after either of these next two profiles, which involve managed services.
Managed services isn’t a new concept, especially for companies like Xerox that have had managed print services for years. A 2016 snapshot that shows 60% of their revenues coming from annuity (managed print services), with some CapEx solutions and consumables is a big part of their revenue engine. Defining characteristics of managed providers are:
This is a new version of managed provider that is just starting to emerge, where half of their revenue comes from annuity and a quarter of their revenue comes from XaaS, while a substantial amount of revenue comes from professional services. These services go to a different audience, primarily the business owner, with the intent to drive business value through outcomes. Defining characteristics of a managed provider plus are:
Again, while all four emerging engines are growing, only two (managed provider and managed provider plus) are generally profitable. So, if you want grow revenue and ensure that it is profitable growth, you’ll need to focus on either of these two models.
No matter which of the above models you choose to define your organization, you’re also going to want to track your revenue growth and measure it. In a transactional, product-led business, there is really only one growth metric that matters, and that’s new revenue growth. However, in a recurring revenue business such as managed services, there are four major growth metrics, with each one offering a different insight into the growth health of the business.
Top-line revenue growth tells you how good your sales organization is doing with the “Land” motion and at generating near-term revenue. Base Revenue Growth tells you how good your sales or customer success reps are at “Expand” revenue. Total Contract Value Bookings is a key indicator of longer-term growth health of the business. Total Recurring Revenue Growth tells you how well the overall organization is doing at growing the business as it combines Base and Net-New growth figures and it factors in revenue erosion.
Here are some simple formulas for how to calculate all of these specific managed services KPIs.
This metric looks only at net-new revenue.
How to Calculate Top-Line Recurring Revenue Growth: Most current full year new revenue minus previous year new revenue. Divide the difference by the previous year’s net-new revenue. Convert to percentage.
This metric looks at all recurring managed services revenue, including net-new, base revenue, and base revenue growth. This revenue includes all base revenue and new revenue from both new and existing clients.
How to Calculate Total Recurring Revenue Growth Rate: Total current year’s recurring managed services revenue minus the previous year’s total recurring managed services revenue. Divide the difference by the previous year’s total recurring managed services revenue. Convert to percentage
This metric looks at the value of all contracts, including recognized revenue and revenue still yet to be recognized over the duration of the contracts.
How to Calculate Total Bookings Revenue Growth: Total value of existing contracts minus the total value of previous year’s contracts. Divide the difference by the previous year’s total contract value. Convert to percentage.
This metric looks at the growth of base customers only.
How to Calculate Total Base Revenue Growth: Most current full year revenue from existing customers (excluding revenue from new customers) minus previous year base revenue. Divide the difference by the previous year’s base revenue. Convert to percentage.
If the answer to any of these is “no”, TSIA can help! I encourage you to check out my “State of Managed Services and XaaS 2019” paper, which is available to anyone. Members of TSIA’s Managed Services practice have exclusive access to another valuable resource, “Emerging Economic Engines of Technology Providers”.
Be sure to reach out to TSIA to talk to us about how membership in our Managed Services research and advisory practice can help you solve your biggest challenges in successfully integrating managed services into your as-a-service business strategy. From data-backed research to business frameworks and focused advisory, TSIA is helping thousands of technology and services professionals like you stay ahead in the face of this changing industry. I look forward to hearing from you.
Post Date: April 24, 2019
George Humphrey is the vice president and managing director of service and delivery research and advisory for TSIA. Given his extensive background, George also directly supports the managed services research practice. He is a networking and communications industry veteran with over 25+ years of experience. Throughout his career, he has held several leadership positions in managed services, including global strategy, product line management, marketing, operations, and client management.
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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.