What to know when adopting subscription or consumption business models
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What to know when adopting subscription or consumption business models
The transition away from traditional
licenses to a subscription or consumption
delivery model requires fundamental
structural changes along with adopting
an entirely new perspective on customer
relationships. For those who are ready
for transformation, now is the time to put
in the building blocks of success.
Contents
2 Chapter 1 — Pricing 4 Chapter 2 — Sales 6 Chapter 3 — 8 Chapter 4 —
and bundling transformation and Operating model KPIs, accounting
customer incentives change and revenue
management
Authors
Ken Englund Dave Padmos
EY Americas Technology Sector Leader EY Americas TMT Leader
Contributors
Raghav Mani Richard Golik
EY Americas TMT Strategy EY Global TMT Senior Analyst
and Operations Leader
Introduction
The growing preference for companies more predictable and companies that financial and strategic challenges
to use third-party cloud-based software offer them can generate more revenue companies face as they consider making
services is having a profound impact over the long haul. A recent CIBC World the transition. These discussions
on the enterprise technology market. Markets study found that, on an annual uncovered several key learnings and
For software providers, the subscription basis, SaaS stocks outperformed the leading practices, but the pace of change
business model is becoming the mature software names, with an varies; some companies are rapidly
dominant one. Worldwide, perpetually average stock price return of 83% vs. adjusting, while others are struggling to
licensed software revenues will shrink by an average year-to-date mature work out which steps to take, how and
a compound annual growth rate (CAGR) software return of 22%.² when. Often, the determining factors are
of 6.1% between 2020 and 2024, based on the nature and complexity of
Subscriptions don’t necessarily generate
while software subscription revenues their product offerings and the need to
big up-front fees like traditional
will grow by a CAGR of 16.6%.¹ maintain certain legacy businesses.
licenses do, but the lifetime value of
New software-as-a-service (SaaS) each customer is often greater, as long
entrants were “born in the cloud,” as enterprise technology companies The transition away from traditional
but numerous hardware and software effectively manage churn and are licenses doesn’t happen by flipping
companies started out with traditional successful at selling additional services a switch. Respondents are typically
on-premises licensing models. Those to their clients. Subscription models taking five to seven years. Regardless
companies want to add a subscription are tremendously scalable, so providers of where enterprise technology
element to their business. Eventually, can grab a bigger slice of an expanding companies are in their transition,
many companies may also offer their pie. Using a land-and-expand strategy, our research shows that moving to
products on a pure consumption or enterprise technology companies can a subscription model requires an
“by-the-drink” basis, although this sign customers up to small deals and extensive enterprise transformation,
model is still in its early days. expand their footprint to more products not just technology re-platforming.
and services over time. This also applies Our interviews uncovered several
While there are certainly risks involved
to by-the-drink consumption models, transition challenges, but they largely
in transitioning away from the traditional
where customers can try new products encompassed four main areas:
on-premises licensing model, there
for a very low cost (or even free) and
are also great rewards. Valuations of 1. Pricing and bundling
expand usage as their needs grow.
enterprise technology companies that
2. S
ales transformation and
adopt subscription models with new But this transition is neither simple nor
customer incentives
value metrics like annual recurring rapid, particularly for those enterprise
revenue (ARR) and net revenue retention technology companies that offer 3. Operating model change
(NRR) are higher than those that traditional products and services. EY
4. K
ey performance indicators
generate most of their revenues from professionals interviewed subject-matter
(KPIs), accounting and revenue
perpetual licenses. The higher valuations resources in the enterprise technology
management
occur because subscription earnings are industry to identify the key operational,
1
“Worldwide Software License, Maintenance, and Subscription Revenue, 2018–2024,” IDC, July 2020.
2
Stephanie Price and Scott Fletcher, “Software Valuation Month, November 2020,” CIBC World Markets, 2 November 2020.
1
1
Pricing and
bundling
2Pricing and bundling new offerings to meet changing
customer requirements and increase profitability
At its core, the change to a Many of these companies have As products and delivery methods
subscription model fundamentally customers that are happy with evolve, enterprise technology
transforms the way products are the way they buy IT products and companies must also choose what
developed and delivered. As a services. Enterprise technology markets to serve. Our research
result, enterprise technology companies must offer a compelling shows that many enterprise
companies must create highly value proposition to persuade their technology companies have not done
customized offerings and price customers to switch as well as a proper customer segmentation
them to be attractive to customers provide a simple and straightforward analysis to determine which markets
but not “leave money on the path to do so. Certainly, the key to they can operate profitably in or
table.” Yet our discussions revealed success is the ability to effectively what capabilities they need to serve
that many enterprise technology move away from product-based them. We found that successful
companies still don’t have formal pricing toward new value-based enterprise technology companies
programs, strategies or methods pricing schemes. incorporate data-driven customer
in place to profitably price and segmentation early on as they
measure their offerings. develop their strategic road maps.
Key questions
1. Do you have a structured method to price your offerings
so that they are attractive to customers and don’t leave
money on the table?
2. Have you done a customer segmentation analysis to
identify the markets in which you can operate profitably?
3. How have you performed price segmentation to support
pricing decisions?
32
Sales transformation
and customer
incentives
4Reimagining the sales organization and customer
incentives to meet several needs at once
Sales incentives can be a particularly While specific leading practices These behavior trends can be shared
challenging area. The move are still emerging around sales with clients to help them maximize
toward subscription requires compensation, most enterprise the services they buy, creating a
enterprise technology companies technology companies recognize powerful upsell tool. These tools can
to completely rethink how they the need to move away from a also be used to proactively identify
incentivize, measure and equip their “sell things” mindset to one and address potential issues.
salesforce and third-party sellers. that’s more focused on nurturing
Companies also are grappling with
This is particularly difficult if they long-term relationships. This is
how and when to use customer
offer a mix of both traditional and critical, because it can take up to
incentives. Many of our clients’
subscription options. two years to cover the cost of
customers don’t understand how
sales and begin to turn a profit.
Wrestling with how to calculate new models will benefit them.
compensation, including Companies are also finding that This requires being prepared to
commissions and bonuses, in a establishing a customer success demonstrate the costs and delivery
way that appropriately balances organization — one that monitors benefits of subscription models.
the needs of the salesforce, and reacts to the needs of Some enterprise technology
customers and the larger enterprise customers along their journey — is companies are creating value
goals is key. Sales training is a powerful tool to help enhance and metrics that their salespeople
equally important, since most maintain that critical relationship. take to market. Others phase
salespeople are still accustomed to Companies with well-developed discounts out over time or sunset
selling licenses. Training must be customer success organizations their legacy products, in effect
accompanied by an effective set of use sophisticated data tools to forcing customers to move away
quoting and pricing tools, updated understand customer behaviors. from licenses to subscriptions.
competitive benchmarking and
new total cost of ownership
(TCO) calculators to explain
TCO across different consumption Key questions
models, and new solution-based
value propositions.
1. Do you understand the sales compensation implications of
moving from a transaction orientation to one more focused
on long-term customer relationships?
2. Do you have the capabilities to train your salesforce to
sell subscription-based services?
3. Do quoting and/or pricing tools need to be updated? Do
you have dedicated resources to training on these tools?
53
Operating
model change
6Many enterprise technology The lack of well-developed product
companies are unprepared for the usage and adoption metrics also
Transforming move or are unsure about their surfaced as a challenge for many
organizational readiness. They do enterprise technology companies.
operational not have an integrated operating A lack of these metrics creates a
capabilities model capable of supporting a significant blind spot for gauging
combination of new and existing the success of current products
to support a new offerings across the enterprise. and limits visibility into upsell
delivery model Areas that are often overlooked opportunities. It also leaves
are back-end supporting processes, enterprise technology companies
such as product entitlements and unable to adjust quickly to
provisioning, customer support, market shifts and hampers their
and billing and invoicing. decision-making around long-term
investment priorities.
Key questions
1. Do you have an end-to-end integrated operating model
to support a combination of new and existing offerings?
2. Have you developed customer usage metrics for your
products and/or services to improve internal performance,
drive product sales and marketing, and establish long-term
investment priorities?
3. Can your billing systems and processes support the
transition to a subscription model? With a new and
complex product suite, is there a need to utilize
third-party vendors?
74
KPIs,
accounting
and revenue
management
8Developing a growth and transformation
narrative to gain stakeholder buy-in
We found that there is critical KPIs and value propositions into their state is and how the enterprise
importance being placed on own KPI calculations. Some road technology company plans to get
developing relevant KPIs (ARR test new KPIs for several quarters there. A necessary first step is
being just one), since traditional to make sure they are accurate and meeting regularly with investors
operational and financial measures actionable. to explain how the new KPIs
do not accurately reflect the demonstrate enterprise value, along
Once the relevant KPIs are
changing levers of business value. with clarifying the accounting and
developed, enterprise technology
However, developing these KPIs revenue implications of moving to
companies must use relevant KPIs to
is difficult. First, many enterprise a subscription model. One leading
explain to external stakeholders how
technology companies are still practice we observed is teaching
the transition will impact their near-
unsure of which measures matter CEOs, CFOs and communications
and long-term performance. This
in a subscription model. Once these staff how to speak subscription
includes creating a narrative around
KPIs are defined, the data to support and consumption language with
the long-term benefits of shifting to
them is often scattered in different investors. Finally, the transition
a subscription model, since it is likely
systems and business units, and from on-premises to subscription
that the change will not be revenue
many haven’t deployed advanced fundamentally alters how, when
neutral — at least in the short term.
analytics tools to interpret the data and where revenues are generated,
that does exist. For enterprise technology companies which has significant impacts on
to mitigate any possible negative finance and accounting processes
We found that enterprise technology
share price impact, full transparency that CFOs must address.
companies that are further along in
is essential regarding what the end
their KPI journey include competitor
Key questions
1. Do you understand the sales compensation implications
of moving from a transaction orientation to one more
focused on long-term customer relationships?
2. Do you have the capabilities to train your salesforce to
sell subscription-based services?
3. Do quoting and/or pricing tools need to be updated? Do
you have dedicated resources to training on these tools?
9EY | Building a better working world EY exists to build a better working world, helping to create long-term value for clients, people and society and build trust in the capital markets. Enabled by data and technology, diverse EY teams in over 150 countries provide trust through assurance and help clients grow, transform and operate. Working across assurance, consulting, law, strategy, tax and transactions, EY teams ask better questions to find new answers for the complex issues facing our world today. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Information about how EY collects and uses personal data and a description of the rights individuals have under data protection legislation are available via ey.com/privacy. EY member firms do not practice law where prohibited by local laws. For more information about our organization, please visit ey.com. © 2021 Ernst & Young, Ltd. All Rights Reserved. US SCORE no. 12605-211US 2103-3723778 ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please refer to your advisors for specific advice. ey.com
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