Picking the right recurring revenue model aria systems by Andre Goyette

e-Paper

Picking the Right Recurring Revenue Model

“Not all revenue is created equal.” —Jim Schleckser, CEO of the The CEO Project

Picking the Right Recurring Revenue Model

Table of Contents Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 How Do You Pick the Right Recurring Revenue Model? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Three Models for Recurring Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 The Subscriptions Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 The Usage Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 The Subscription plus Usage Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Pricing Tactics Complement Recurring Revenue Models. . . . . . . . . . . . . . . . . . . . . . . . . . . 10 The Importance of Automation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Requirements for a Recurring Revenue Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

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Sponsored by Aria Systems (www.ariasystems.com). A cloud-billing solutions provider that delivers the full power of subscription commerce to transform business by creating new opportunities, improving customer relationships and providing more revenue predictability. Disclaimer: this Report should be used for informational purposes only. Business strategies and vendor/product selections should be made based on multiple information sources such as, expert opinions, face-to-face meetings, market research reports, direct customer interaction and vendor specific due diligence. The information contained in this Report is a summary of the opinions expressed by individuals who chose to provide us with interactive opinions. The Incyte Group, LLC shall not be liable for the content of the Report, the study results, or for any damages incurred or alleged to be incurred by any of the companies included in the Report as a result of its content. Reproduction and distribution of this publication in any form without prior written permission is forbidden.

Picking the Right Recurring Revenue Model

Executive Summary Would you rather be Netflix or Blockbuster? This e-Paper tackles the question of how companies most effectively generate revenue using a recurring revenue model. Proper billing infrastructure is a key step on the path to revenue, but not the first step. Before companies consider billing, they worry about how they’re going to charge for their products or services. Businesses are moving toward recurring revenue models because they bring more predictable revenue streams, ability to scale costs with revenues, lower cost of sales, and higher lifetime customer value. Customers also benefit from recurring revenue models due to lower up‐front costs and more flexible terms. This document focuses on the three most widely‐adopted models today: subscription, usage, and subscription plus usage. Each makes sense in different situations by delivering different advantages for sellers and buyers. This document will also address various pricing “tactics” that can be used in conjunction with these models such as “freemium,” pre‐paid, tiered and unlimited usage. Finally, this paper also considers: • The importance of billing automation and flexibility • What to look for in a recurring billing platform • Handling billing functions • Experiences and best practice

Picking the Right Recurring Revenue Model

How Do You Pick the Right Recurring Revenue Model? Over the last decade, CEOs, investors, analysts and business advisors have fallen in love with the recurring revenue model. And why not? Compared to a company that lives on one‐time sales, recurring revenue makes great sense. Suppose you run a $10 million company and 90% of that is recurring revenue. When the year starts, you can count on $9 million in repeat revenue and only need to book $1 million in new sales to reach last year’s level. If you run a $10 million non‐recurring revenue business, you’re starting at zero when the year starts. Also, there are significant competitive advantages to recurring revenue models. Compare the fates of two movie rental businesses: subscription‐based Netflix and once‐mighty Blockbuster, a company that relies on one‐time transactions. As Netflix soars, Blockbuster flails in bankruptcy, unable to effectively compete with Netflix. Clearly customers voted for the convenience and cost advantages of a subscription model, which enabled Netflix to quickly develop a large recurring‐revenue business. The financial advantages of recurring revenue are many: predictable revenue streams, ability to scale revenues with costs, lower cost of sales, and higher lifetime customer value. For customers, paying every month means that vendors must meet their needs every month, or the customer can flee. Also, by paying month by month, customers stretch their financial obligations to even out cash flow. With usage‐based models, customers are able to keep costs down by paying for only for what they consume. This document examines the ins and outs of both business models, presenting argumentation and evidence for the superiority of the recurring revenue model.

Picking the Right Recurring Revenue Model

Three Models for Recurring Revenue Recurring revenue models come in three basic flavors:

Subscription

Usage

Subscription plus Usage

Fixed payment for service for a specific period of time— a day, a month, a year.

Charges per use or per unit of service.

Combines fixed subscription for service level, with “overage” billed as extra charges.

Example: Magazine subscriptions in which the subscriber pays to receive every issue for a year.

Example: Home water service is commonly usage‐based billing. The more water used, the larger the bill.

Other terms: Flat rate, membership.

Other terms: Metered usage, pay per use, pay per view, bandwidth billing.

Example: Canadian Internet provider Shaw Communications offers five tiers of subscriptions based on data transfers from $25 a month for 15 gigabytes to $150 for 350 gigabytes. Users who exceed limits are charged per gigabyte for overages. Other terms: Combination billing

What makes these models unique? Non‐recurring revenue models exist, including concurrent user licensing (high-end software), time‐based billing (professional services) and others. Though a grocery store strives for repeat customers, that’s not the same as recurring revenue. Businesses that rely on repeat customers (supermarkets, airlines) often utilize loyalty programs to incentivise repeat customers, but these are not “recurring” models because each decision to use that store or airline is made separately and paid for as a one‐time transaction. In picking the right revenue model, businesses should align with what works for their customers. For example, Salesforce.com’s monthly subscription offering not only delivers predictable revenue for Salesforce.com but also works for Salesforce customers who continue to pay month after month, and only for what features they use. Some Salesforce customers also pay for API usage when extracting data from the Salesforce service. And SalesForce also charges for storage by metering it. These different services with distinct price plans meet the needs of separate segments of customers. The next section illustrates how to think about a decision among subscription, usage or combined billing.

Picking the Right Recurring Revenue Model

The Subscription Model Advantages to Sellers

• Generates predictable revenue over subscription term. • Can promote customer retention as subscribers must actively opt out to change service providers.

Advantages to Buyers

• Predictable cost over subscription term. • Allows subscribers to spread cost of a service over time, smoothing out expenses, making expenses more predictable.

Advantages to Both

• Flexibility to change or cancel service when needed (if allowed), though early termination fees may be charged. • Promotes a continuous relationship between seller and customer.

• Collects substantial customer information beyond payment data for cross‐selling and personalized or database marketing. • With automatic renewals, generate more revenue from subscribers who might otherwise procrastinate steps to active renewal. • Low cost of entry compared to outright purchase (car lease vs. purchase) • Takes advantage of sophisticated technology with lower upfront purchase or personnel costs. • Keeps costs down. A tiered/seatbased subscription can offer the same advantage.

• Keeps costs down. Tiered or seatbased subscriptions allow buyers to pay only for what they use. Scale as • Aligns customer and sellers toward revenues scale. common goal, potentially enhancing customer loyalty.

For some sellers, subscription models may imply higher support and customer care costs because of an ongoing relationship with each customer vs. just touching them at a single point of sale. For other businesses, these ongoing support costs were already part of their cost structure at a single point of sale. In all cases, automating various customer touch points and offering self service options is a key to delivering high customer satisfaction while lowering costs of supporting large subscriber bases. Financially, monthly subscription payments don’t provide as much working capital as large upfront payments do. Some recurring services assess “activation” fees upfront to offset or cover the cost of service or delivery. Likewise, penalties or incentives for automatic renewal for early termination allow sellers to discourage churn.

Picking the Right Recurring Revenue Model

Answer three questions to shed light on whether subscriptions are the right model for your business: • Does your service offer value not just once but over a period of time? • Do you have additional services to cross‐sell to the customer so that knowing more about your subscriber would be an advantage? • Is there a strategic imperative, such as competitive pressures, that is prioritizing a more predictable recurring revenue stream? If you answered yes to any of these questions, then you may want to explore subscriptions more deeply. Consider: • Subscription revenue generally requires specialized accounting treatment. For pre‐paid subscriptions, sellers receive payment before delivering product or service, a cash flow advantage even though revenues are not typically recognized until the month of service delivery. • Customers may prefer to stretch out payments rather than paying upfront, helping their own cash flow. To encourage upfront payments, some sellers offer discounts on prepaid subscriptions.

WHAT SELLERS SHOULD SEEK IN A CLOUD BILLING PLATFORM

• Single interface for multiple payment types • Full, flexible support for all recurring revenue models • Ability to evolve to new models • Ability to experiment and test billing models • Native channel management, not workarounds • Ability to offer promotions and discounting, upsell and cross-sell • Integration to other systems (CRM, ERP, service delivery systems, etc.) • Support for multiple card payment processors • Global capabilities to support different languages and currencies • A viable, proven vendor • Proven success for companies with similar business models

Still, if a subscription model doesn’t fit well, examine other recurring revenue/billing models.

Picking the Right Recurring Revenue Model

The Usage Model Advantages to Sellers

Advantages to Buyers Advantages to Both

• Scale revenue to the cost of delivering the service.

• Reduce barriers to adoption through low‐ or no‐cost to start.

• Increase revenue per subscriber.

• “Foot in the door” strategy for selling to difficult-to-engage customers such as large corporations that may require several layers of approval. • Pay only for what is used.

• Scale costs to revenue generation or service delivery. • Lends itself to try‐before‐you‐buy approaches.

Overall, the usage model nicely matches the seller’s costs to deliver a service, but it carries some downsides. The usage model requires that the service can be measured, and the billing price must align with how customers perceive value. You could charge for a book “by the word,” but would the customer interpret reading 50% of the words as getting 50% of the value of the book? Usage‐based billers are often significantly dependent on high transaction volumes—low volume sinks profits. That means billers must boost either the number of users or usage by existing customers, often through a “volume discount” pricing strategy where the price goes down for all units as the total unit consumption goes up. That approach can work when the incremental cost of adding an additional user declines as volume grows, so sellers share some of that savings to entice customers to increase volume. For example, an online video service that charges for views (usage) adds little cost for Viewer #1 million vs. Viewer #999,999, so it can afford to offer volume discounts or unlimited‐use pricing. But unlimited pricing famously backfired for one large U.S. mobile telecommunications provider when it offered an “unlimited data” plan without properly anticipating the incremental cost of delivery, so it had to revert to a “capped” model. If you’re serious about charging for usage, ask: • Are your customers using your offering more and more over time? Usage billing turns increased use into higher revenue. • Do customers use your product sporadically, heavily at certain times but light or not at all at other times? Can your service delivery infrastructure handle that variability?

Picking the Right Recurring Revenue Model

The Subscription plus Usage Model In their simplest form, combination plans (subscription plus usage) charge a subscription fee for service with any overage billed as extra charges. More broadly, a combination plan can be any combination of recurring charged services with usage services. For example, the standard telephone bill generally has a base subscription, a variety of usage‐based services (texts, data, mobile telephone pricing structure, etc.) plus overage charges for usage beyond levels included in the base subscription. Advantages to Sellers

Advantages to Buyers Advantages to Both

• Earn extra revenue from heavy users • Monetize added features or services under a subscription plan. instead of bundling in subscription. • Recoup higher expenses from more costly subscribers. • Allows extra usage without moving to a higher‐priced subscription.

• Access extra capacity seamlessly and on demand.

• Flexibility.

Combination revenue models most often result from subscription‐based sellers seeking to extract more value from their heaviest users. Sometimes, however, usage‐based sellers add a subscription option (or base user fee) to drive more revenue from infrequent users to cover fixed costs. Companies in digital media, software and gaming add usage charges on top of subscriptions on various metrics: Concurrent or named users, emails received, files scanned (or saved or printed), installations, storage space, etc. Many gaming companies complement recurring subscriptions with the ability to purchase items from within the game.

Picking the Right Recurring Revenue Model

Pricing Tactics Complement Recurring Revenue Models Beyond the three basic types of recurring revenue, a wide variety of pricing tactics can be used with any of the recurring revenue models. A billing system should support these tactics. Freemium Basic functionality or content is free with charges for premium features, content or usage. Example: Popular with Web 2.0 companies, Hootsuite uses a billing platform to manage free and paying users for its popular social media client to access Twitter, Facebook, LinkedIn. Pre‐paid Pay before service starts. Example: For AT&T Go Plan (pre‐paid) for North America, customers pay upfront for a certain number of mobile minutes. Once pre‐paid minutes are used, the customer must buy more minutes. Some companies provide a pre‐payment option with an incentive for users that pre‐pay. For example, Mozy (online back‐up service) offers 15 months’ service for prepaid one‐year subscription. Post‐paid Subscriber’s payment card is charged for prior month’s usage. Example: For mobile phone service, customers usually pay their base portion a month ahead, while paying for overages and add-on in the month prior. Model may include early termination penalties for stopping before contract term. Tiered Different levels of service offered for different prices. Example: Many web‐conferencing companies provide volume discounts so that the more a customer uses the service, the lower the cost per meeting.

10 QUESTIONS TO ASK BEFORE YOU BUY

1 3 5 7 9

How long will the billing platform take to implement?

2 4 6 8 10

Is billing a core competency or will it shift my focus?

Is the system ﬂexible enough for my evolving business needs?

If someone else provides my solution, is their business viable? Will the system truly scale to meet my needs?

Will the system meet all the requirements for leagal compliance?

What third-party security standards or certiﬁcations does the product meet?

Does the system truly add value to my business? Or just create an expense?

Will the system add value and become a core part of my sales and reporting systems? Will the system work with evolving channel strategy?

Picking the Right Recurring Revenue Model

Trials and promotions Free service or usage for a limited term—often combined with an opt‐in or opt‐out requirement to automate the transition to normal services. Example: Adobe Systems and Intuit both offer free, 30‐day “try before you buy” trials on many of their software offerings. Other terms: Try before you buy, free device for two‐year subscription, bundling. Unlimited usage For a fixed fee, no limits Example: AT&T’s “unlimited” plan for early iPhone subscribers Other terms: “All-you-can-eat”, volume discounts.

The Importance of Automation With so many business models and billing practices, companies seeking to monetize their offerings have two core requirements: Automation and flexibility. Traditionally, automation hasn’t always been so important. In the non‐recurring or one‐time purchase model, it doesn’t affect margins so much if, for a $200 purchase, it costs $10 to produce a one‐time bill manually. But if a product is sold through a $20/month subscription, and manual billing costs $10 every month, costs climb and margins shrink. Suppose a customer calls to update payment information. With manual billing, the seller loses at least one month’s margin just dealing with that routine customer service issue. To benefit fully from the revenue and service improvements of a recurring model, companies must automate to avoid investing all savings in supporting the “ongoing” relationships with customers. That’s where a flexible, automated billing system comes in. Full billing automation—not partial with “a few” manual exceptions—is critical. In the high‐ volume and low‐value per‐transaction businesses such as the growing MMORPG (massively multiplayer online role‐playing game) market, companies can save millions every month with recurring revenue models by employing an automated billing system. Companies also need to link the billing platform not only to service delivery, but also to CRM, ERP, accounting and other critical systems. For this reason, look for very comprehensive API support to accommodate different integration needs. True automation, in any scale, usually requires that the integration between systems and processes also be automated.

Picking the Right Recurring Revenue Model

Requirements for a Recurring Revenue Model Billing flexibility comes in multiple forms: Flexibility to evolve from one business or billing model to another, flexibility to handle different billing models for different products in the seller’s portfolio, flexibility to experiment and test new pricing tactics, flexibility to unify disparate billing types into a single, enterprise‐wide user interface. Likewise, sophisticated merchandising can be critical to business success. Promotions, discounting, limited time offers, upsells and cross‐selling all carry vast billing implications. Examine how they are managed in your billing platform. Of course, metrics matter. You need to track those marketing campaigns, evaluate resellers, monitor changing customer tastes. Make sure your billing partner offers strong analytics. Distributors, resellers, and referrers are important for expanding your market reach. If you sell through or with partners, strong channel management tools—native, not workarounds—allow you to allocate revenue easily based on consistent rules. It’s easy to think that sending a monthly bill should be relatively simple, but recurring models vary in inherently complex ways, requiring integrations with other internal systems, compliance and security certifications, etc. An important question to answer is: “Do you prefer to pour internal resources into your core business or into a brand new billing competency?” The ability to do business globally brings its own set of challenges and is another important factor in choosing a recurring revenue model and billing system. Handling multiple currencies and ever‐changing exchange rates is important, but other international tax and import‐export issues may prove even more troublesome. A billing platform designed for international use can provide the flexibility needed to deal with multiple currencies and tax requirement. Finally, when the only constant is change, companies want to “future‐proof” their business by working with a billing platform that can accommodate evolving business models. Optimize your business for today, but assure you can adapt to unforeseen innovations you may create. Two simple questions illuminate your billing vendor’s future‐proofing potential: How many billing options does the platform currently support? And how many new features or options has it added in the last 18 months because of customer demand? Ask those questions.

Picking the Right Recurring Revenue Model

Conclusion No decision in a company’s life is more important than its business model, and recurring revenue models garner lots of attention for good reason—they’re better. They bring more predictible revenue streams, give companies the ability to scale costs with revenues, lower the cost of sales and bring high customer value. But business models evolve over time, so flexibility in all operations is critical. The most successful recurring revenue models rely heavily on automation and flexibility to minimize service delivery and support costs while boosting profits.

About Aria Systems Aria Systems delivers the full power of subscription commerce to transform business by creating new opportunities, improving customer relationships and providing more revenue predictability. The Aria Subscription Billing and Management Platform was chosen by brand name companies such as Pitney Bowes, AAA NCNU, Experian, Red Hat, Ingersoll Rand, EMC, VMware, and HootSuite to evolve their company’s subscription businesses while delivering outstanding customer experiences. Acknowledged as the cloud billing expert, Aria manages and maintains more than 1 million accounts and has processed more than 1 billion transactions.

® Headquarters Aria Systems, Inc. 274 Brannan Street, Suite 602 San Francisco, CA 94107 Phone: 415-852-7200 Fax: 415-852-7251 Sales Toll Free: 1-877-755-2370 www.ariasystems.com