Subscription business model

  • March 18, 2018
  • After the markets closed on Friday, Zuora announced it had filed paperwork for an initial public offering (IPO) with the Securities and Exchange Commission (SEC). Although the quantity and price of the class A common shares has not been set, the company intends to trade on the New York Stock Exchange with the symbol ZUO. According to a press release from the company,

    Goldman Sachs & Co. LLC and Morgan Stanley & Co. LLC are acting as the joint lead bookrunners for the proposed offering. Allen & Company LLC and Jefferies LLC are acting as bookrunners. Canaccord Genuity LLC and Needham & Company, LLC are acting as co-managers.

    Zuora is one of many companies to spin out of Salesforce.com. Although the product, a billing and financial system tailored to the needs of businesses that sell subscriptions instead of conventional products and services, is home grown, CEO Tien Tzuo is a former CMO at Salesforce. Tzuo was one of the earliest employees at Salesforce and in one of his many jobs there oversaw development of an in-house billing system for subscriptions. In the early 2000s, subscription businesses were gaining a foothold and scoring their first successes, but the problem of billing dogged the whole industry.

    Briefly, in the early days just as today, subscribers paid a monthly fee for each user and the headcount could fluctuate each month along with other variables. So, unlike product companies, the billing for subscription vendors could vary from month to month, a condition that conventional billing systems could not accommodate, at least not easily. A lot of manual effort went into monthly billing.

    Zuora made its reputation as a vendor that could turn an end-of-month billing problem into a routine process. That enabled emerging subscription companies to focus their resources on building products and serving customers. It also made revenues more predictable, something that CEOs and their boards valued.

    For more than a decade Zuora has grown as a private company raising well over $100 million from investors. The company has been valued at over one billion dollars making it one of a select group of companies known as Unicorns in Silicon Valley and the investment world. Unicorns get their name because they are start-ups having valuations over one billion dollars and because such companies are as rare as, well, unicorns.

    Zuora’s valuation was helped by its understanding of subscription business tactics such as identifying and aggressively addressing potential customer churn and managing billings for future services. Customers might sign long term contracts and pay up front with an understanding that the payment would be drawn down over the term of a contract.

    Having this unrecognized money in the bank or at least on the books made Zuora and other subscription companies’ future revenues easier to evaluate and predict and thus establish them as unicorns.

    The market for subscriptions has grown with Zuora. Subscriptions are essentially a way to commoditize products enabling vendors to sell them in more bite-sized quantities. This in turn enables vendors to enlarge their markets without slashing core pricing. For example, earth moving equipment producers have started subscription businesses by providing a service of earth moving without requiring the purchase of heavy equipment. Depending on the job they might bill for cubic yards of material moved per day or tonnage. Regardless, the customer signs up for moved earth not bulldozers and the cost difference is considerable.

    The subscription business model has been the wind in Zuora’s sails and there is little sign that the breeze is slacking. In fact, it is just beginning in many industries. Many vendors now find they have multiple channels to market that include traditional sales as well as subscription services. At the same time, they learn that the way that subscription billing, collections, and fiscal management occur differ. Zuora has become one of a few companies that can do the subscription billing work up front and then contribute financial information to the company’s traditional financial systems in ways that are intelligible to legacy accounting systems. It can thus function as the business’ system of record for subscriptions making it indispensable for many of them.

    Look for the IPO to occur in the second quarter, most likely. There will be a quiet period before the event which is standard procedure. We’ll have to wait for the underwriters and the market to set the market value to understand how this unicorn’s billion-dollar valuation fares.

     

    Published: 6 years ago