There will be little New Year’s Eve celebrating but much potential morning after hangover for US businesses not preparing for ASC 606, the Financial Accounting Standards Board’s (FASB) new rules about revenue recognition set to go into effect on January 1, 2018. The news is much the same for Europe though with only the rule’s name being different; for them it will be IFRS 15.
A recent KPMG report, “The Deadline Is Approaching for Accounting Change” has some hard numbers and equally hard facts, among them, the change is hard to do. Where have we heard this before? Some findings include,
- Even though the effective date for revenue recognition is just months away, 60 percent of public companies said they are facing challenges staying “on track,” and a similar percentage of private companies felt the same way.
- Only 6 percent of respondents believed they were faced with minimum impact requiring “little of no action” on their part
- Total expected implementation costs had increased from the prior year for 57 percent of the public company respondents
- Most respondents did not think the new rules would have a significant impact on their company’s tax issues
- Internal communications need to be improved; 33 percent said C-level executives had little or no involvement in the process
Additional data shows that the largest clusters of companies were either still in the assessment phase (39 percent) or in implementation (35 percent), only 6 percent said their implementation was complete.
With so much foot dragging, it’s a reasonable bet that a healthy number of companies will miss the January 1, 2018 implementation deadline. Then what? To put it all in perspective, many companies don’t have a revenue recognition issue and 57 percent, according to the survey, say their organizations are not planning for system changes for the new standard. This may be a good indicator of the percentage of companies throughout the economy don’t rely on subscription business, at least not yet.
But it’s hard to see what companies are in this group. Even companies as old school as Caterpillar, the earth moving equipment maker, have significant initiatives in offering their products as services. So, a logical follow up might be, why aren’t these companies more focused on the economic opportunity provided by subscriptions?
The answer might lie in the way that subscriptions have been handled so far. With few standards for revenue recognition or definitions for how sales are booked and commissioned, it’s likely there are companies that offer some form of subscription services that don’t think the new rules apply to them. But since the new rules also apply in the EU and there are penalties for non-compliance, we might look for a sudden burst of activity in this area after the first of the year as the laggards finally discover that the new rules really do apply to them.
To be fair though, there really are companies for whom the new accounting standards really are a non-issue. Zuora, the subscription billing and financial management company trying to shepherd as many businesses as possible into the new standards, has developed a website that tracks many big-name companies that might have an issue with the new rules. Indeed some do but it’s surprising the number of them that don’t foresee an impact on company cash flows, including Salesforce, Caterpillar, General Electric, and many others. Perhaps that’s because these companies are so big that they’ve had to deal with revenue recognition for a long time. Or perhaps they’re so rich that they’ve been tracking the issue and getting ready for it. The information is gleaned from public records of 10-Q filings so it’s reliable.
What’s a company to do if it doesn’t fall into any of these buckets? It’s not too late and Tien Tzuo, CEO of Zuora has this advice.
“Even if a company has not yet started their ASC 606 project, there are a few things they can do to get set up for reporting under the new standards immediately. First, get an accounting firm to do an assessment and determine the risk of impact on revenue. Then, identify the timeframe required to fully automate revenue recognition to reduce that risk. If that’s not possible, a company will be forced to suffer with expensive, manual-intensive labor to report on time. Doing manual calculations will be error prone and can cause restatements later due to complexity of 606. If you’re stuck doing manual processing now, think about launching an automation project at the same time to collect data and analyze it for the first reporting cycle under 606.
Ok, it’s time for the other shoe to drop. All of the above is for the consumption of public companies. If you work in a privately held company, and especially if you’re one of those large pre-IPO outfits called unicorns, you’ve got an extra year to figure this all out and you ought to do it ASAP. As Tzuo points out the danger for the unicorns is this,
“Deloitte released a new survey of 3,000 companies indicating slow progress among private companies on implementation of the new revenue standard may delay IPOs. That’s a bad sign, especially when Fortune’s Data Sheet reported that the IPO window is now again open for tech companies following successes of Roku, CarGurus and MongoDB.”
Imagine working for ten years to build a company and bring it public but then failing to do so at the optimal time. Come to think about it, don’t, it’s too depressing. Better to get to work on finding your optimal solution. It’s out there.
So much is happening as we approach the end of Q2, our industry’s busiest quarter, at least by some measures. I’m flying around seeing things but not always able to comment from a middle seat on a red-eye. So this piece is an attempt to catch up and set some markers for the traditionally slower summer.
Last time, I was searching for a word to describe a new category I see. You can call it various things like on-demand services or even services as a service which somewhat distinguishes them from things as a service such as SaaS but it’s also confusing.
SaaS has led the way in things as a service and while it’s a perfectly good descriptor the rapid evolution of IoT, Internet of things, has introduced some confusion. Things as a service describe any traditional good delivered as a service, such as software or a car or a cell phone. Services delivered as services often don’t have a physical component or that component is of a different type, perhaps not even human.
For instance you can get software as a service but the training or consulting that needs to go with it is very different. First, it’s delivered by people who show up, do a job, and disappear; you don’t employ them and you certainly don’t own them and their work product is pure service, often leaving behind only thoughts in other’s minds or software code.
Another example, and my favorite right now, is earth moving. Various makers of things like excavators and bulldozers now offer earth moved as a service obviating the need to purchase the big device. The difference is that the service is intentionally and decidedly temporary. These companies calculate amount of earth moved (in a simple example) and charge by a meaningful metric such as tons or cubic yards moved. Moreover, these are short-term services; the equipment and people to run it show up one day, do a specific task and then are gone. Or perhaps they are idle for one week per month—how do you charge for this?
In a SaaS model you might buy a specific number of seats per month and that’s it, if your people don’t use it, too bad. But in the earth-moving example, an idle machine still has overhead for a vendor. How does the vendor capture revenue when the device is idle? It’s not hard to do but it gets into some branching logic that typical billing systems might not cover. So very quickly, we see that service as a service is different from a thing as a service. What do you call that? And what’s the name of the business model and how do you account for these services?
My thoughts include words like precision services or discrete services. Each conveys a sense of the ad hoc, a temporary, specialist thing that won’t become part of the status quo in the sense that it will be gone at some point. Just think of the earth-moving equipment required to build a tall building and understand that it’s not there any more once the building is completed.
So that’s one thing I’ve been noodling on. Send me a note with your thoughts.
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Also on the docket have been Oracle’s results for the last quarter. It’s only important to look at the direction, which is up and to the right of the graphs, to know that the company has hit stride on cloud computing. I am happy for them and have previously written that their model is uniquely suited to their customer base. It includes all phases of cloud computing including infrastructure, applications, and platform to support customers in various stages of the move.
Oracle’s big footprint attracts lots of competition from Amazon’s AWS at the infrastructure end to Microsoft, Salesforce, and SAP on applications and platform. I am not even sure if they all agree on what platform is and that’s important. It tells us that the tip of the spear is platform and that’s the competitive landscape. It’s also the metric that we need to use to analyze and understand the quality of any software vendor’s earnings.
Infrastructure is heading toward pure commodity status and it’s getting close if in fact it has not already arrived there yet. But ironically, you can’t be wildly successful in the other phases of the game if you don’t have a credible infrastructure offering. So you have to look with great interest at Oracle’s infrastructure number which equals just north of $400 million on what I believe is a $1 billion cloud base. Is it a good thing? I think it’s a necessary thing and it might set the company up to do well in other phases but that jury is still out.
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Finally, there was a piece on AI in the New York Times Sunday Review, “The Real Threat of Artificial Intelligence” by Kai-Fu Lee that I am in complete disagreement with. I’ve seen the argument before: AI will swallow up jobs leaving a large and unemployable group of people who will require some form of guaranteed income support. But rather than offer an opinion, let me supply an analysis and some data.
Massive income assistance has never worked well in human history. You might go all the way back to the Roman Empire and recall the idea of bread and circuses as an example of such welfare. But if you do, you also need to factor in that it didn’t work out well for guys named Caesar. In modern times the top earners have always objected to the confiscatory taxes needed to make such a scheme work.
This kind of analysis is too dependent on straight-line thinking. What’s missing is any sense of the dynamism of free markets in a democracy. Free markets enable innovation and entrepreneurship and with them come new industries and new jobs. I know things look kind of bleak for people with high school educations or even people with BA’s in literature or philosophy. But the fact of the matter is that since the Industrial Revolution there have been 5 ages when an industry or a clutch of them took off and did really well for a few decades only to fall back to earth later killing some of the jobs it created in the name of efficiency and commoditization.
What we’re going through with AI is cyclical and not one of a kind. I just wrote a book about it and it’ll be out in September, a time when we come back from the beach and put our game faces back on and rediscover that a machine really can’t do what we do.
A lot happens in a decade. Bill Gates, among others, once said that we over estimate what we can do in two years and underestimate what we can do in ten. 2017 is a particularly good time to stop paddling and look back at what’s been going on in the last decade and while we will all have our favorite memories, there’s one in CRM that stands out more for me than others.
After all 2007 was the year of the iPhone as well as the year before everything in the financial world began going down in a big way. There was barely any social media to speak of—Facebook was founded in 2004 but only in 2006 could anybody over the age of 13 join. Twitter was founded in March of 2006 but while social was making waves in 2007, the introduction of the iPhone helped make it the huge part of our lives it is.
But as one who has been writing about CRM and especially SaaS, 2017 marks the tenth anniversary of Zuora’s founding. You might think that wasn’t significant but just as the iPhone made social networking a big deal, Zuora had a similar effect on the SaaS business. Sure there were already big companies like Salesforce.com in the space by 2007, they’d even gone public a few years before.
But there was a looming problem in SaaS that was either being ignored or avoided, and it was creating drag on the whole industry. The problem was that although SaaS businesses were successful, they were scrambling each month to get their billing out. In 2007 even the best SaaS companies were using a combination of spreadsheets and archaic ERP systems that couldn’t fathom the idea of a recurring charge. ERP could do services but not the recurring part and spreadsheets aren’t systems, at best they’re the equivalent of life vests for business processes.
So along came K.V. Rao, Cheng Zou and Tien Tzuo, veterans of WebEx and Salesforce to tackle the problem. I am not certain if Zuora was the first company of its kind, but it certainly put a floor under the industry in a way that competitors didn’t. That floor looked a lot like Salesforce. When Salesforce got started subscriptions were thought to simply be another delivery mechanism for software and not the revolution they turned into.
Similarly, Zuora didn’t simply approach the subscription billing problem as, well, a billing problem. Zuora saw a revolution in the making and not just in software as a service. They saw subscriptions as a new economic entity, a way to bend the cost curve downwards that would expand markets by vastly increasing demand. Importantly, though, the subscription difference has been that while markets expanded they did not necessarily commoditize, which might have been the first time in history that’s happened.
Under more normal conditions that have prevailed throughout history, commoditization involved elements of mass production as well as finding ways to cheapen a product. Mass production takes labor out of making something reducing costs. Cheapening products can take many forms, for instance, you can remove features or substitute materials or components in the process shortening the product’s useful life. You can also curtail services, which are expensive to provision when using employees rather than systems.
Until subscriptions, that was the reality of commoditization but by their nature, subscriptions do none of that. The same grade of product delivered as a service is available to all, though the current reckless actions by the FCC to degrade net neutrality may be a retrograde step in the direction of cheapening the Internet. Everyone also pays the same base price though there’s still opportunity for creativity when it comes to volume discounting. Most importantly, development and maintenance in many subscription industries are ongoing and if they aren’t, like when you subscribe to a car through a lease, at least the service level remains high. The reasons are all the same, subscription vendors are always in the hunt for the renewal.
Zuora saw subscriptions as the revolution they are and that’s one reason they’re one of Silicon Valley’s unicorns, a startup worth more than a billion bucks on paper. Undoubtedly, we’ll see that valuation tested at some point through a public offering but for now it’s worth recalling that the revolution is continuing. U.S. and international financial accounting boards that set standards for how businesses report their financial activities have recently (after more than a decade) announced standards for how businesses report on recurring revenue, which goes to the heart of the industry.
The new rules ASC 606 (U.S.) and IFRS 15 (Europe) begin going into effect next December. As I’ve written previously, Zuora has acquired Leeyo a revenue recognition specialist company to prepare its customers for the transition. It’s not the first acquisition for Zuora, which has been steadily innovating and acquiring businesses as needed to build out its platform and support the subscription economy.
Zuora has come a long way since its founding ten years ago but so has the industry, so have we. Gate’s original insight should probably be amended because not only do we underestimate what can be done in a decade, we absorb new technologies so fast that a decade can cause amnesia about the way things were just a short while ago.
There is a business problem that comes up in the life of every company and these days, it seems that a lot of companies face it at once. It’s the question of how to transition from one business model to another without clobbering your current revenue flow. Even if a company’s executives really want to change their model the reality is that the current model, as clunky and outdated as it might seem, is still generating revenues and profits so there is always a faction that says, not yet.
You know where this goes. It’s the story of the boiled frog. It starts with the animal sitting in a pot of tepid water when the heat gets turned on and the frog slowly fades into drowsiness rather than realizing the danger and hopping out. Or so it goes. I have never run the experiment.
We pride ourselves on our large brains and all that they have created. In the last several millennia we’ve built tools and intellectual constructs that give us ways to think about all sorts of things. We’ve been so successful that according to some scientists by some point in 2014 human knowledge will be doubling about once every eleven hours.
Regardless, we still have a challenge when it comes to shifting business models and there’s nothing more trying today than figuring out how to shift from a model that makes and delivers things for a price, to a model that makes things but delivers them incrementally over time, a.k.a. the subscription model. That’s because collecting the money in the second transaction looks nothing like collecting it in the first. Along with the basic act of collecting goes a long list of other important issues like continuously nurturing customers so that they continue to consume what you are delivering.
There’s also accounting for the revenue flow. And then there’s the kicker — most businesses in this situation have decided to branch out into subscriptions while still maintaining their tried and true accounting systems. But the finance and accounting systems in place don’t “do” subscriptions very well, and that might be an overstatement.
But according to a recent study by The Economist magazine’s Intelligence Unit, the issue of collecting the money involved in subscription transactions was only the fourth biggest worry for executives surveyed. Number one was lack of internal co-ordination and second was the technical aspect as in how do we integrate these seemingly disparate ideas so that we can have a single, integrated, and accurate view of the business?
Well, the simple answer is that you need a system for that. Sometimes our big brains, inventiveness, and the sheer joy of tinkering prevent us from taking on solutions right in front of us. I am of course talking about the all to human propensity for using spreadsheets to plug all kinds of business problems instead of biting the bullet and getting a real system.
Many years ago companies used spreadsheets in lieu of CRM systems because they were readily at hand and enabled smart people to model sales processes within them. Alas, a model is not the thing itself and too often a model won’t stand up to volume, which is what happened with spreadsheets in CRM. Among their many shortcomings, spreadsheets don’t have databases and the models they represent are ill equipped for high volume operations.
Fast forward to the subscription economy and you can see the same trouble. Companies getting involved with the subscription model sometimes use spreadsheets as their sub-ledgers feeding into the company’s general purpose ERP system. This tends to work well enough for the company’s first few subscription customers but if the subscription model becomes successful, the spreadsheets can represent a not so happy, happy problem. At least the auditors aren’t happy.
This is preventable. The initial impulse to use spreadsheets as a sub-ledger perfectly models the situation many businesses find themselves in when they adopt subscriptions and they should be applauded for this. But no business can stay in spreadsheets for very long because it turns out that the subscription model is not simply a new way to bill customers.
Subscriptions, really are a business model meaning they have to be accounted for throughout the customer lifecycle including first discovery of a business problem, evaluation, the sale, product use, customer nurturing and bonding, and, most importantly, customer advocacy. It does no company any good whatsoever to do the early stages of the lifecycle well only to fall down on bonding — which too many companies do.
Subscribers expect their vendors to be with them in their moments of truth throughout their lifecycle journeys. The penalty for not being present is attrition and churn but the benefit for doing things right is renewal and advocacy. Luckily, subscriptions throw off a great deal of data that subscription vendors can analyze so that they can meet their customers within those moments of truth. But a spreadsheet won’t catch that data. A spreadsheet can contain today’s data but without a database it can’t tell you about yesterday so that you can predict tomorrow and successful subscriptions are all about predicting demand and meeting it.
This is where lifecycle subscription management systems come in. These systems started out as simple billing and payments solutions but the gap is widening between them and more advanced systems that provide a range of financial, accounting, and database services that make them appropriate for enterprises beginning the transition from conventional models to subscriptions. A system like Zuora, for example, provides the technical integration with popular ERP to enable an organization to co-ordinate its subscription business with its conventional model. That’s why I am advising my clients to evaluate solutions like Zuora as they take their first steps into the subscription economy.
Measure, iterate, scale
Everyone in business claims to want to listen to the voice of the customer; it’s a non-controversial issue. But the approaches are all over the map. There is little consistency and, truthfully, many vendors do a poor job of it.
Capturing customer feedback has always been a challenge for conventional vendors because they have to generate new processes to reach out to customers. Surveys, focus groups, and even social media are useful but many of these approaches are time and resource intensive and they are not automatic in business models that make and sell things then move on to the next opportunity.
Subscription vendors are in a much better position because they can take advantage of all the customer data generated in the normal course of business. Virtually every customer action gives off data that, when aggregated and analyzed can give a business great insights into the customer base. Savvy vendors can use the information thus generated to measure, iterate, and scale their businesses.
One of the greatest built-in data sources a subscription company has is its billing data and this data becomes even more valuable when it is time stamped. Capturing billing data and its timing enables a vendor to make comparisons between periods and even between years that can reveal variations in use, uptake, and signal some aspects of satisfaction.
Subscription vendors have to measure everything, at least they should. Often a subscription business can run on an impersonal website and a decision about continuing use or changing to a competitor might come down to cosmetics like ease of use, clarity of design, and other things that a vendor can’t improve without feedback. Customer feedback does not usually come from long emails or in-depth interviews. It emanates from simple decisions by customers about how and when to subscribe. So use data can be a gold mine and analyzing this data is what ultimately drives business improvement.
Measurement provides vendors with visibility into customer behavior from initial purchase to future demand. Leveraging this visibility gives businesses the assurance of customer knowledge on which to make decisions.
Visibility is fleeting and gaining it must become a repeatable exercise. Once you’ve figured out what to measure to gain the most useful insights, there are two steps you need to take to ensure the health of your subscription business. First, by all means, keep measuring and compare results with earlier measurements. Some businesses notice seasonal fluctuations and understanding this makes it easier to see the difference between the start of a worrying trend and normal variation. Second, use what you learn to improve your business. This might sound like common sense but some times your research will suggest doing things that are either expensive or counter intuitive. In either case, don’t reject the findings out of hand. Do more research.
The measure-iterate cycle can do more than simply tell you the health of your cash flow. For instance, it also provides a simple and economical approach to researching product demand. Customer use data can provide a quick and economical means for A-B testing as in do customers prefer this or that? With subscriptions there’s no need to guess and hope you get it right. The answers are available if you know how to set up a controlled experiment.
Pricing and packaging are two areas where subscription companies must constantly iterate and the measure-iterate cycle can be a great solution for helping a company zero in on the best pricing and packaging approach for the moment. Keep in mind that customers constantly change their minds, which is why measure-iterate is a cycle and not a one-time event.
If you analyze your customers’ use and payments data you can develop the confidence to plow good ideas back into the business. This will enable you to scale your business with confidence because you have real customer generated information to back up each decision.
When combined, measures like attrition and customer lifetime value can combine to provide a powerful picture of future revenues before new business is counted. This can give you a more precise way to build and achieve sales targets. At the same time, triangulating with measures like lifetime value and the cost of new revenue can provide insight into not just revenue but its profitability too.
Every business uses some form of measure, iterate, scale and some are more effective than others. Subscription companies are fortunate because they have so much data in their possession to start with and so many ways to apply it. But some measurements are best made against outside measures. For example, you might be able to measure and accurately predict customer attrition, something every subscription business faces. Objectively, it’s easy to conclude that less attrition is better than more and determine levels that are acceptable for your business. But how does your business stack up against other subscription vendors in general and in your market? What is the best practice goal?
Historically, this kind of information has only been available through independent research; however, it could also be generated from anonymous customer data. As the subscription market continues to evolve and mature, providing this kind of information will become a necessity and I foresee a time when subscription vendors will pool their resources through a trusted third party to provide this kind of information.
We hear a lot about the customer experience these days but many prognosticators have little more to go on than their opinions about customer behavior. Subscription companies have a great advantage in the data they collect if they collect it faithfully and analyze it rigorously.