By Tamsyn Attiwell, VP Global Services, Zuora
Subscription services are intrinsically woven into the fabric of many of our everyday lives. At breakfast, we digitally access a specific section of our favourite newspaper. We stream music on Spotify on our commute to work, snack food from Graze automatically delivered to our desks and remotely adjust the heating of our home through AlertMe, so that it has exactly the right temperature when we come back.
But the opportunity of accessing so many goods and services so easily through subscriptions hasn’t been around for long. We call this new business environment the “Subscription Economy”; and it is only now becoming mainstream – most of the companies mentioned above were not even around five years ago.
The reason for this lag in adoption is that many investors have needed a lot of education to show them how subscription models with recurring revenue – when managed well – are a healthy and financially attractive business model for companies. Since then, we have seen many subscription SMBs receive vital cash injections to spur growth. Online storage company Box raised $120 million through its IPO earlier this year, and Zuora, the company I work for, recently secured $115 million in funding.
So why do recurring revenue businesses appeal to investors? The answer: they offer predictability, growth and visibility.
Investors value predictability
To investors, the primary appeal of recurring revenue models is the value of predictable recurring revenue, particularly in comparison to one-time transactions. For example, a one million pound company with eighty percent recurring revenue can count on 800,000 pounds at the beginning of every year. That figure is stable and predictable. Management can plan and invest accordingly.
The same cannot be said of a one million pound business with no recurring revenue. That company has to start the year at zero. Of course it can make some predictions based on past performance, but it doesn’t have a contractually obligated revenue stream to base ambitious expansion plans around.
Investors value growth
Having a predictable revenue stream allows subscription businesses to invest aggressively in growth, particularly in kinetic market conditions with multiple players.
All companies are vulnerable to disruption. There is no such thing as a permanently established incumbent, particularly in a wildly disruptive industry like IT, where one company’s dominant position can crumble overnight if an exciting start-up enters the market.
That being said, traditional, established vendors have an advantage in their resources, customers and partners. It takes an aggressive, disruptive approach to capture their customers. Subscription businesses provide that disruption with lower up-front costs, greater flexibility, intuitive delivery mechanisms and a keen ongoing sense of their customers’ needs and wants.
Investors value visibility
Recurring revenue models have much better future visibility and therefore much easier expense management. They’ve also resulted in much more visibility into the consumer.
As companies have had to pivot from selling products to managing services, they require huge amounts of customer engagement. Product metrics like units, margins, and inventory have been replaced by relationship metrics like renewals, upsells, and churn. In other words, companies are less concerned about the number of units shipped than the successful outcomes they deliver to each and every one of their customers.
Investors value the fact that subscription businesses almost always require less effort for their implementation – reducing both the cost and the “time to value” for the customer. They also understand that a successful subscription business is by definition one that has keen insight into the needs of its customers.
Now it’s your turn
Venture Capitalist Jeff Bussgang said that “When you have a recurring revenue business model, you rarely miss your monthly or quarterly numbers by more than 10-20%.”
This makes it easier to determine your growth rate, a fact that will really impress investors and might make them consider you for a potential funding round. The UK business community needs to move on from solely thinking about the concept of shipping products through one-off transactions. This will only get you so far. By introducing subscription business models and entering into meaningful relationships with your customers, you can really drive long-term growth, and crucially, investors will love it.