Recurring Revenue

Recurring Revenue Rising

As more companies adopt recurring revenue products, CFOs try to plan for the necessary changes in processes and IT systems.
Gerry MarlettaFebruary 27, 2019
Recurring Revenue Rising

Recurring revenue business models, also known as subscription or usage-based models, are opening up new opportunities across many industries — even in sectors where they haven’t traditionally. For example, the subscription model has taken root in industrial sectors, like heavy equipment manufacturing, and in specialty markets such as medical devices.

A survey of senior finance executives by CFO Research, in collaboration with Salesforce, showed recurring revenue models are well established and growing. More than half (53%) of the CFO Research/Salesforce survey respondents said at least 40% of their organizations’ revenues were recurring, that is, sold via a subscription- or usage-based model. (See Figure 1.)

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Two key benefits accrue from recurring revenue models. First, the initial sale becomes just the starting point of an ongoing customer relationship that can present an abundance of chances to upsell and increase share of wallet. Second, the seller receives a series of payments over a product or service’s lifetime instead of a single upfront payment. As a result, cash flows are steadier and less likely to suffer a sudden drop. That makes planning easier for the finance team.

Those advantages have C-suite executives’ and boards of directors’ mouths watering. Both are increasingly committed to developing recurring revenue. According to the CFO Research survey, 23% of C-suites and boards at respondents’ companies were incorporating such business models into their strategic planning. In addition, 17% of C-suites and boards were planning to launch a new or additional recurring revenue business in the near term.

Seeing the Obstacles

Build a subscription business and they will come? Not exactly. However attractive the product, internally the organization may face unique operational hurdles. Of the companies launching a recurring revenue product or service, nearly two-thirds (65%) of those surveyed faced operational problems in doing so. The problems arose in numerous areas — from not being set up to process, track, and manage recurring revenue, to not having the tools to manage and leverage the data produced by subscription sales, to not using the metrics that the business model demands.

More particularly, basic tasks such as calculating and managing pricing can become much more complex, because prices can vary according to subscription levels, term lengths, and product or service bundling. Renewing customer contracts, for example, can be a headache. Process-driven delays for a recurring revenue customer can limit opportunities for renewals. And the sales function often adds to operational challenges by demanding too much flexibility in product design and pricing, which can result in manual downstream processes to clean up confusing invoicing and billing.

Finally, nearly half (48%) of companies with a recurring revenue business model struggle to meet accounting and reporting challenges created by the dynamic customer relationship. As of December 2017 (a year later for private companies), such revenue has had to be recorded according to ASC 606 and IFRS 15 standards, which stipulate revenues have to be recognized when realized and earned, not necessarily when received. If not properly managed, those accounting rule changes can lead to audit and compliance issues.

Overcoming Pain Points

Selling via subscription model can also necessitate IT modifications. Traditional systems, for example, have a hard time handling bundling. When a subscription product or service is sold with upgrades or add-ons, a traditional system may create a new SKU for every change to the bundle, producing a dizzying array of pricing, bundling, and distribution combinations.

That can lead directly to some of the pain points identified in the survey: inaccurate forecasts and reporting based on inconsistent or imprecise tracking of existing sales, for example, or collections problems due to invoice disputes. (See Figure 2.) A traditional order and invoicing approach can also lead to frustrated customers and subscription terminations if multiple cancelled invoices and new invoices are produced with every change.

Typically, companies that transition to a recurring revenue model use their existing customer relationship management and ERP systems. Since most ERP systems are designed for transactional businesses, it can be difficult for them to handle sales spanning multiple periods. When product sales reach $75 million to $100 million annually, the problems with old systems start becoming insurmountable. Thus, nearly two-thirds (67%) of survey respondents were actively explored new processes or systems to support recurring revenue products or services.

What can happen when the obstacles are overcome? Finance executives have high expectations. A majority (57%) of the surveyed finance executives indicated solving their “quote-to-cash” pain points (product configuration to payment) would lower finance and sales costs by at least 5%. A similar majority (55%) also believed it would increase enterprise revenue by at least 5%. And nearly three-quarters of respondents (73%) said both sales and finance would benefit from a solution that supports dynamic and recurring contracts.

In addition, more than seven in 10 of the surveyed finance executives (71%) indicated a more efficient pricing and approval process would substantially improve their organizations’ profitability.

Constant Attention

Systems issues are only part of the battle, however. A cultural shift is required to build and grow ongoing customer relationships. Renewals often require the same level of attention as new sales — though many companies’ sales efforts skew toward generating new business. Sales and marketing become more involved in the lifecycle of the customer at all potential transaction points. In addition, many non-sales groups in the company become customer facing, and interactions between finance and accounting, services, and sales and marketing occur daily, not quarterly.

Improved coordination between the sales and finance teams is a key to success. Two-thirds (67%) of the finance executives said finance leadership should better align with sales leadership to improve forecasting and maximize revenue growth. More than eight in 10 (81%) said sales and finance would benefit from improved collaboration and better communication about customers and contracts.

Finance is enjoying the advantages the new subscription models offer, especially the real-time data generated to help decision-making and the steadier cash flows produced. But when launching recurring revenue products, CFOs need to have their eyes wide open. Operational, cultural, and technical complications can hinder the realization of even the most promising market opportunities.