Services With A (CFO) Smile

Finance must adapt to the hybrid, services-added business model.
Josh HyattApril 6, 2017

It’s a blockbuster combination, even if it won’t attract attention on the scale of big deals like the $65 billion Bayer-Monsanto merger or AT&T’s prospective takeover of Time Warner. What combination are we speaking of? The blending of products and services into a hybrid business model as companies look for ways to differentiate themselves and to extend one-time transactions into long-lasting and profitable customer relationships.

The payoffs from a hybrid business model are easy to envision: plumper margins, clingier customers, and value-added offerings that incite a trickle, then a stampede, of customer interest. What’s tougher to foresee are the delicate strategic maneuvers needed to control such a two-headed model.

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Nonetheless, concerns such as product commoditization and customer capriciousness have led finance executives to begin reconfiguring their revenue streams. For product-based companies, the lure of adding services revenue can be tantalizing: Unlike products, services can be difficult for rivals to replicate. They can also provide a recurring revenue stream—especially welcome as sharp rivals start grinding away at a product’s profit margin.

In a recent survey conducted by CFO Research, in collaboration with FinancialForce, 71% of senior finance executives reported that their companies derive half or more of their revenues from services, either directly or linked to product sales. More than half (55%) said services generate a higher percentage of revenues today than they did five years ago.

The survey’s findings are based on 163 responses from senior finance executives at companies based in the United States and the UK, the former accounting for about two-thirds of survey-takers. Almost 65% of respondents hold the title of director of finance or above, with most serving as CFOs. Nearly three-quarters of respondents (72%) are employed at companies with revenue above $10 million and below $5 billion. The businesses represent a broad range of industries, with the highest proportions of respondents originating from manufacturing/industrial/automotive and financial services/real estate/insurance.

17Apr_FieldNotes_Fig1_v2When asked to indicate the most important motivations for introducing or expanding service-related revenues, many executives surveyed (39%) selected finding new sources of revenue and profit growth. One-quarter of respondents cited achieving a more stable recurring revenue stream (see Figure 1).

Reaching for the Cloud

For finance executives, technology has made it far less taxing to add services to company offerings, given the prevalence of cloud-based technology.

As services begin to drive growth, the finance function must take a leadership role in monitoring and improving customer satisfaction. For finance executives, the transition requires adopting a more customer-centric approach, tracking such metrics as customer acquisition cost and retention rate.

Survey respondents were asked if they agreed with the statement that they felt “substantial pressure” to change their finance team’s mindset to be more customer-centric and focused on renewal revenue streams. Nineteen percent said they strongly agreed with that statement while 48% said they “somewhat” agreed.

Using data analytics—a skill that will need to be acquired, if it hasn’t already been nurtured—finance executives can create and communicate a clear vision for decision-making within the new services-oriented framework. For CFOs, such responsibilities represent a welcome opportunity to focus on driving revenue growth rather than spearheading spending cuts, as has been their lot in recent years.

To support the strategy, the finance function also needs to develop technical know-how. Reporting service revenue—whether from maintenance or via subscriptions—requires skills distinct from accounting for product sales. For example, it’s key to understand the subtle difference between bookings (representing customer commitments) and revenue (tallying received payments)—and to pinpoint the percentage of bookings that can be recognized as quarterly revenue.

Just under 30% of survey respondents said subscription-based services have become significantly more important over the past five years. Roughly the same number (27%) saw them as an important part of the company’s growth plan over the next two years.

17Apr_FieldNotes_Fig2With products and services bundled together, the sales function’s skills will need development as well. Instead of focusing on features and functionality—as is standard in selling a product—the value proposition relies on supplying customers with integrated “solutions.” While product companies traditionally offer services such as product maintenance and repair, they may choose to expand into software/apps delivered as a service, managed services, and usage-based contracts.

Guardians of Profitability

Moving beyond the one-time buy—and into a subscription model—puts a premium on achieving customer satisfaction for one simple reason: Returning customers replenish profit margins. Happy customers are not only a source of recurring revenue but will also become effective advocates, a low-cost pipeline for acquiring customers.

The expansion into services requires finance executives to change the metrics they rely on to track the company’s progress. Whether capturing recurring revenues via subscription or on an “as-a-service” basis, CFOs must be able to establish and monitor metrics—such as renewal rates—that will drive the company to improve its performance at managing the customer experience.

Asked how the CFO role should change to accommodate the services-added business model, nearly half of survey respondents said they are more likely to use new metrics (see Figure 2, above).

It’s worth noting that 44% of finance executives chose “more involved in product/service pricing decisions”—indicating awareness of the central role their knowledge of customers plays in the evolving business model. To maximize services revenue, finance departments can use technology to segment customers, matching each group with appropriate (and, presumably, irresistible) service offerings. They can track customer acquisition and retention, monitoring the up-sell and cross-sell rates that are the lifeblood of profitable services businesses.

As their priorities undergo a transformation, CFOs will need to serve as role models, displaying their enhanced knowledge of customer satisfaction–related skills as an ongoing reminder to colleagues that the business is expanding in a distinctly different, and promising, strategic direction.

In their changed role, they’ll serve as the embodiment of a new message: Improving the customer experience is a top priority. It will also be up to them to make sure that new services, no matter how creatively designed, are profitable.

For finance executives, that’s one duty that endures—no matter how speedy the pace of innovation or how dizzying the rate at which business models mutate. Ever the crusader for growth, the CFO also remains the steadfast guardian of profitability.

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