Monetization That Fits the Business: The Limitations of Subscription Billing

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1 A research report prepared by: Publication sponsored by:

2 TABLE OF CONTENTS Introduction: Cloud Monetization Changed Pricing 1 The Shift to Recurring Revenue 2 Varieties of On Demand Monetization 4 Making Changes to the Monetization Strategy 6 Modeling and Managing Revenue 6 Conclusion: Moving Beyond Subscriptions 7 Sponsor Perspective 8 TABLE OF FIGURES Figure 1: Early Attitudes Towards SaaS Pricing 2 Sidebar: Five Key Monetization Metrics for Recurring Revenue Models 3 Figure 1: ISVs Transitioning to Cloud: Eight Leading Cloud Transition Challenges 4 Sidebar: Case Study - 5 About this Report This report was prepared and published by Saugatuck Technology Inc., which is solely responsible for all content. The research, analysis, and conclusions cited and presented in this report were conducted by Saugatuck Technology. The publication of this report was sponsored by MetraTech. About Saugatuck Technology Saugatuck Technology, Inc., provides subscription research and management consulting services focused on the key market trends and disruptive technologies driving change in enterprise IT, including Software-as-a-Service (SaaS), Cloud Infrastructure, Social Computing, Mobility and Advanced Analytics, among others. Founded in 1999, Saugatuck is headquartered in Westport, CT, with offices in Falmouth, MA, Santa Clara, CA and in Frankfurt, Germany. For more information, please visit or call Saugatuck Technology Inc. i

3 As monetization approaches have evolved over the past decade or so, an overreliance on subscriptions has limited some providers, even as it has enabled them to easily communicate their value proposition to potential buyers. Subscriptions make sense in many contexts, but hardly in all. There are countless monetization challenges that cannot be met by subscription billing. If you cannot bill for it, you cannot monetize it. That much is clear. Solutions providers need an approach to monetization that fits their business, and yields maximum profitability, and not the other way around. INTRODUCTION: CLOUD MONETIZATION CHANGED PRICING The mass exodus of software to the Cloud brought with it a monetization challenge for Cloud solutions providers and at the same time introduced pricing flexibility in all software and services markets. Much of the early appeal of Cloud, whether for SaaS or for Infrastructure solutions, was its term-based licensing with pay-as-yougo pricing. The early Cloud providers, including salesforce.com, Concur and Hewlett Packard, whose Utility Data Center in 2003 predated Amazon Web Services by three years, recognized at the outset the importance of pay-as-you-go pricing as a purchase incentive. Before long, subscriptions and metered rates were offered to enterprise buyers of both Cloud and on-premises solutions. The earliest pay-as-you-go pricing models combined a need to simplify the provider s value proposition with the customer s desire for reduced capital outlay and greater flexibility to scale up or down, together with the managed trade-off between billing predictability and price. The buyer had to see the price as intuitively fair, and the seller had to set a price that would capture and grow revenues and provide an eventual path to profitability. Solution providers typically offered pricing based on a featured value metric, appealing to the customer s perception of the solution s value, while layering on additional premium services and extras that could inflate the bill significantly Saugatuck Technology Inc. 1

4 THE SHIFT TO RECURRING REVENUE For many traditional software vendors, the move to the Cloud was freighted with so many challenges that the monetization challenge was easily overlooked, or else given insufficient attention for full understanding. For Cloud pure plays often the challenge was in understanding the full potential for monetization made possible by a Cloud solution, and many business models were overly simple as a result. It may be hard to believe it today, but in the first wave of SaaS and Infrastructure solutions, many thought that there would no longer be a channel, and consequently they formed highly-simplistic views of how Cloud solutions could be sold, and bundled. Moreover, the impact of Cloud solutions was felt in traditional software and services markets where subscription billing became a mantra and a formula for stemming customer defections. Soon subscription billing became almost synonymous with Software as a Service, a misconception that persists to this day. In 2003 Saugatuck surveyed both software vendors and enterprise buyers regarding SaaS pricing, and the result is surprising when viewed in retrospect. Subscription billing was nowhere near the top of the list. Nevertheless, the conceptual simplicity of per user / per month, made popular by salesforce.com s ground-breaking marketing, led to a knee-jerk response in favor of subscription licensing among ISVs migrating to the Cloud and pure play Cloud ISVs alike. At the same time as this, Cloud Infrastructure was being priced by Hewlett Packard on a metered basis, sometimes in tiers or bands (See Figure 1: Early Attitudes Toward SaaS Pricing). Figure 1: Early Attitudes Towards SaaS Pricing It is clear from this data that early buyers and sellers had little idea where the Cloud revolution would take solution pricing. The subscription model, often compared with cable-tv pricing, was significantly less favored than metered or tiered pricing models Saugatuck Technology Inc. 2

5 The least favored was the per-seat model. Today all three approaches find their place in the portfolio of pricing we see in the Cloud and in on-premises and services solutions. On the buy side, SaaS subscription pricing became popular because it was simple to explain, and the CIO or line of business (LOB) executive could rely on the same monthly bill. Some buyers negotiated and locked-in more favorable multi-year agreements with quarterly billing because, overall, predictability was considered a strong plus. In contrast to SaaS or Cloud business services, Infrastructure billing was consumption-based, and this varied considerably from month to month, though few enterprises early on committed significantly to Infrastructure services in the Public Cloud. Developers would charge the use of software testing resources, for example, to a credit card and expense it. However, before long, hosting providers got into the game with monthly billing based on metered usage and, eventually, enterprise billing. As venture capitalists began to forgo investments in traditional software startups in favor of Cloud pure plays, a new set of business model metrics became de rigeur for the Cloud provider, focused primarily on monthly recurring revenue (MRR) and its close cousins (See the Sidebar Five Key Monetization Metrics for Recurring Revenue Models ). These metrics have become the basis for understanding and managing Cloud business models and for shaping the management decisions of Cloud ISVs. For those divisions of on-premises software or services companies with term-based licensing and pay-as-you-go pricing, they are also very useful. FIVE KEY MONETIZATION METRICS FOR RECURRING REVENUE MODELS Saugatuck has long been a fan of Bessemer Venture Partners and their approach to Management Metrics. Bessemer identifies 5 key metrics as essential top-level performance indicators for Cloud providers: CMRR Committed Monthly Recurring Revenue (MRR plus newly-committed revenue minus de-committed revenue or churn) provides an ongoing view of financial health CASH FLOW Gross Burn Rate (monthly expenses debt and finance charges) and Net Burn Rate (monthly cash received minus expenses) are two metrics for managing cash CAC Customer Acquisition Cost / Payback Period is a metric for managing the efficiency of sales and marketing investment CLTV Customer Lifetime Value is the net present value of the recurring profit flows from a given customer net of the acquisition cost CHURN Logo Churn, CMRR Churn, and CMRR Renewals are percentages over a given period. CMRR Renewals can exceed 100 percent in the event of upsell. Saugatuck Insight: Bessemer points out that these metrics apply especially well to pre-public companies and are often used by Cloud CEOs for their executive team objectives and bonus plans. Nevertheless, Saugatuck believe these metrics will continue to be useful internal management metrics, even as leading Cloud providers embrace GAAP Revenue, Gross Margin, and EBITDA on the road to going public Saugatuck Technology Inc. 3

6 VARIETIES OF ON DEMAND MONETIZATION? Today, when ISVs first move to the Cloud in the current competitive environment, pricing is one of those challenges that few feel well-equipped to deal with. While only a small percentage consider monetization to be the primary challenge, especially in comparison with the operational issues they face for the first time, the weight of the issue is such that overall it is felt to have the greatest impact (see Figure 2: ISVs Transitioning to Cloud - Eight Leading Cloud Transition Challenges). Figure 2: ISVs Transitioning to Cloud - Eight Leading Cloud Transition Challenges Source: Saugatuck Technology Transitioning ISV Interviews, 1H2013, n=12 The Cloud shift to subscription and usage pricing is the top challenge for ISVs Transitioning to Cloud. This Cloud transition also entails operational changes and the use of an appropriate billing and payments solution. While there are a wide range of tools to enable Cloud, on-premises and services providers to realize revenue, it is critical to select a solution with a sufficiently varied set of monetization capabilities. There are literally an unlimited number of ways to monetize, and yet transitioning ISVs and pure plays overlook many of them. Partly, the popularity of subscriptions has provided an easy choice for some ISVs and services providers. Partly, the potential for monetizing is so wide open and few understand all the possibilities. Lower-end billing providers may reassure those new to term-licensing and pay-asyou-go that their subscriptions solutions can handle nearly every monetization need Saugatuck Technology Inc. 4

7 This line of thinking can be an effective way to sell billing services to naïve or short-sighted solution providers, but ISVs (and other providers) grow larger, serve new markets, launch new offerings and encounter aggressive competition. A monetization solution has to be able to meet those challenges. Some of the things that are worth considering when selecting a billing solution provider are customer account management options, service agreements, pricing models, billing plans, contract terms and rate plans. Metering capability may prove to be very important, if usage models are, or will be, part of the monetization approach. How complete the billing solution is may determine the provider s ability to respond competitively to shifts in the market. Consider the comparatively simple, but real-world example in the Sidebar below (CASE STUDY - The Limitations of Subscription Billing). CASE STUDY - THE LIMITATIONS OF SUBSCRIPTION BILLING A Cloud Marketing PaaS targeting businesses selling to consumers was about to launch their Cloud platform, offering marketing, digital storage, commerce functionality and social media, and initially targeting small-to-midsize businesses. Client businesses would experience a platform similar to Amazon with capability for selling products and services, full shipping integration, and integration with Stripe for reduced card fees. Customers would engage directly and purchase goods, products and services and share information with other customers on the platform. However, once launched in the SMB space, Cloud Marketing PaaS discovered it would have no way to scale to large consumer enterprises, e.g., Pizza Hut, because they could not manage the complex billing that was essential for meeting the needs of those customers. They would be constrained from offering their solutions to large consumer enterprises because their current billing system could not go beyond subscriptions. Specifically, the Cloud Marketing provider needed to have a pricing model with a base subscription plus a percentage of transaction dollars. Because it was important to this Cloud Marketing startup to be able to scale up to large consumer enterprises, they were forced to drop their billing provider and go with one that could offer them much greater flexibility in monetization beyond their immediate needs, so that their future potential entry into new markets would not be constrained. They were fortunate. Had they launched without that capability, it would have proven very difficult, and expensive, to remedy that limitation. Best Practice: You cannot monetize what you cannot bill for. The choice of a Billing and Payments solution can make or break a Cloud provider. Ensure that the solution you use is fully -functional, adaptable and will continue to evolve. Should you change your sales strategy, e.g., from direct to channel, or introduce more complex monetization models, be sure your solution can change with you Saugatuck Technology Inc. 5

8 MAKING CHANGES TO THE MONETIZATION STRATEGY Clearly it is important to be able to make changes to your monetization strategy. For instance, a solution provider may need to move beyond subscription billing to embrace elapsed-time rates, tiered rates, bracketed rates, metered-usage rates, day-of-week rates, time-of-day rates, or some combination of all of the above approaches. If the billing system will not permit that change, the solution provider may be doubly constrained, both on the top line and in the cost of operations. Let s look at a couple of practical examples of that. As we saw in the example in the sidebar above, it may be important to a SaaS (or Cloud business services) provider to have a pricing model that combines a base subscription with a percentage of transaction dollars or transaction volume in tiers. Such pricing may enable the planned acquisition of additional processing capacity in line with increasing revenues. Subscription pricing would not allow for aligning revenue and expenses with the resource consumption necessary to sustain the business. Consider an Infrastructure provider with a computer data center that sees periods of intense activity and still other times when little is going on. In order to achieve improved utilization of that data center, it would make sense to offer day-of-week rates or time-of-day rates that provide incentives to make use of the underutilized periods. By doing so, the Infrastructure provider can attract new customers drawn to the incentive pricing and shift other current customers to those underutilized days or day parts. Rather than having to acquire additional capacity, and increase operating costs to meet the needs of peak processing times, the provider can smooth out usage across the underutilized periods and not only capture new revenue but avoid expense. Monetization may also include the way in which customers are acquired and billed for services. Amazon enjoys an enormous advantage in the Cloud Infrastructure space because of its monetization approach, which may be termed frictionless, enabling licensing terms and conditions to be accepted with a single click and credit card billing with a few keystrokes more. If we consider Amazon s example, the key is to make your offering easy to understand and easy to consume. Moreover, there should be no limits to the ability to change pricing easily should continuously lower pricing become the terms of competition. MODELING AND MANAGING REVENUE MetraTech s innovative Agreements-Based Billing TM and Compensation powered by its Real-time Commerce Decision Engine TM makes possible a unique variation in monetization options. It enables providers to tailor their service offerings via unique pricing models and volume or commitment-based agreements that span any combination of subscription and consumption-based services. The result for the provider is a predictable, recurring revenue stream, while giving the enterprise customer both elasticity and value. The Real-time Commerce Decision engine processes a virtually unlimited set of account, contract, agreement, product, service, sales and usage information to price, adjust, discount or true-up individual or aggregated events. Aggregations can be applied to any combination of consumer accounts, family accounts, enterprise 2013 Saugatuck Technology Inc. 6

9 hierarchies (partial or full), suppliers or channels that span multiple national jurisdictions and currencies. This broad flexibility in monetization is complemented by a now-cast dashboard that provides the end customer or partner with a view of the individual, departmental or enterprise status against the agreement in place. Configurable threshold notifications also enable behavioral modifications to manage costs and meet commitments. In effect, the MetraTech solution creates a real-time financial model to accompany any pricing plan that may be contemplated. Because MetraTech s products are built on a metadata-driven architecture, this enables service providers to quickly configure their data models, transaction-processing models, pricing schemes, GUIs and APIs to meet their business needs, rather than forcing them to fit the software. Entirely new verticals or business models can be configured in days or weeks, not months and years. The advantage to the ISV, infrastructure or service provider is undeniable, removing the guesswork from monetization strategies, allowing the solution provider to shift and customize monetization approaches at the pace and in the context of business. Sales teams can fluidly negotiate agreements based on tailored pricing, bundling, discounting and commitment terms across any number of accounts, services, service metrics or commitments. This results in service differentiation, stickiness, higher margins and increased customer satisfaction. While no one can predict how buyers will react to pricing changes, having the ability to adjust pricing as needed is a bit like having the knobs and dials to fine tune revenue and profitability. In Saugatuck s view, adding in financial metrics such as the aforementioned five key Bessemer management metrics would be the icing on the cake. CONCLUSION: MOVING BEYOND SUBSCRIPTIONS As monetization approaches have evolved over the past decade or so, an overreliance on subscriptions has limited some providers even as it has enabled them to easily communicate their value proposition to potential buyers. Subscriptions make sense in many contexts, but hardly in all. We have demonstrated several examples of monetization challenges that cannot be met by subscription billing. If you cannot bill for it, you cannot monetize it. That much is clear. Solutions providers need an approach to monetization that fits their business, and yields maximum profitability, and not the other way around Saugatuck Technology Inc. 7

10 SPONSOR PERSPECTIVE Subscriptions are not a new way to offer services; however, it seems that some believe we are entering a new era, even a new economy, dependent on subscriptions and driven by the Internet. Subscriptions are the most rudimentary model on the path to reducing the incremental cost of products and services. Billing companies should not dictate to customers what their business model should be; rather they should communicate how monetization can be used as a tool to meet a company s business needs and differentiate service offerings and monetize the business model they want to bring to market for customers and partners. The next logical evolution is to evolve subscription services from today s one size fits all. To us at MetraTech the notion of trying to dictate the business model to a customer does not represent innovative thinking. We ve seen this before; software companies guiding customers to monetize in line with their functionality rather than meeting the customer s variety of business models, pricing plans, discount schemes, and loyalty programs. MetraTech s view of current and future commerce is much different. Products in all industries are now being sold as services. A simplistic good, better, best offering will not lead you to success; rather it will take you down the path to commoditization. Enterprises are looking for more personalization and differentiation in services. Companies need to innovate through the bundling of partner offers resulting in the need for channel and partner compensation. Enterprises want to pay for what they use and pricing needs to reflect usage and two-way commitment rather than a fixed subscription amount. Services that correspond to this are no longer a nice to have, but a key requirement for success. We see the economy driving personalized multi-party agreements which require a flexible and agile billing and settlement platform to support relationships with customers, partners, channels and suppliers. MetraTech is the only billing provider with an extensible metadata-driven architecture that makes it simple for customers to model services, introduce products and services, pricing plans, new business models and to change them in rapid response to market demands or customer behavior. MetraTech customers do not have to consider time, cost and risk associated with making changes. MetraTech offers two products to address all customer delivery models across Cloud, Communications and Media, Financial Services, and Transportation and Utility markets. Customers can select the full control MetraNet platform, which is available on-premise perpetual or term license or as a managed service (managed infrastructure and billing operations) or the SaaS solution with the Metanga offering. Learn more at Saugatuck Technology Inc. 8

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