The Basic Equation Behind all Successful SaaS Business Models

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A CFO Perspective on SaaS

The Subscription Economy is here to stay, and CFO's need to adapt. Tyler Sloat, CFO, Zuora

Simply put, SaaS finance is different. The SaaS business model is just fundamentally different from the business model of traditional product companies, with different priorities, concerns, metrics, reporting, etc.

As CFO of a Subscription Economy company, I’ve found that the most meaningful metrics for our business are not addressed by GAAP standards, because what SaaS companies need is to:

  • Value one-time revenue very differently than recurring revenue.
  • Measure business across multiple dimensions of time – not just the past, but the future as well.
  • Manage complex changes that can create chaos in downstream processes, such as mid-month subscription cancellations that can result in credits or refunds thereby impacting revenue recognition.

GAAP vs non-GAAP

I’ve talked to many SaaS CFOs who are struggling with the current systems they have in place. Tyler Sloat, CFO, Zuora

CFOs and their teams are in pain because it takes longer for them to close the books. My revenue team, like many, was drowning in spreadsheets with a row for every customer – spreading revenue across a multitude of columns. I know this has forced some SaaS CFOs to maintain one set of GAAP books to please auditors and another to run their business.

On the executive side, CEO and board members demand insights into more than just balance sheets and income statements; they need insights into forward-looking metrics, like ARR, Churn, and ACV.

I don’t know about you, but at Zuora we have to rely more and more on non-GAAP off-balance sheet accounts to explain our success. In addition, despite a growing awareness of these recurring revenue models many Wall Street investors don’t fully understand the subscription business model and often fail to value subscription businesses correctly.

I know what it’s like to go through this, and you’ve just got to get it done right.

Das Grundlagen-Deck für CFOs

This data-driven, research-backed deck curated by Zuora CFO Tyler Sloat provides detailed insight into Zuora's business model and explores how CFOs in the Subscription Economy are preparing for the new revenue standards.

Read now!

New Model, New Equation: The Basic Equation Behind All SaaS Businesses

Recurring revenue business models deliver greater financial predictability, grant greater insight into what your customers’ like, and give much greater flexibility to adapt to your customers’ evolving needs. Upsells, cross-sells and upgrades become entirely new revenue streams. Tyler Sloat, CFO, Zuora

For SaaS companies, your business strategy must be focused around offering innovative services that breed long-term relationships. So instead of being about single, discrete sales, the Subscription Economy nets down to monetizing and retaining relationships for a predictable recurring revenue.

Here is the basic equation behind all SaaS businesses:

Subscription Finance: Hier ist die einfache Rechnung hinter allen Abo-basierten Unternehmen.

 

ARR

Annual Recurring Revenue, or ARR, is the amount of revenue you expect to repeat. It’s that simple. Note that, this does not include one-time revenue, it only includes revenues that recur. And with that said, ARR is different than revenue. Revenue is a backwards looking number while ARR is a forward-looking number — emphasis on “Recurring” in ARR.

The Problem? Well, your traditional financial statements only show revenue for a past period and have no concept of forward-looking, recurring revenue. But for SaaS companies, because of ARR, they can actually start each fiscal year knowing what their revenues are going to be for that year. In the formula above, we call this Starting ARRn.

Kundenabwanderung

In its simplest sense, churn is the number (often noted in revenue) of subscribers who will not renew. Typically, downsells are also factored into your churn number.

It’s a hard reality to swallow, but even if you’ve got the best SaaS offering in the market, you’ll still have customers that will leave you. So, in the formula you’ll need to subtract your churn from your ARR for the year.

ACV

Der jährliche Vertragswert (oder ACV) ist der neue Umsatz, der von neuen Kunden eingebracht wird oder von Kunden, die ihren vorhanden Vertrag upgraden oder verlängern. Sie investieren in Vertrieb und Marketing, um neuen Umsatz anzukurbeln, weil so schließlich Ihr ARR gesteigert wird. Und das finden wir toll.

If you add up all of these metrics, you not only have a complete financial picture of your SaaS business, but you also have your recurring revenue for next year, or your Ending ARR.

 

Where ERPs Fail SaaS Businesses

When it comes to tracking metrics for subscription businesses, traditional systems just can’t account for the whole picture. Mike Walker, Customer Success Manager, Totango

So, by now you get the subscription business model on which SaaS is built: ARRn – Churn + ACV = ARRn+1. But how do the ERP financial systems you have in place today support a new model based on fostering and monetizing relationships?

Tracking recurring revenue is a forward-looking process. So, when it comes to tracking metrics for subscription businesses, traditional systems just can’t account for the whole picture.

Sicher, Finanzkennzahlen wie Buchungen, Abrechnungen, Barmittel und Umsatz wurden in der alten Handelswelt verfolgt, aber sie waren rückblickend und konzentrierten sich auf einmalige Transaktionen.

Let’s look into some ERP limitations when it comes to SaaS:

SaaS relationships are committed relationships, not one-night stands.

Wiederkehrende Umsätze sind die Ergebnisse einer langfristigen Kundenbeziehung, in der Kunde und Händler sich an ihre Versprechen halten. Eine feste Beziehung muss natürlich konstant gepflegt werden, während ein einmaliger Kauf nach dem Kaufvorgang abgeschlossen ist.

Aus diesem Grund müssen Unternehmen wiederkehrende Umsätze anders abrechnen als einmalige Umsätze. Aber herkömmliche Finanzsysteme können nicht zwischen einer einmaligen Transaktion und einer wiederkehrenden Kundenbeziehung unterscheiden und werfen daher meist beide in einen Topf.

With SaaS, relationships evolve over time.

Menschen, Kunden und Unternehmen – die einzige Konstante ist die Veränderung. Ihre Bedürfnisse und Wünsche werden sich fortlaufend ändern, während sie reifen und sich ihr Umfeld verändert. Ihre Beziehung muss sich weiterentwickeln, um die Bedürfnisse und Wünsche Ihrer Kunden zu erfüllen.

This means you need to be able to iterate on your pricing and packaging. And do it quickly — before your customer goes elsewhere. But this can result in quite a burden for the finance team. Every tweak to pricing or bundling can complicate matters, or make things real wicked if there are multiple time periods in play.

In fact, because traditional finance systems do not know how to spread a series of changing transactions over time, they limit you to simple debits and credits. And if your “system” is a spreadsheet, well good luck tracking the business impact resulting from these changes — things like bookings, billings, cash and revenue – across multiple dimensions of time.

Entscheidungen in Beziehungen haben Konsequenzen.

Machen Sie es sich nicht so einfach, zu denken, dass die Stornierung eines Abos mitten im laufenden Monat einfach nur ein Klick ist. Komplexe Änderungen wie diese können in nachgelagerten Prozess Chaos verursachen und Ihre Umsatzbilanzierung direkt beeinflussen. Insbesondere, wenn jede Veränderung durch den Kunden manuell verwaltet wird.

You need to be able to quickly adapt to changes in the relationship and automatically calculate how this will impact the account, as well as the business. But the core functions of old world financial systems are around tracking raw goods, not software services. They are not powerful rule engines. They are not smart enough to adapt to subscription changes in real-time, and re-calculate any schedules impacted by those changes.

Einschränkungen machen sich überall bemerkbar.

Jede Abteilung in Ihrem Unternehmen wird die Einschränkungen und ihre Auswirkungen spüren, die traditionelle Finanz- und ERP-Systeme mit sich bringen – und diese Konsequenzen setzen sich noch weiter fort bis ins Büro des CFO.

  • Die Buchhaltungsabteilung hat ordentlich zu tun, den Monatsabschluss rechtzeitig über die Bühne zu bringen
  • Revenue Manager ersticken in Excel-Dateien
  • CMOs können keine neuen Preis- und Verpackungsstrategien implementieren, da das Finanzteam gar nicht in der Lage ist, dies zu bewältigen
  • CEOs können ihren Erfolg den Investoren nur schwer erklären
  • And, last but not least, CFOs are forced to maintain one set of GAAP books to please auditors and another to actually run their SaaS business.

Relationships require a new system.

At the heart of any successful SaaS business are the customer relationships. In order to properly manage these relationships, you need a system that will partner in offering a new subscription experience and a new customer journey, and has an integrated approach across not just subscription finance, but commerce and billing, too.

3 Key Strategies for Ongoing SaaS Success

Managing and monetizing relationships implies a completely unique business model. Carli Leary, Finance Manager, Zuora

In short, here’s a cheat sheet for the key strategies for SaaS companies:

Strategy 1: Increase Your Customer Value

All companies focused on growth have a goal of acquiring new customers. But for your SaaS business, you’ll also strive to establish valuable, meaningful relationships with your customers to increase their value and to retain them over time to minimize churn.

Eine Strategie zur Steigerung des Werts Ihrer Kunden ist die Implementierung eines Preisrahmens, der verschiedene Editionen bietet. Das bedeutet, dass ein Kunde einfach auf eine höhere Edition upgraden kann, wenn seine Bedürfnisse wachsen.

Alternatively, a customer can move to a lower edition if their needs decrease. Initially, the latter scenario sounds negative. But just think, if you didn’t have that lower edition as an option you risk losing the customer all together, whereas just moving down a tier, means you retain the customer — aka, you hold on to at least some revenue.

Strategy 2: Analyze Data in the New Economy

Traditional finance statements are really only good for the product economy. Why? Because they are backwards looking — anchored on a revenue number for a period of time that already occurred, whereas SaaS businesses need to align themselves and drive growth by maximizing recurring revenue.

Sometimes this is called monthly recurring revenue (MRR), annual recurring revenue (ARR), and sometimes quarterly recurring revenue (QRR). Regardless of which you choose, in order to optimize for forward-looking revenue, aka recurring revenue, you need to be looking at a completely different set of metrics.

Kundenabwanderung: Der Abzug Ihrer Kundenabwanderung von Ihrem ARR ist erforderlich, um die Mindestmenge neuer Geschäftsabschlüsse zu erkennen, die Sie dieses Jahr erreichen müssen, damit Ihr Unternehmen rentabel bleibt.

Recurring Profit Margins: This is simply the difference between your recurring revenues and your recurring costs — things like COGS. Leveraging this metric is critical. Why? The higher the recurring costs, the less money you have to play with. Meaning you have the intel to choose to either book as profits or invest in one-time growth expenses.

Wachstumseffizienzindex: Dieses Verhältnis zeigt Ihnen, wie viel neuen regelmäßigen Umsatz das Unternehmen mit einer bestimmten Investition in Vertrieb und Marketing einnimmt. Mit anderen Worten: Wenn Sie einen Dollar in Vertrieb und Marketing investieren, wie viele Dollar bekommen Sie als regelmäßigen Umsatz wieder heraus?

Strategy 3: Optimize Customer Relationships

Traditional finance systems or ERPs just aren’t built to support the subscription business model. Scenario after scenario of subscription business use cases only validates that running your SaaS business on a legacy system is like attempting to stick a square peg in a round hole. Where at the center of a legacy system is a SKU, it really needs to be the relationship.

In order to build a thriving SaaS business, you need a system that enables you optimize customer relationships, quickly change pricing and packaging to keep up with market needs, and be flexible, scalable, and intelligent enough to calculate recurring revenue, churn and forward-looking metrics.

The subscription model is not only a cost-effective, low-risk model for customers, but it also provides a huge potential for subscription businesses and investors. Seize the opportunity and leverage these strategies to build and maintain valuable relationships with your customers and, ultimately, accelerate your company’s growth.

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