One of the interesting aspects of new service-focused business models -- related to SOA and SaaS -- is their concentration on new pricing models. As opposed to requiring payment upfront, these models enable customers to pay on a subscription or incremental basis. Whether one is selling a perpetual license or a monthly service, more and more companies have now embraced something that might be called "subscription-based accounting."
This is an important advance for the software industry. It changes the dynamics of risk and reward -- putting buyers and sellers in the same boat. No more throwing the software over the wall and running for cover before the implementation explodes.
Robert O'Connor, president and CEO of Softrax, has written an intriguing piece discussing some of the key elements of this "financed-centered" strategy -- one that promises to help vendors better manage regulatory requirements while meeting the demands of their customers. He notes that other industries have already begun to tie pricing to usage behavior. Consider the telecom industry's decision to provide rollover minutes, off-peak pricing, free weekends, and friends and family plans. The software industry, he suggests, needs to think the same way.
"When you sell software as a service you are essentially bundling a whole set of products and services with support and other customer entitlements into a single financial arrangement," he explains. "Contracts become more intricate with tiered pricing strategies that differ by customer, product and consumption levels. This triggers a number of technical accounting rules that make revenue accounting very complex...Billing capabilities must also become more sophisticated. Services have to be added to the bill upon completion, support has to be tracked against the commitment level. Usage items must be billed in arrears while subscriptions are billed in advance - on the same invoice. Making sure revenue is being optimized while all this is going on requires the ability to monitor vast amounts of transaction activity and quickly find meaningful insights."
His point is that vendors who intend to roll out service-based business models need much more sophisticated finance capabilities. "The crux of the issue is integrating contract terms into all the downstream financial workflows from order entry to billing, metering, renewals, revenue and expense accounting, and financial forecasting," he adds. "Many existing financial systems are not equipped to support these demands and there is a risk of having spreadsheets crop up like weeds around the core system. This is one of the key things CEOs are concerned about today - how many spreadsheets did it take to produce the financial data they are being asked to sign off on? Ideally the answer is none. While regulations like Sarbanes-Oxley have forced the issue, software as a service models also demand more timely and detailed financial data."
You can read on to learn more about the "financial instructure" solution he is proposing (One his company, unsurprisingly, can help you create). The new systems should "accurately capture, track, and forecast totally new revenue streams." They should provide anb array of new performance metrics such as:
- Reporting and comparing bookings and revenue growth
- Tracking renewal rates
- Matching expenses (especially commissions) against revenue
- Understanding how add-on sales to existing customers contribute to bookings and revenue goals
- Having instant insight into revenue growth by new and existing customers
- Improving visibility into how deferred revenue will be recognized over time
As O'Connor sees it, such reporting will be critical to measure the success of service-driven initiatives and support new strategic decisions. "In particular, analyzing how efficiently revenue goes from deferred accounts onto financial statements is emerging as an effective tool for finding operational problems as well as keeping revenue recognition practices in compliance with complicated accounting rules," he concludes. "Not only will these reporting capabilities help you manage for success, these are the metrics your board and financial analysts will be looking for to evaluate your [service-driven] business."