Steps to transition to a subscription-based business model

Steps to transition to a subscription-based business model

Since Salesforce disrupted the software industry at the turn of this century, businesses whose models are based on recurring revenues and cash flows rather than “fire-and-forget” products and services have attracted a lot of attention, particularly from investors.

The frequently cited reasons are compelling, not just as a driver of company value but also for the organisations themselves. Greater upselling and cross-selling opportunities and more predictable revenues combined with a vigorous focus on end customers’ needs lead to stronger customer relationships, greater competitiveness, and ultimately higher customer lifetime values. Although often presented as a pricing strategy alone, subscription-based business models inform all aspects of an organisation from finance to IT to culture.

Finance is exceptionally well positioned to champion companies along the subscription journey — from building the business case for change, to operationalising strategies, to incentivising culture change and shaping IT.

Components of a subscription pricing model

At the heart of any subscription pricing model is the idea of customers paying regularly, say monthly or annually, to receive the benefit of a product or service. The most common examples are subscriptions to magazines or streaming services such as Netflix, YouTube Premium, or Spotify.

Sometimes, subscription products or services include multiple components and bundling is an important aspect of subscription pricing strategy. For example, a mobile phone sale can involve a device, airtime (minutes, data, and texts), and insurance.

Subscriptions typically allow customers to continue, upgrade, downgrade, or discontinue the service contract annually, quarterly, monthly, or even daily. That is why continuous customer engagement and satisfaction become critical for any subscription business.

As such, organisations will need to zoom in on the product portfolio and contractual terms to ensure high customer loyalty. Achieving this will require a high degree of organisational flexibility and customer-centric processes and IT systems.

Moving to a subscription model is a strategic undertaking that affects all areas of the business, including culture, people, processes, and technology. This demands that the finance function deploy the full breadth of their capabilities, including business modelling and driver analysis; planning, budgeting, and forecasting; key performance indicator (KPI) development; and incentive structure definition.

Steps to transform to a subscription-based model

Management accountants play a key role in most aspects of a subscription-pricing transformation initiative. With their position between strategy, operations, and IT, they need to be heavily involved in setting up the appropriate technology and business intelligence data infrastructure.

1. Translate strategic objectives into KPIs and incentive structures

Transitioning from a traditional model to a subscription pricing model frequently requires a change in mindset to one where the long-term and changing needs of the end customer, rather than the short-term sales success of the product or distribution partners, become the primary focus of activity.

It also means data trumps intuition. The finance team, therefore, needs to get involved early on by translating strategic objectives into appropriate business drivers, KPIs, and incentive structures. The results from this exercise not only inform the way sales or other parts of the organisation are incentivised but, crucially, determine the business intelligence and data requirements. Despite the known shortcomings, Kaplan and Norton’s classic Balanced Scorecard and Strategy Map, or more recent frameworks like the Business Model Canvas, can provide guidance for this exercise.

2. Define data and analysis requirements based on strategic objectives and KPIs

Subscription businesses typically focus on three central areas: annual recurring revenue (ARR), customer retention, and cash flow metrics. Translating these metrics into KPIs and being able to monitor the KPIs can prove to be challenging for businesses that have traditionally followed a perpetual pricing model or have a channel-centric sales and distribution model.

Finance is best positioned to develop and operationalise the KPIs in the organisation. It can translate the KPIs into data and analysis requirements. Because the end customer is the focal point for any subscription business, organisations need to clearly define end customers, identify them in their data, and capture any interactions, including sales activity and pricing. As the business grows, it becomes crucial to be able to track customer interactions over longer periods of time and to establish leading indicators based on many data points, past or present, that can easily be interrogated.

3. Drive technology, data, and business intelligence infrastructures

Businesses that transform their pricing model will have to make significant changes to their operational systems, particularly the enterprise resource planning (ERP) software. They must typically also invest in processes and technology to deploy and monetise their products over the subscription period and to manage the product’s use at the end-user level. This includes, for example, systems to reliably initiate, renew, terminate, and charge for all or part of a software functionality and associated support services.

Traditional subscription products that are typically of a physical nature, like newspapers or gym memberships, can easily be managed over the customer’s lifecycle, and, for example, be withdrawn upon contract termination. Software products, such as Microsoft Windows, on the other hand, require new technologies and processes to control their usage at the end user level. This is a key area where early market innovators in the software space such as Salesforce disrupted the market.

Finance will have to take ownership of the required business intelligence infrastructure. This in turn demands a firm understanding of the organisation’s technology architecture and data.

Experience shows that unless finance gets involved early and ensures that business intelligence requirements are met, companies run the risk of being unable to effectively master subscription pricing.

The business’s ability to make good decisions based on data requires finance leaders to understand the implications of what is being proposed operationally.

Moreover, they need to work with IT and operations to confidently place their specific requirements on the roadmap and take full ownership of reporting as well as planning, budgeting, and forecasting for technologies.

Experience also shows that “outsourcing” any data and business intelligence competency to the IT function will often lead to not only inefficiencies and a loss in flexibility but also to business requirements not being met sufficiently or data not being interpreted correctly. Instead, subscription pricing initiatives require finance, IT, and other business functions to operate in lockstep.

4. Constantly realign IT systems and data with strategic requirements

Because subscription businesses first and foremost need to be built around customer satisfaction, they need to respond flexibly to changing demands. This also applies to reporting, incentives, IT systems, and data. Finance teams therefore need to adopt a flexible “lean startup” mentality when it comes to their willingness to drive and adopt change or accept failure.

IT systems and data should be flexible enough to support whatever strategic or operational change is necessary to realign the business. Examples here include the ability to re-map customers, products, and teams to new reporting hierarchies or to change the algorithm behind the calculation of KPIs.

Formulating and testing hypotheses based on data and then updating metrics as well as reporting structures should become second nature to any management accountant involved with subscription pricing. As the guardian of enterprise value, finance also needs to lead by example when it comes to making IT investment decisions; a rigorous use of business cases to test and clearly outline objectives, costs, benefits, and alternative options is good practice in any business, not just subscription businesses.

5. Provide strategic and operational insights from data

Finance professionals’ core competency is the ability to provide strategic and operational insights from data to support decision-making. To do this, they need to become experts in packaging and pricing methods, subscription pricing models, and their value drivers. They should also have a firm grasp on KPIs and how and where they are being calculated, including the caveats that the underlying data and calculations entail.

Finance’s championing role

Subscription pricing offers significant upside in terms of growth, competitiveness, and long-term value. But it also puts a high level of demand on businesses’ and individuals’ ability to manage complexity and change. Placed between strategy, operations, and IT, finance is able to champion subscription pricing models that are fast becoming the standard in many industries.

A prerequisite for this is for management accountants to fully embrace technology, data, and change — a challenge that promises the reward of making themselves indispensable for business success.