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Dhaval Moogimane and Amy Fletcher, West Monroe partners
Tech companies continue to transition to As-a-Service (XaaS) models – and for good reason: They’re lucrative, popular with investors, and allow software companies to deliver better service on a larger scale.
This trend was clear in a West Monroe Partners investigation distributed last year, in which 40% of private equity respondents said between 50% and 70% of their tech portfolios sell and provide products and services in subscription form.
But there are a lot of things companies should consider when maximizing their XaaS or subscription models. They especially need to think about customer focus and scalability. In other words, it’s more than just a change in billing model.
The market is growing
If you need to be convinced that the XaaS model is here to stay, consider this: Over the next five years, SaaS subscription services, a category within XaaS, are expected to experience a compound annual growth rate of 12%, according to a Gartner study. Salesforce, one of the main SaaS providers, reported Q4 2020 revenue of $ 5.82 billion, up 20% year-over-year. The RingCentral cloud communications company reported a 32% increase in total revenue for the first quarter of 2021 to $ 352 million, in addition to a 34% annual increase in subscription revenue.
Meanwhile, the valuations of software companies using an XaaS model have soared. Last year, Insight Partners paid $ 5 billion for the Veeam Software cloud management platform; Clayton, Dubilier & Rice bought Epicor Software from another private equity firm KKR to $ 4.7 billion; and Canadian buyout manager Onex paid New Mountain Capital $ 2.65 billion for the OneDigital benefits platform.
The benefits of using XaaS models are not limited to evaluation. To retain subscribers over time, companies using these models must constantly engage with their customers. If done right, this activity can make these clients ‘stickier’, empowering them as advocates and increasing retention rates.
Businesses have tended to operate in a vacuum, with clients invariably “shifting” from one department to another. However, companies need to understand the importance of recognizing the moments that matter and learning how to generate value at these critical points in the journey. Roles and responsibilities should be clear so that each customer engagement builds on the previous one.
Customer acquisition cost is a key metric that most technology companies manage closely. Typically, the cost of retaining or growing a customer is a fraction of the cost of acquiring a new one. That said, companies need to be careful not to underinvest in retention and expansion – and smart investing includes in-depth analytics to understand customers, digital workflows to guide value-driven engagement, as well. as frictionless service and support.
Product design also has a critical role to play in this process. Traditional investments in B2B software products tend to focus on creating the next best functionality. These efforts must be balanced with investments in data-driven customer engagement to maximize use and adoption.
Businesses that can orient themselves to put customers and users first will thrive in the subscription model. Of course, that’s easier said than done.
it is not for everyone
There is a constant debate on the merits of the pay-as-you-go model versus the subscription model. The predictability of the subscription model has its appeal. Management teams and investors certainly appreciate it, and even clients find it easier to budget. However, depending on a company’s products and customers, as well as its maturity and competitive dynamics, a pay-as-you-go model may make more sense and can disrupt the market as well.
For example, a start-up marketing a whole new kind of app might have difficulty getting customers to subscribe. With a whole new kind of software, how will consumers know the product is worth the recurring expense?
In this case, a pay-as-you-go model makes sense as the startup hits the market and customers begin to discover the value of its products. Then, as customers understand the vendor’s unique value proposition, the business can explore longer-term subscription commitments.
While the investment community appreciates the predictability of revenue from the subscription business, they likely wouldn’t reject a smart pay-as-you-go business with a high customer retention rate. In fact, investors might be drawn to such a business if they saw a clear growth opportunity with a pivot to a subscription model.
A major transition
Businesses moving from pay-as-you-go models to subscriptions shouldn’t underestimate the changes needed to be successful. Beyond the basics of designing thoughtful pricing strategies, careful consideration of the customer and user journey is required.
On the pricing side, businesses need to consider their customers’ usage patterns and complement them with a thorough understanding of their cost structure to design attractive subscription packages. Let’s say Netflix had a pay-as-you-go option charging $ 1 per movie. If a user watches an average of six movies per month, they are unlikely to be inclined to upgrade to $ 9.99 per month for unlimited access. However, they might be tempted by a $ 7.99 per month option. Defining the pricing thresholds for a subscription requires a solid understanding of customer value drivers and competitive dynamics. In addition, it also requires a fundamental understanding of the cost structure of providing the service. Netflix is expected to determine what the costs are to provide the service for $ 7.99 per month.
Apart from pricing, the customer engagement model also needs to be carefully designed. Businesses need to know when to offer the subscription to the pay-as-you-go customer. In addition, there is a need to focus on ensuring continued value for these customers. Netflix’s recommendation engine and email prompts are examples of engagement to ensure consistent renewals.
It’s not just about the money, it’s about the customer
Shifting to subscription and XaaS models is more than just pricing and valuation changes, in part because a successful subscription business is all about customer value.
A deep understanding of the customer and their value drivers is essential, and designing an engagement model and workflow to guide the customer towards achieving these value drivers is even more important.
This is a significant change for some organizations. Implemented thoughtfully with the customer always in mind, these models can make a business smarter, faster, and more responsive to the needs of its users, transforming it into a more successful business.
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