on subscription software and customer centricity
There’s a famous quote on software1, the gist of which is that “shrink wrapped software is the best business model on earth. You write it once and distribute it to the world with 99% margins and no marginal cost.”
This was the magic of licensed software in the 90s and early 2000s - write a piece of software that does something useful and important, put it on a CD or stick it on a Linux box, and let sales reps fly around from customer to customer selling it.
The sales rep sends some emails, makes some calls, takes the customer out to a steak dinner, arranges a POC, and gets a perpetual license agreement signed. Then, they fly on to the next dinner reservation. The customer is left to install, operate, and hopefully find some value in what they’ve bought.
But in the early 2000s a new deployment model arrived on the scene – multi tenant SaaS. The customer was no longer required to install and manage the software. The software provider did that for you. And with it, a new business model emerged – the subscription.
Rather than a large, up front and one time perpetual license with a nominal maintenance stream attached, the subscription contract is a smaller, recurring payment, contingent on a mutual agreement to renew. It shifts the contract from a large capital expenditure that depreciates, to an operating expense that can be adjusted (in either direction!) as value is delivered.
So why abandon the best business model in the world? Why give up large, up front cash payments, and why pay for infrastructure hosting and support costs that eat into that magnificent gross margin?
Because it changes the nature of the relationship in a way that makes both parties better off. The subscription contract is the start of a relationship – governed by the SaaS agreement. It’s a transaction with a long term relationship at the center.
It shifts the software purchase from one of up front value extraction by the vendor, to one of long term partnership. The customer is buying not just what the product does today – the customer is buying into a relationship, into a roadmap. It’s a transaction built on mutual trust.
For the vendor, it forces long term, customer-centric thinking across the organization. I’ve made the sale – how do I get the renewal. Before I’ve made the sale – can I get the renewal? Am I promising something upon which I can deliver? It forces the builder and seller of the product to prioritize LTV over the initial ACV2.
On the other side, the would-be customer asks is this a relationship that I want to invest in long term? Do I believe that the investment up front will pay increasing dividends down the road? And maybe most importantly, am I excited about where they’re going?
The benefit this brings is a foundation of stability and repeatability. If you can deliver on the promises you’ve made, you earn the renewal. You know what’s coming next year. With a license model, every year your annual revenue starts at 0. Every customer is a new relationship that needs to be built, in a short amount of time. It leads to short term thinking and rewards salesmanship.
With a subscription model you might start with lower contract values than with a perpetual license, but a lower bookings year doesn’t kill you. If you earn the renewal, and if you continue to earn your customers trust, the revenue base is there, and you can build upon it intelligently (and aggressively, when the time is right!).
This presents the foundations for repeatable and intelligent scale. It allows for long term thinking – your annual revenue doesn’t start from zero when the calendar flips to the new year. Your recurring revenue can support your costs, provided you’ve centered everything on customer value – and that you’ve earned the renewal. That you’ve upheld the promises you made when you signed the contract. That a trusted relationship is intact.
This is why the subscription, simple a concept as it is, presents the best business model for long term value creation. It aligns incentives – it creates a situation in which both parties have each others’ best interests at heart, and trust and value compounds mutually.
And over time, as you earn trust, you earn the right to solve more problems for the customer, at ever increasing contract values. And if you do it right, they’re happy to pay you more. When they win, you win. This is particularly important in a world where the barriers for competitors to get started are continuously decreasing. Few things can prevent churn like a strong relationship.
It isn’t the business model that’s magic – it’s the mindset and the customer focus that it forces that is. It’s about people, and it’s about trust, and it’s about relationships.
It puts the customer at the center, and requires that you orient the organization accordingly. Because in the end, delighted and committed customers are all that matters.
A link to this post on twitter, which is a better forum for discussing the words above, is here.
I can’t seem to find the original quote… if someone knows the one I am talking about, please reach out!