A universal question that businesses across industries share is how to make their underlying book of business and existing revenue more “sticky” – which in essence boils down to increasing the recurring nature of a company’s revenue base. When looking specifically at license / maintenance software and Software-as-a-Service (SaaS) businesses, the areas on the financial model and income statement where owners and investors typically place most emphasis on is the mix between recurring (subscription and maintenance) revenue and services revenue - most importantly around finding the “magic number” for the split. A typically quoted mix that companies should look to generate is as follows: subscription / maintenance revenues of greater than or equal to 80% of total revenue and services revenue that is less than or equal to 20% of total revenue. Although this rule of thumb is not applicable to all businesses, given each is unique in its growth and profitability cycle, and its approach to serving customers as best as possible, it is worth considering the factors that are detailed in the below scenarios to help understand how revenue mix shifts vary across business cases.
Scenario #1: High-Growth (40%+ Growth) Company Aggressively Seeking New Logo Adds
Operating in an under-penetrated market with a large total addressable market opportunity available for capture, the high-growth company is seeking to expand via acquisition of new customers. Given the importance of acquiring new logos to maintain its growth rate and trajectory, the company decides to scale up its internal project delivery team in order to sufficiently support customer implementations and activations. Operating under the assumption that many of the potential new customers will be price sensitive, the company also makes a deliberate decision to discount its implementation and services in order to secure new contracts. In this instance, the company values subscription revenue that results from the new logo acquisition over services revenue, as it helps them accomplish their near-term growth goals, while also adding long-term, stable, recurring revenue to their overall base. The below highlights an illustrative example of the unit economics for the company over a given period.
Scenario #2: Mature (<40% Growth) Company with Large Existing Customer Expansion Opportunity
With much of its high-growth new logo acquisition behind it, the mature company has a strong, existing base of recurring clients with a substantial amount of additional penetration opportunities available. Much of the new growth will come in the form of upselling and cross-selling into existing customers, which comes in the form of a healthy mix of recurring subscription revenue, as well as add-on services. Given that the upsell and cross-sell opportunities will require less intensive implementation services, the company can offer additional high-value services like consultation and training to further imbed customers on its offerings. This example details how the company will drive a combination of subscription and services revenue as it continues to increase wallet share with its existing customer base.
Scenario #3: Company Transitioning from License / Maintenance Model to Subscription Model
As many companies in today’s cloud / SaaS-heavy environment experience, this company is making a business and financial model transition from selling license contracts and offering maintenance to selling and supporting subscriptions. The company is making an intentional trade-off in the near-term, forgoing some growth and profitability to secure subscriptions over time. Through this process, the company will also look to convert existing maintenance customers to subscriptions, which will require corresponding services in order to complete the transitions. During this period, the company will add incremental services revenue, which will also offset some of the near-term losses in revenue and profitability arising as a result of the shift. This example provides additional detail on a company going through a license / maintenance to subscription transition.
Concluding Thoughts: Generating the Right Mix for Your Business
These select scenarios provide a glimpse into the considerations companies face and the decisions they must make to continue delivering the most value to their investors and customers. In many cases, companies in the software realm value subscription / recurring revenue over services, as it is indeed more predictable and sustainable over the long-term. However, it is imperative to understand the value that services can provide to businesses and customers, especially those at a mature growth or transitioning phase, as it can deliver an additional avenue for scale and stability.