In recent years, the transition from a bookings-centric model to a recurring revenue model has been problematic for most technology organizations. After all, many companies will experience in-year revenue decline at some point in the conversion, leaving CFOs and investors less than enthusiastic. In response, many traditional tech companies have not aggressively embraced a transition to XaaS; instead, they have allowed customers to demand the change to a recurring model instead of driving it themselves. Today, tech companies who have successfully migrated to the recurring revenue model are demonstrating they can expand an initial booking dollar exponentially by focusing on post-sales activities. However, adopting a “healthy transition” is key.
In a bookings-centric model, most revenue accrues at the booking event (immediately); whereas in a revenue-based model, revenue accrues and recurs over time. Revenue-based models promise not only a potential stabilization of notoriously “lumpy” tech revenue streams, but also an initial booking that ultimately serves as a platform for expansion. However, there is an inherent danger within recurring revenue models. Consider the following example of a legacy software company who announces its intention to transition the business from perpetual license to subscription. Figure 1 below demonstrates a “Healthy Transition” to subscription revenue:
This financial outcome is predicated on a very important caveat: companies must “pull-through” recurring (and retain) subscription revenue at a sufficient rate to replace eroding M&S streams. Now consider an alternative scenario of “Unhealthy Transition.” This scenario (Figure 2 below) assumes the same progression of bookings and erosion of M&S revenue.
The significant difference here is in the lack of “pull-through” of Recurring Subscription Revenue. Though the bookings performance is the same as in Figure 1, recurring revenue “pull-through” is significantly less than the “healthy transition” example. There may be any number of reasons why such a situation may occur: deployment failure, lack of solution adoption or usage, customer defection and many others. Most importantly, companies need to watch the growth rate of their recurring revenue relative to bookings growth. In particular, if Bookings growth starts to outpace Total Recurring Revenue by more than 2X, the recurring revenue engine is likely in peril.
The key question for companies attempting to make this shift is, “How can we avoid an unhealthy transition to recurring revenue?” At a high level, the Alexander Group would recommend the following steps:
The good news is that the Alexander Group can accelerate tech companies’ ability to crack the recurring revenue code and get to top-line growth more quickly. For a briefing on market trends and what our experts are seeing in the Tech space, please contact us.