XaaS is not just technology that is priced by the month and hosted in the cloud. It’s just a new way of running a tech company. And it’s powered by your real-time connections to the customer.
The ability to “prove deliverable business outcomes” will supplant “win the feature bake-off” as the central focus of senior leadership at tech companies.
Software will eat services. The ability of technology companies to reduce technical complexity and build best customer practices into their software will be a defining characteristic of successful XaaS providers.
The act of selling will undergo radical change. Customers can now self-serve a huge amount of the information they need to make a technology purchase decision.
Delivering and measuring customer success will become a defining characteristic of market leaders.
Organizational structures will be significantly reinvented with highly integrated development, marketing, sales, finance and service teams swarming around specific customer segments.
Channel partner models will get re-thought and reconstructed.
The employee skill sets that companies covet will expand from the traditional obsession with hiring technical and sales skills (that built the last generation of tech companies) to including deep vertical industry and business process expertise.
Large tech companies will begin to enable their global footprint of customers, partners and employees to create competitive XaaS advantages that many small but disruptive companies struggle to match.
The traditional cost structures that high-tech and near-tech industries have supported with high unit prices for their products will be destroyed.
The labor – intensive operating models for marketing, sales, services and general and administrative expense (G & A) will be torn apart and reinvented.
Benefits of the subscription business model:
- Customers in all marketplaces want flexibility in how they consume.
- Customers only want to pay for what they use, and subscription models are designed to support that desire.
- Subscription relationships provide greater insight into what customers are consuming and what they value.
- Subscription business models create predictable, renewable revenue streams.
- Subscription business models create the opportunity to produce highly profitable revenue streams as more and more customers are served from a common platform.
In a subscription model, you obviously need to acquire customers. More importantly, you need to keep those customers on the platform. Most importantly, you need to convince those customers to spend more money with you over time. High sales costs, customer churn and offer commoditization create downward drag on the profitability of the subscription business model. The sharing economy is not yet proving a panacea of profitability in tech.
New XaaS offers require a significant investment in multiple areas such as:
- New technology platforms
- New pricing and financial processes
- Revised sales and marketing motions
- New service offerings and capabilities
- Reengineered partner models So at the same time that revenues decline from our highly profitable legacy offers and we begin to replace them with new subscription offers, additional investments must be made. In B4B, we referred to this phenomenon as “the fish”
The 3×3 of XaaS
As we have studied the XaaS marketplace, we believe there is one defining factor in determining XaaS offer strategy: the profit horizon. Profit Horizon: The length of time targeted to achieve significant GAAP profits. Applying this concept of a profit horizon to XaaS offers in the marketplace, we can easily recognize three common, distinct profiles of XaaS solution providers:
- Future Value Aggregator (FVA). These are XaaS providers that believe the real financial value of the offer will be realized at some date in the distant future.
- Mid – Term Wedge (MTW). These are XaaS providers that expect to achieve profitability in the not-too-distant future (3 to 5 years, or so) selling their core subscription.
- Current Profit Maximizer (CPM). These are XaaS providers that are focused on maximizing the revenue and margin opportunity surrounding their XaaS offers as soon as possible.
Common Behaviors of the Future Vaule Aggregator. Companies in this profile care more about attracting new potential customers than anything else and are willing to do whatever it takes to make that happen — almost no matter what that costs.
Common Behaviors of the Mid-Term Wedge. Companies in this profile have clear signals that their revenue model and product-market fit are valid. Subscription or transaction revenues are consistently trending up each quarter. Cost of goods sold (COGSs) as a percentage of revenue might be beginning to shrink as economies of scale kick in.
Common Behaviors of the Current Profit Maximizer. Companies in this profile either have, or quickly will have, a critical mass of revenue enabling them to pass the wedge inflection point within 1 to 2 years.
The company needs to clearly define the XaaS offer and how it should be priced. They should consider those elements:
- Technology Offer Definition. What form will the core offer take?
- Value – Added Services Offer Definition. Are there any additional services the customer may need in order to be successful with the technology?
- Offer Pricing Model. How will the offer be priced? Will the price be based on consumption of specific features, number of users, business outcomes or other factors? Will required services be bundled or sold separately?
- LAER approach:
- Land. All the sales and marketing activities required to land the first sale of a solution to a new customer and the initial implementation of that solution.
- Adopt. All the activities involved in making sure the customer is successfully adopting and expanding their use of the solution.
- Expand. All the activities required to cost-effectively help current customers expand their spending as usage increases, including both cross-selling and upselling.
- Renew. All the activities required to ensure the customer renews their contract.
When working through the financial keys, a provider is creating the parameters for how success will be measured for this XaaS offer.
- Revenue Mix. What percentage of total company revenue will come from the core technology subscription and what percentage of revenue will come from other value-added services you intend to monetize with the customer?
- Margin and Profit Targets. What are the gross margin expectations for each revenue stream we have identified?
- Sales and Marketing Costs. What will the cost of our LAER model be as a percentage of revenue?
- Key Performance Metrics. What are the specific metrics we will monitor to determine if we are on track to meet our financial objectives?
- Three “killer Cs” of XaaS success:
- Customer churn,
- high costs
- and offer commoditization.
Digging an Economic Moat for Your XaaS Business
Proffer six attributes that will help determine if a XaaS offer can generate strong and consistent profitability.
# 6 Attribute: Virality and Other Paths to a Low-Cost Sales Model Virality is the concept that a company has a product or service that almost sells itself. There is organic demand for the product.
# 5 Attribute: Diverse Revenue Streams Most consistently profitable companies have been able to diversify their revenue through multiple offers.
# 4 Attribute: Network Effect Another economic moat similar to virality is the concept of a network effect. This is the phenomenon whereby a good or service becomes more valuable when more people use it.
# 3 Attribute: Economies of Scale A powerful economic moat for your XaaS offer can be dug when economies of scale play a significant role.
# 2 Attribute: Unique Capabilities Of course, something powerful must be said for having a truly unique capability. If a company can do something few others can do, then that company is in a position to create higher-than average profits.
# 1 Attribute: High Switching Costs The traditional trump card in creating highly profitable tech revenue has been high switching costs for customers.
There are many ways to create high switching costs for customers that include:
- Requiring a large capital up-front investment that creates a sunk investment the customer will not readily abandon.
- Technically, making it difficult for customers to migrate all their data off of your offer.
- Contractually, making it financially painful to switch.
- Requiring a large training investment that makes it painful to retrain employees on substitutes and cause a protracted negative impact on productivity.
- Embedding your capabilities within the customer’s business processes so your offer becomes critical to the customer’s success.
Companies in the T & S 50 index spend an average of 22 % of revenues on sales and marketing. Software companies spend an average of 29 %. Accenture, with all of its advertising and direct sales costs, spends 11 % to 12 % of revenues on sales and marketing. Ford Motor Company spends 10 % to 11 % on selling expenses.
There are many reasons why technology companies have been generating so much profit. Both their product and product-attached service revenue streams contain attributes that create deep economic moats.
However, the inability of so many XaaS companies to be profitable can be disconcerting, especially if you are a traditional tech company trying to decide whether you should take the plunge into subscription business models.
Our point of view is that many of the first-generation XaaS companies are suffering from shallow economic moats.
SaaS companies in the TSIA Cloud 20 index spend an average of 40 % of revenues on sales and marketing — much higher than their traditional license software peers (which is yet higher than many other industries).
Having expensive field sales resources doing small upsell or renewal deals is simply not smart. It is our point of view that the selling models in these XaaS 1.0 business models have not yet been truly optimized. For most XaaS companies, cost-effective LAER coverage models have not yet been implemented at scale.
Once an offer has established its value in the market, it is time to start building adjacent offers and diversifying the revenue streams associated with the core offer.
We believe XaaS business models can be profitable. We believe some XaaS business models will be highly profitable. However, to achieve profitability, XaaS providers must use economic moats and operating best practices to battle the three key enemies of XaaS profitability. We call them the killer Cs: High selling costs, high customer churn, rapid commoditization of the offer. Successful XaaS companies will need to be open to different ways of creating demand that rely more on marketing and less on sales.
A growing number of enterprise technology decisions are now being made by business buyers. Business buyers speak a different language. They are not interested in speeds and feeds.
The shifting buyer landscape and the killer Cs are all forcing successful tech companies to rethink and innovate their sales and marketing models for all the phases of the customer life cycle.
Marketing-Led Selling is potential new approach. Sales organizations were receiving five dollars to every one dollar spent on marketing activities. Marketing was often measured on lead volume, not lead quality. Marketing’s role is eating into the sales cycle. Marketing organizations at many XaaS companies are being charged with owning not only the identification of a lead but the cultivation of a lead, as well.
Some of potential new selling models are:
- Remote Selling Models. Now some enterprise XaaS companies are successfully conducting the entire XaaS subscription sales process without ever going to the customer’s site.
- Process – Driven Selling. Hiring less-experienced talent and then teaching and enforcing very tight adherence to a proven sales process.
- Land-Only Sales Teams. The land team and the customer success team. In this model, sales lands. That’s what they do. They don’t own adopt, they don’t own renew and they even don’t own most of expand. The adopt/expand/renew team own growing a customer’s spending on the offer platform already in use (adding more users, more transactions, more services), but they hand opportunities to land an additional (major) offer platform at that customer to the land team.
- Automated Sales. Everyone has had the experience of buying something or signing up for a subscription on a website. A new and far less-used tactic is to imbed upsell and cross-sell offers that present themselves to the customer directly through the technology. We have seen resistance to this tactic.
- Blended Sales and Service Models. At TSIA, we predict there will be a massive blurring of the historical lines that separated sales from services. You empower service and marketing teams to up-serve the customer by both providing services or information and recommending those new products and services that the employee truly believes would benefit the customer. Service interactions can occur 15 to 20 times more than sales interactions.
- Outcome-Based Selling. Let’s face it: Tech has always been a product industry at heart. Selling to business buyers is fundamentally different. They don’t want to start the conversation with the product; they want to start the conversation with their business outcomes. Business—not technology— is the new language of sales.
Exciting new offers that can be built in operational services, adoption services and information services.
By building service – enabling capabilities into the core products, services can be automated and delivered to the customer at margins equal to or better than the core offer itself.
There is no reason that XaaS 2.0 companies can’t also one day count on having half or more of their revenues coming from cloud-enabled operational, adoption or information services along with traditional professional, educational or premium support services.
Every XaaS company is sitting on top of an incredible data set being generated by customers that use the offer.
The more customers on a specific XaaS platform, the more valuable and insightful these data-driven offerings become to customers.
Another key strategy to leverage the network effect is to create compelling revenue generation opportunities for third-party partners.
In addition, stickiness can be achieved through very smart use of the data customers generate in your system.
Historically, the deep economic moats of traditional technology business models enabled wonderful GAAP profits. Most XaaS business models so far do not share that good fortune.
Stressing Traditional Organizational Structures
Our general recommendation is that technology companies delay the conversations on specific organizational structure until after they have designed the operating model they are building, how the customer experiences that model and the capabilities needed to execute it well.
Software companies in the T&S 50 invest an average of 28 % of revenues on sales and marketing (S&M). The vast majority of those S&M dollars are spent on sales, not marketing expenses. These companies also spend an average of 18 % of company revenues on R&D, making it the second best-funded organization.
Drivers of organizational structure in the world of traditional, full – service tech:
- Sales and development are highest influence organizations.
- Each function has its own organization.
- Field functions are organized geographically.
- Horizontal, not vertical go-to market.
- Each organization performs a task for the customer. Many handoffs.
- Budgets weighted heavily toward execution/delivery, less on planning/design.
- Goal: Optimize the function, control the organization’s performance.
This heavy investment in sales and R & D combined with a geocentric bias, an intradepartmental approach and a “one size fits all” go-to market mentality has led to organizational structures that support highly profitable, multibillion-dollar businesses. However, these structures do have four stress points that executive teams still debate to this day:
- How seamless is the customer experience across all these organizational handoffs?
- What processes and resources should be optimized regionally versus globally?
- How do we optimize and account for resource investments that cut across the P&Ls of different departments?
- As software and IoT eat the world, how do we align resources across sales, services, R & D and marketing to develop and land vertical solutions?
Number one mistake companies make is that they change their strategy but keep basically the same organizational structure.
Profitable XaaS offers will need a single, unified structure that cost-effectively drives customers across the entire LAER life cycle.
Two overarching goals of the combined organizations (beyond product-market fit, of course):
- Great customer life-cycle experience.
- Lowering cost of sales (COS) and overall delivery costs.
We don’t think the big organizational boxes will need to change right away. Ultimately, some may converge. At some point soon, you will need to add one new box for customer success and one for the platform infrastructure.
The second factor forcing organizational change is the capabilities gap. Selling and delivering XaaS offers is not the same as selling and delivering technology as an asset. The winning organizational structure for XaaS is a moving target. Many companies are creating chief customer officer (CCO) or chief revenue officer (CRO) and senior vice president of infrastructure roles. New functions are emerging, like the ones of customer success, success science and consumption analytics.
Who will own the new customer engagement platform infrastructure? Ultimately, you will want a senior vice president of infrastructure who is a peer to the top execs of all the other functions.
What matters is not who ends up initially owning the platform. What matters is that the owner truly understands how incredibly important that platform is — both to the customer experience and to the cost structure of the business.
We would recommend the following six organizational changes early in the journey:
- Consolidate portfolio management.
- Identify the key members of your platform infrastructure team.
- Establish a customer analytics team.
- Establish a customer success team.
- Begin planning to migrate renewals away from sales resources you want focused on “land”.
- Collapse the service delivery P&Ls.
- Add a chief customer officer (CCO) or chief revenue officer role (CRO). The CCO is looking at the customer experience and the CRO is looking at revenue generation processes. They have high influence but small staffs.
- Redundant functions focused on efficiency should centralize and standardize whenever possible.
- Maximize the ability to share resources across organizational lines.
- Separate long-term focus from short-term focus whenever possible. This is why sales (short-term focus) and marketing (longer-term focus) should not be combined into one organization.
- Leverage proven best adoption practices across regions.
- Expand sell in a cost-effective manner. Educate prospects and customers through marketing in a cost-effective manner.
- Support vertical solutions via outcome engineering and success science.
Your organizations structure. It may look like this after a few years in the XaaS business:
- Land sales segmented by vertical industry (if applicable).
- Customer success segmented by account size.
- Big M marketing:
- lead generation for sales
- portfolio management for all the company offers
- customer analytics that inform offer development and offer success. Success science may live here.
- Global customer growth team.
- Big-picture product development.
You not only have to bring employees along on your XaaS journey, but you also have to bring along your existing customers.
In B4B we covered the four levels of supplier business models.
Level 4 was for suppliers/providers who were willing to price as true services based on usage or outcomes. We described it as the most exciting and most dangerous of all the models, but led by Amazon, it is where much of tech is heading.
Swallowing the Fish
For the past decade, incumbent market leaders in the technology industry have been grappling with two mega-trends:
- Acceleration of New Consumption Models.
We track product revenues, product margins, service revenues, service margins and overall operating income to place companies in one of four states:
- State # 1: Traditional offerings are not yet under pressure from commoditization or new consumption models.
- State # 2: Traditional offerings have commoditized and new profitable offers that adhere to the new consumption models have not been put in play.
- State # 3: New XaaS offers have been put in play, but they are not yet profitable.
- State # 4: New XaaS offers are in play and they are now profitable.
Revenue growth and operating income are not the critical metrics during a business model transformation.
How do you know if your specific market will truly be disrupted by XaaS? There are four obvious markers:
- Percentage of deals disrupted.
- Noise from leading-edge customers.
- Growth rate for traditional product and service offers.
- Your share values.
It seems logical that if a company was facing the trifecta of deal disruption, declining revenues and declining market value that the executive team would aggressively launch into business model transformation mode.
In Zone to Win, Moore’s recommendation is that management teams make three moves with investors during the transition.
- Announce XaaS initiatives.
- Start the clock ticking.
- Declare victory.
Successful XaaS companies, at some point in time, must transition their investors from a “high growth” story to a “growth and profitability” story. You don’t want to swallow the “high growth” to “growth + profit” fish until you absolutely have to.
What are the signs for a XaaS provider that it is time to swallow that fish? Pipeline that does not support the current annual revenue growth rate.
Here is our take on those three moves as it relates to swallowing the slowdown fish:
- Define the target financial model.
- Start the clock ticking.
- Declare victory.
The Power of XaaS Portfolios
No amount of packaging or pricing can overcome a weak offer that customers don’t see value in purchasing.
In the world of enterprise technology, however, that has not always been true. The preferred historic battleground for tech companies hasn’t been price. It’s been features.
So, for the past several decades, enterprise technology has been a tale of two cities. Hardware companies faced intense competition that yielded commoditization in many market segments. Software companies competed head-to-head and feature-to-feature, but rarely based on substantially lower prices.
Seven exciting offer categories to draw from for your XaaS portfolio:
- Technology Subscription.
- Adjacent Modules.
- Attached Services. This category includes classic service activities such as professional services related to implementation and integration, technical education services and technical support services.
- Operational Services. These are services designed to reduce operational complexity for customers.
- Adoption Services. These are services designed to help customers maximize their usage of technical capabilities.
- Information Services.
- Outcome Services. These are where the provider has some or all of the customer’s pricing tied to the delivery of a result.
Being able to remotely drive user adoption, operate or manage technology, supplement data, use real-time analytics to compare customer performance levels, monitor and monetize actual outcomes . . . these are exciting and heady opportunities that can only be done profitably and at scale in the XaaS world.
In order to catch them right you need to understand bellow mentioned elements and prepare offers that will include answers to challenges they pose:
- Development of a Core Offer or Portfolio Description.
- Target Buyer (s).
- Financial Outcome.
- Key Performance Metrics.
- Customer Processes.
- Key Capability (s) enabled by Your Offer.
- Portfolio Components.
The concept of outcome engineering is a sort of mapping process that links technology capabilities to the customer’s financial outcomes.
In the old playbook, differentiated feature functionality was all that mattered. In XaaS marketplaces, feature functionality is unlikely to keep offers differentiated in the long term.
In the world of XaaS, pricing is a conversation that gets interesting very quickly. Scanning the marketplace, there seems to be an incredibly wide variance of pricing models. Some seem (and probably are) overly simplistic. Others seem (and probably are) overly complicated.
Because once a prospective customer decides to purchase your core technology subscription, they move from one market — the general market — to another, far more captive market — your customer base. Once that happens, your pricing power with that customer goes way, way up.
Once you can offer customer support globally at scale, the cost to take on one more incremental customer is minimal. Margins grow and grow as you put more customers on the pile.
The best approach is to create a broader portfolio of adjacent modules and services where you are the only game in town, where your pricing power with that customer is limited only by their ability to pay, not by your competition.
You need several pricing strategies inside your portfolio, not just one.
We do think there are a few key decisions and data points that are particularly important in setting XaaS prices. We have listed these in two phases you can follow to provide a solid rationale for the pricing of your portfolio.
- Phase 1: Set Your Boundaries
- Phase 2: Apply Pricing Tactics
XaaS Customer Engagement Models
When working on your XaaS strategy, you need to understand the journey you are undertaking with your customers — and the journey with a XaaS offer is very different from selling and delivering technology as an asset.
If you are selling technology as a service, the number of critical milestones on the revenue journey increases, and the trajectory changes shape. The spending level of the customer often starts off low and must build and build if the deal is to become profitable. If anywhere along the journey the customer does not like or use a service, they may stop using it and the revenue may stop flowing. To prevent that killer churn, new critical milestones must be achieved to ensure adoption, expansion and renewals.
Compared to traditional tech revenue models, the revenue optimization process is more complex in XaaS. Once customers are landed onto a new XaaS offer, the following revenue life cycle unfolds:
- Total Available Revenue to Renew.
- Churn Rate.
- Down – Sell Rate.
- Retention Rate
- Upsell Rate.
- Cross-Sell Rate.
- Expansion Rate.
- Renewal Bookings Rate. Add the retention rate (Item 4) and the expansion rate (Item 7). This is the net growth (or decline) of all renewal bookings. This can also be expressed as CVRR (contract value retention rate).
Assuming you have some product-market fit for your offer, churn is probably the most likely reason for your business to fail.To be a profitable enterprise XaaS provider, we think churn really needs to be kept to single digits, with top performers experiencing less than 5 % per year. So, what causes churn?
- Poor product-market fit has to be at the top of the list.
- The competition is better than you are.
- You messed up.
- Wrong customer or a change at the customer.
- Lack of adoption.
Customer journey has two perspectives:
- Supplier Perspective.
- Customer Perspective.
The customer wants better business outcomes. Making that happen involves four stages. We call them PIMO:
- Plan. All the pre-sales discussions, strategies and agreements.
- Implement. All the traditional technical and human implementation activities.
- Monitor. The ongoing activities of the customer and the supplier.
- Optimize. The interventions that optimize the outcome.
Seven tactics that we have seen in play in XaaS companies:
- Marketing-led selling
- Remote selling models
- Process – driven selling
- Land – only sales teams
- Automated sales
- Blended sales and service models
- Outcome – based selling
That’s because XaaS is a service and, in the world of services, you get paid as you deliver, for what you deliver.
Some important elements of successful XaaS business practices:
- Stickiness. Is the customer leveraging features that lead to unique value and renewal?
- Data Quality. The ISO 9000 standards define data quality as the degree to which a set of characteristics of data fulfills requirements. Characteristics are: completeness, validity, accuracy and consistency.
- Efficiency. Is the customer minimizing the time and expense associated with leveraging the technology?
- Outcomes. Finally, are the activities being performed with the technology impacting critical performance metrics for the customer?
We observe that analytical models move through a natural progression. First, companies start collecting consumption data to better describe what customers are actually doing. Then, the consumption data can be used to predict customer renewal and expansion. Ultimately, the consumption data can be used to understand if the customer is on track to achieve targeted business outcomes.
To engage with a customer in the journey of effective adoption, expansion and renewal, a team member will need some or all of the following skills:
- Product/Technical Expertise. Understands how the offer works.
- Soft Service Skills. Effectively works with customers to help them adopt.
- Process Expertise. Understands the critical processes that are common across many customers.
- Vertical Industry Expertise. Understands the language and challenges of a specific industry or market segment.
- Opportunity Recognition Skills. Can discern an opportunity to accelerate value to the customer, including adding additional products and services.
There are no less than 27 customer – facing roles that are common in the technology industry. It’s no wonder that customers get confused! There are only two roles of the 27 that are regularly given the responsibility to drive customer adoption activities: customer success manager and technical account manager.
Adoption will not be the domain of one group or one role — adoption will be the charter of every role that touches the customer before or after the initial sale.
Outcome engineering (OE) is a new concept that TSIA is advancing. In essence, OE is about making sure that all of the prerequisites to high customer success are present at a single customer.
We see three patterns for how companies are situating customer success inside the company:
- Customer success is a service function.
- Customer success is a sales function.
- Customer success is an independent function reporting directly to the CEO/COO/CCO/CRO.
Where most employees in success and service roles need help is on opportunity recognition.
There are three classes of practices related to driving adoption:
- Enabling Practices. Practices designed to motivate and enable the customer to use the technology.
- Monitoring Practices. Practices designed to understand how the customer is actually adopting the technology.
- Intervention Practices. Practices designed to address specific gaps in adoption that have been identified through monitoring or benchmarking.
We suggest you prioritize these 10 practices inside those three segments:
- Enabling Practices –
- Account Segmentation.
- Relationship Mapping.
- Customer On-Boarding.
- Value Visioning.
- Monitoring Practices –
- Adoption Framework.
- Adoption Monitoring.
- Adoption Analytics.
- Intervention Practices –
- Predictive Analytics.
- Adoption Playbooks.
To drive adoption, you need a customer data model that is full of the current, critical data about the customer and their use of your XaaS offer. That data will be analyzed to determine what action needs to be taken. That means it has to integrate with tools that the actors who own the action use every day. Once the actor has been assigned a specific action, they (generally) follow a well-defined process. Once that action has been taken, the customer’s data should change as the results of the action take hold. That change will alter the profile of the customer’s health and analytics will determine the next action. Then, the cycle repeats until you have a top-performing customer.
Leads for expansion can and should come from every touch point we have with the customer. Purpose-built sales teams can often outperform general field sales in expansion and renewal conversion rates and do so at a lower cost of sales.
On average, XaaS companies report they are spending more than $ 1 to land $ 1 of revenue from a new customer. However, they are spending less than $ 0.20 to secure $ 1 of expansion revenue from an existing customer. Also, XaaS companies are spending even less than that to secure $ 1 of renewal revenue from an existing customer. This is an unsustainable model. At some point, SaaS companies will need to leverage higher margin renewal and expansion revenues to balance the books. Investing in purpose-built sales capabilities today will prepare XaaS companies for the day profitability becomes the requirement.
You want all the customer success and renewal processes that are proven to drive great results and you want the sales team in there trying to upsell.
The second segmentation strategy is to separate expand sales opportunities into three buckets:
- Large cross-sell opportunities
- Large upsell opportunities
- Small and standard upsell/cross-sell opportunities
When selling traditional CapEx deals, technology companies relied on success metrics such as product revenue growth, product margins, average deal size and maintenance renewal rates. In the world of XaaS, the success metrics shift from a focus on land and renew to a focus on adopt, expand and renew.
The company Infor established three distinct roles:
- Account Relationship Manager. Responsible for the renewals of small to midsized accounts.
- Customer Account Manager. Responsible for the renewal and adoption in larger accounts.
- Customer Success Manager. Fee-based account resource a customer can invest in to help drive adoption.
Maria Martinez, the president of Customers for Life at Salesforce, is responsible for their coverage model.
This coverage model has two roles in play that we have seen in the previous examples:
- Customer Success Manager.
- Renewal Manager.
But they also have:
- Support Specialist.
- Account Executive.
- Solutions Advisor.
The renewal of highly adopted customers should be a process, not an event.
Future value aggregators with this long-term profit horizon will invest heavily in marketing or sales resources to land users/customers. The key for future value aggregators is to make sure they put enough investment on the adopt phase of LAER from the very beginning.
Mid-term wedge model will begin decreasing their land investment as a percentage of revenue, further increasing their investments in adopt and adding investments in expand and renew. We would expect overall cost of sales and marketing for companies in this mode to be in the 20 % to 30 % range.
There should be two levels of PIMO:
- Free, automated PIMO road maps for SMB.
- Fee-based, consultative PIMO engagements for large enterprises. They should want your consultative expertise. These paid engagements need cross-functional involvement.
We think customer success should own the road map ultimately because they will be held accountable for the eventual renewal and expansion performance of the customer.
Just like convincing your customer to use your XaaS offer in the first place, getting them to commit to PIMO means it must be seen as a valuable endeavor.
How will your solution translate into a measurable business outcome for the customer? Business outcomes are achieved by mastering a chain of activities that involve an ecosystem of players and technology. The outcome chain itself is broken into three sections:
- The Outcome (s)
- The Synch
- The Execution
- The Outcome (s):
- Targeted outcome (s) — what the customer can attain.
- Financial results — what the financial impact will be.
- The Synch:
- Operating KPIs — the critical KPIs that will be targeted for improvement.
- The Execution:
- Customer processes — the processes that will be affected and improved.
- Capabilities — the new organizational or technical capabilities that will be added.
- Products — the technology products that will enable the new capabilities.
- Services — the services required to plan, implement, monitor and optimize the outcome.
- Players — all the players required in its execution (customer, provider, third parties).
The ability to systematically grow customers will become a defining element of a XaaS supplier’s engagement model.
First you need to find those high- performing customers; then, you need to get them under a microscope. You need to discover why they are such great performers. Next, you need to figure out how to replicate those best practices for as many customers as possible.
Success science is going to become a side-by-side partner to both technical innovations like new features and the business levers like a big sales force.
Companies that collect information on the specific features customers have purchased are growing overall service revenues twice as fast and experiencing service margins that are 10 points higher than companies not capturing this data. Tracking and leveraging adoption data seems to impact revenues and margins.
The Financial Keys of XaaS
Larger SaaS companies are still not profitable on a GAAP basis and the traditional license companies are exhibiting superior financial performance on all five key indicators.
SaaS companies in the Cloud 20 are currently spending an astronomical average of 39 % of revenues on sales and marketing. This percentage is much higher than the 28 % of revenue being spent by license-based software companies on sales and marketing .
The pros and cons of XaaS economics. On the upside, there are lots of things to love.
- Customers like the consumption model.
- Investors are keen to reward the revenue growth potential.
- Recurring revenue is a beautiful thing.
- Free cash-flow generation can be very strong.
Traditional tech-company stocks are still valued the old-fashioned way, as a multiple of GAAP earnings. But pure-play XaaS company stocks are being priced based on a multiple of revenues driven by the revenue growth rate.
Another case for higher sales and marketing spending by SaaS companies in particular can be made by arguing that these companies may have a larger total addressable market (TAM) than traditional companies.
It is safe to say that running a pure-play XaaS company today is a simpler task than transforming a traditional systems or software company. Investors support and reward their simple message: growth.
Deferred revenue is revenue that has been contracted for, billed and even paid — but not yet delivered. The beauty of deferred revenue is that it is already committed and paid up front. Unbilled deferred revenue represents business that is contracted but unbilled and off the balance sheet, meaning that customers are contractually committed to subscribe to the services for future periods. Deferred and unbilled deferred revenues give visibility and confidence to a company’s future financial performance.
Free cash flow often occurs before and at a higher rate than GAAP profits! That’s because the revenue recognition rules force the company to defer the revenue ratably over the entire year, but the cash often comes in up front.
Many larger XaaS companies report free cash flow gains that are much stronger than their GAAP profits.
Many even articulate a fifth defense based on redefining the market’s view of “true profits”. This argument, also known as “non-GAAP profits”, maintains that certain expenses like stock option costs and acquisition goodwill should not be imputed into a company’s operating expenses.
The most controversial financial aspect of the subscription business model. Let’s call the problem the “current cost of acquiring future revenues”. Service-based businesses have been dealing with the current cost of acquiring future revenue problems for decades.
The economic engine of a XaaS company is typically composed of up to five potential revenue streams:
- Asset Revenue. This is when the customer pays for the right to own and use a copy of the software or hardware product.
- Technology Subscription Revenue. This is when the customer pays for access to technology as a service.
- Annuity Services Revenue. This is when the customer pays for ongoing premium services.
- Project Services Revenue. This is when the customer pays the XaaS provider for specific deliverables such as implementation or user training.
- Transaction Revenues. These are revenues that occur per customer transaction.
Each of these revenue streams has a unique financial profile in terms of margin and profitability.
Software company average gross margin is 87 % and the median is 89 %. Hardware/systems company average gross margin is 50 % and the median is 58 %. The bottom line is that we think XaaS can be a 20 % EBITDA (GAAP) business or better.
Customer acquisition costs (CAC) should become a relevant metric early on for most XaaS providers.
Here are six metrics that are typically highly correlated to the success story of future value aggregators:
- Growth in units of future value
- Growth in number of paying customers
- Average revenue per user
- Monthly recurring revenue (total recurring revenue from all paying customers)
- Customer acquisition costs (the amount of money spent on average to acquire a new customer)
- Churn rate percentage of paying and non-paying customers who stop subscribing or using the core offer each month)
In the midterm wedge profile (MTW), subscription growth and MRR are still critical metrics. However, companies in the MTW profile must now also focus on costs.
Nine financial metrics the MTW should watch and improve:
- Monthly Recurring Revenue (MRR). Average amount of money a customer is spending with the company.
- Customer Acquisition Costs (CAC). The amount of money spent, on average, to acquire a new customer.
- Unit Renewal Rate (URR). The percentage of customers that are renewing their subscriptions.
- Contract Value Renewal Rate (CVRR). When renewal contracts come up each month, does that pool of customers spend more or less money with the company? Ideally, CVRR is over 100 %. When CVRR is below 100 %, customers may be churning or customers may be securing discounts during renewal.
- Discount Rate on New and Renewal Deals. If discount rates are high, it is a sure sign the offer is commoditizing.
- Technology Subscription COGs. The percentage of subscription revenues spent on the technology and support related to delivering the offer.
- Annuity and Project Revenue COGs. The percentage of annuity and project revenues that are spent to deliver those services. In the FVA profile, these services may have been free or break-even. Now, these revenue streams should be achieving at least industry average gross margins.
- Cost to Renew Customers (CRC). What percentage of sales and marketing dollars is spent on the process of renewing customers? If this percentage is high, it will be difficult to tamp down overall S & M spending.
- Cost to Expand Customers (CEC). What percentage of sales and marketing dollars is spent on securing incremental revenue from existing customers?
Three revenue streams in play for the MTW: the technology subscription, premium annuity services and fee-based, project-based professional services.
CPM have additional financial focal points:
- Revenue mix.
- Revenue line profitability.
- Upsell rates and COS.
- Cross-sell rates and COS.
- Focused R & D and G & A expense targets.
- Platform investments eating away at sales, service and G & A labor costs.
There are three very recognizable scenarios of disconnect:
- FVAs that are spending like a drunken sailor on acquiring units of future value, but have no effective strategy to monetize them.
- MTWs that have accumulated a large mass of paying customers but are not yet demonstrating improving economies of scale or efficiency, especially in sales and marketing.
- CPMs that need current profits but are afraid to make some of the hard decisions to rapidly build scale by forcing customers onto their platforms, charging profitable prices or diversifying their revenue mix.
If you are a traditional tech company, you should aim at entering at scale in a CPM state. If managed correctly, they can use their huge scale to skip the FVA/FPI state and maybe even the MTW state. By forcing all their customers onto the XaaS offer, they can literally enter the market as a CPM and achieve GAAP profits.
The Case for Managed Services
Managed services (MS) as entrée into XaaS. Multiple trends are driving the demand for managed services:
- Reducing Operational Complexity.
- On-Demand Capacity.
- OpEx versus CapEx.
- Value Beyond Technology.
- Economies of Scale.
- Strategic versus Tactical.
Five common MS offering value propositions:
- Managed XaaS.
Current and future generations of MS don’t look anything like the low-margin outsourcing businesses of the past.
Highest-to-lowest margin MS offer types:
- Customer premised, customer owned, remotely monitored.
- Customer premised, customer owned, remotely operated.
- Hosted, customer owned, remotely monitored.
- Hosted, customer owned, remotely operated.
- Hosted, provider owned and operated.
There is a nine-point profit improvement if an MS offer can be standardized across customers.
The customer is asking for managed services, but the CFO and other executives at your company are quick to raise the following concerns:
- We don’t own customer assets.
- Delayed revenue recognition.
- Service revenue intensive.
- Increased risk.
- Channel conflict.
- Complex sales cycle.
- Smells like outsourcing.
With your MS offer, you create value far beyond commoditized technical features by reducing total operational complexity.
MS offers for entrenched product companies are a classic example of a neutralization offer. A large and strategic customer that previously purchased technology assets from you is now asking for a XaaS option. You meet them halfway with a special MS offer. Establishing MS offers is a forcing function for developing new organizational capabilities that will be required to compete in the XaaS economy. All of these emerging capabilities will serve a product company well as customers pull them into the new XaaS economy.
Picking the Right Customers matters in manages services business even more.
When you look into the technology industry today, you’ll find two common types of service contracts:
- Contracts crafted by technology providers that are centered on meeting service level agreements and
- contracts crafted by system integrators that cover large, complex technology implementations.
If you are relying on customers to successfully adopt or attain specific business outcomes from your technology in order to achieve your revenue or margin goals, you must qualify their willingness and readiness to take the necessary actions. No contract, no matter how detailed, will replace the need for applying a solid customer profile tactic.
Incubating Managed Services: Key Success Tactics – a set of success tactics to consider as you explore MS opportunities with your customers :
- Make finance your friend.
- Understand the net-new capabilities that will be required to successfully deliver an MS offer.
- Understand the new sales skills that will be required to land MS offers.
- Establish key performance indicators and measure them regularly.
- Pilot, pilot, pilot. It is unlikely your first MS offer will spring from the heads of your offer designers fully formed.
- Invest in automation early.
- Don’t ignore the channel.
We sit at an inflection point where old business models collapse and new business models emerge. Managed services represent a unique opportunity for product companies to start navigating through this inflection point.
Changes in the Channel
From the OEM’s perspective, the channel performs two critical roles:
- It puts more salespeople into the market than the company does directly.
- It delivers product – attached services that the company does not want to perform directly.
Some of the challenges we are facing in channel during transition to XaaS business model.
We have to overcome is redefining what partner-added value truly means in the age of the cloud and XaaS.
If the customer isn’t paying much up front to subscribe to the XaaS offer, who is supposed to pay the sales costs?
We need experts in vertical markets, business process consultants, solutions engineers and outcome engineers. The people who have these skills are unicorns: They are hard to find and hard to keep. They have the unique ability to think like a businessperson but also be a product expert. They can interface with senior business buyers, not just IT and procurement staff.
With software costs and development times coming down, app exchanges and marketplaces speeding time-to – market and IoT spawning unlimited new application possibilities, software is becoming the game.
Let’s summarize the important questions we need to answer:
- What strategic, value-creation activities do partners need to engage in?
- What are the new financial models for partner companies?
- How do salespeople get compensated when a partner resells OEM XaaS offers?
- How do direct and indirect LAER teams interact?
- How will the requirement for new partner skills be met? How do we overcome the security concerns of customers?
- How does the channel avoid the need to make huge capital investments for XaaS offers?
- How does the channel put its customers on a successful XaaS migration path?
Successful XaaS channel partners of the future:
- Will be educators, business model experts and solution architects.
- Will work seamlessly with OEMs and other value – adding partners inside the partner network.
- Will offer vertical market solutions.
- Will play a unique and differentiated role in achieving the customer’s outcome.
- Will have sales teams able to tie the key features of the solution to the financial outcomes of the customer.
- Will have a customer success offer.
- Will have a business process consultative capability.
- Will have annuity offers to help the customer operate and optimize the solution.
Coordination problem when multiple OEMs and/or partners are required to deliver a business outcome to the customer. Three good rules of thumb: One is that the provider who is the highest in the stack, i. e., closest to the application level, is probably most important to the customer and, therefore, may be best suited to lead the deal. Second is that vertical trumps horizontal. Finally, we think that the OEMs should be orchestrating the first and most important “certified multivendor solutions”, including coordinating sales activities.
We think channel partners can play a large and profitable role in delivering the outcomes either through their proprietary software, their vertical or business process expertise or through their optimize services portfolio.
XaaS customer engagement technology platform. Again, the concept here is that the OEM builds a sophisticated technology platform that has three main attributes:
- The product offers attach to the platform.
- The customers interact directly with the platform.
- Internal delivery functions such as services success and finance also leverage the platform.
The Internet of Things is going to light vertical opportunities on fire! Security will go vertical; collaboration will, too. So will high-performance networks and analytics.
We think services should be a combination of people and software with a trending toward software.
Selling business outcomes to business buyers is where the real growth is going to be.