Is CFOs’ ignorance of subscription accounting metrics holding back new business models? Last week I caught up with Tien Tzuo, CEO of Zuora, a cloud billing program that helps big companies run subscription businesses.
Tzuo compares the position of today’s CFO to that of the CIO (chief information officer) before cloud computing arrived.
“Fifteen years ago people hated the IT department. It was where everything went to die,” Tzuo says. “The CIO would say, ‘I can’t give that project to you’ or ‘it’s going to cost $200 million’. Now the IT department says, ‘Yes, here’s a cloud app you can use’.
“The CFO is the new CIO. If the business division asks, ‘Are we doing better or worse in our subscription business?’, the accountant says, ‘I can’t tell you’.”
Zuora heavily promotes the concept of the Subscription Economy – the transition from selling products and services on demand to a subscription model for everything from razor blades to car hire. The same model is appearing in accounting firms as fixed-fee or value-billing compliance services.
Zuora’s customers are a mix of traditional subscription businesses such as newspapers and telcos, and transaction-based companies moving to subscription models for the first time. Tzuo spends a lot of time explaining to CFOs how accounting for subscription-based businesses is not the same as historical accounting.
Accountants need to know how to translate subscription metrics. “Churn is not inventory. They don’t know how to do a cohort analysis. There’s a whole new way of thinking about margins,” Tzuo says.
“Analysts often say Salesforce.com is not a good stock because there’s no profit. But you have to look at the profit before sales and marketing. That’s the only way to look at it.”
When accountants don’t know the language of subscription metrics it can cause problems when a company wants to experiment with a new business model. “If you look at a subscription business without the right language then you get an incorrect picture and you might make bad decisions,” Tzuo says.
The danger for companies is that they leave these experiments with new business models too late. Customers are driving the change to the subscription economy and there are many examples of cashed up startups taking on incumbents who fail to adapt.
Tzuo saw this phenomenon recently at a two-day company conference in Cologne, Germany. A large publisher selling business directories to law firms was repositioning itself.
The publisher’s CEO took the stage and spoke about how the 38-year-old directory business was no obsolete. The company would build a completely different experience for its customers by selling services to corporate law departments.
“The CEO said this will require new workflows, software applications, acquisitions, and more of a focus on the customer. The CFO was saying if we decrease churn by 5 percent we can increase revenue by 20 percent, and this is how we can resurrect our P&L. It was an inspirational message,” Tzuo says.
Tool of Trade: The Cohort Analysis
One of the most useful tools for understanding the performance of a subscription business is the cohort analysis. A cohort is the number of customers signed up in a month or a quarter. A cohort analysis works out how successful the company is at holding onto new subscribers.
The cohort analysis tends to follow a U-shaped pattern. A lot of people will sign up at the beginning of the period, followed by a gradual decline over the next four months. “By month five they stick with us and it’s all gravy from there,” Tzuo says.
“We can look at the value of all the customers that sign up in that month and in the subsequent months. You want to see that there is a U curve but then they become sticky and that the cohorts grow over time,” Tzuo says.
Image credit: Aljonzc.wordpress (… it’s a Roman cohort)