How to Successfully Transition to a SaaS Model?
All “PROS” and no cons!
We are in the midst of a large scale transformation of all types of businesses to a subscription model, and why not, it generates predictable revenue, investors love it and if you are in the market right now for fundraising, you will probably get a sweet paycheck at exorbitant valuation.
However, despite the many benefits, it is unfortunately not as simple as “flipping the switch”. The challenges are expounded if you are an enterprise technology company providing mission-critical applications or even if you are a consumer technology company but have a bundled hardware offering or just have a very customized and complex product portfolio. In order to successfully transition to a SaaS model, you have to consider the “PROS” (it was not just a cheesy title!):
- Product pricing
- Revenue, KPI and margin management
- Operating model
- Sales / Go-to-market
1. Product pricing
To successfully define your product and pricing strategy, put yourself in the customers’ shoes. If you are already selling a perpetual license and providing updates via either a maintenance contract or through additional update charges, what would incentivize a customer to move towards a SaaS pricing model at a higher price point.
This is not an easy question to solve and it takes enterprise technology companies anywhere between 5 to 7 years to fully transition their customer base. The key is to define the SaaS product and what is in it for the customers. It could be along a number of factors such as saving on hosting costs for the customer, better security, easier updates, access to additional features, more flexibility and modular pricing structure and better support.
Moving to a SaaS model without considering all the factors, and forcing customers to move, could lead to churn, customer backlash and even cannibalization if pricing structure is not thought through.
Depending on your product, you can then go with either a core-plus, feature/modular or all-inclusive bundled pricing structure. If you are a consumer tech business, you can look to start with a freemium model. It is typically easier to convert customers from a free product to subscription license vs converting from a perpetual license to a subscription license.
The key is to have a defined product differentiation to incentivize transition and perhaps even a discount on initial contracts. It is also imperative to define a transition timeline and clearly define the timeline until when the perpetual licenses will be supported. Having a squeezed timeline can risk the customer opening an RFP for the solution and moving to a competitor in the process.
2. Revenue, KPIs and margin improvement
Moving from a perpetual on-prem license model to a SaaS model, almost always hurts the revenue and margins in the transitional phase. Under ASC 606, if you are US company, or IFRS 15, if you are an international business, revenue for on-prem licenses is recorded upfront and revenue for a pure SaaS offering is recorded ratably (there are exceptions depending on how the contract is structured). However, overtime, as your subscription base matures, you have a much more predictable and growing top-line.
Similarly your gross margins in the transitional phase may also take a hit as you will extra costs for hosting and also additional support in the initial years to ensure a smooth transition for your customers.
The key here is to develop KPIs that provide a better story for subscription business, such as Annualized Recurring Revenue (ARR), Net Retention, Expansion metrics, customer life time value (CLTV), etc.
To manage the dip in gross margins, some companies start increasing maintenance rates on legacy on-prem products and also billing multi-period upfront to have better cashflow. In addition to covering the dip in margin, that also incentivizes the customers to move to SaaS.
If you are reporting to investors or if you are listed, it is important to communicate to investors and analysts, the transition story and the expected short-to-medium term volatility in revenue and margins. You would also need to manage your investor communication to focus more on the growth in SaaS and the SaaS KPIs.
3. Operating model
The change in operating model will at the end define your success or failure of moving to SaaS. If your operating model is not built to scale and support customers, it may not matter that you have the best product, eventually customers will either churn away or ask to be moved back to an on-prem model.
The key aspects to consider here are: (i) is the back-end infrastructure scalable to support the new offerings, (ii) is it more cost-effective and efficient to buy a technology that allows you to transition vs building it from scratch, (iii) is the current management and R&D team skilled to lead the new vision successfully, (iv) does the support team have capacity to support hybrid delivery model, and (v) is the billing system adaptable to the change in revenue and billing model (you will not believe how much money some of the companies lose because of not having an adequate billing system that can cater to multiple pricing structures).
Given how critical sales and marketing are to the success of transitioning to a SaaS model, I have it as a separate point in the “PROS”.
4. Sales / Go-to-Market
Transitioning to a subscription model from a perpetual license model, requires a complete over-haul of the sales and marketing functions and a greater emphasis on the customer success function.
To incentivize sales teams to sell more subscription products, the compensation structure need to move from a point in time sales to a compensation structure tied to the customer lifetime value. The sales team need to be trained on the benefits of the subscription product and they would need to be supported by the technical pre-sales team to successfully demonstrate value to customers and close a deal.
The key is to drive a mindset shift in the sales team from a traditional hunter type salesperson to a more team-based hunter and farmer types of salesperson, with the customer success team taking more of the farmer role and driving expansion and renewals. The quotas and targets need to be refined to drive the shift in mindset from “land and convert large upfront deals” to “land and expand deals focusing on lifetime value”.
Similarly marketing spend and effort also need to move from pure acquisition to retention. This would involve redefining marketing metrics to also include customer engagement and retention metrics, in addition to the traditional funnel conversion metrics only. Overtime, you may have to split the marketing function between lead-gen and customer engagement.
Conclusion
Transitioning to a subscription model has challenges but in the “longer term” it provides more predictable revenue stream, greater customer engagement and higher valuation. Always remember that it is a long term game and the customer is still the king. The key is to make your intentions, pricing, features as transparent as possible and have a customer centric mindset to develop long-term relationship with your customers.
If you find the article useful, please share with your network with the hashtag #subscriptionPROS. It took me multiple coffees to come up with a catchy mnemonic that allowed me to write a cheesy subtitle!. Good luck with your transition and in your quest to be part of the #subscriptionPROS.
