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Although Box’s stock value has had its ups and downs since its IPO in January, going public sent an important signal to investors. Aaron Levie has demonstrated that a subscription-based service is now the only viable business model in the technology industry today.
When Salesforce debuted in 2004, there was very little market awareness of recurring revenue-based business models. They were mostly associated with print media and telecoms. Eight years later, Workday’s successful IPO convinced many sophisticated institutional firms of the viability of the subscription model, but Main Street investors largely remained on the sidelines.
But the recent liquidity events of HubSpot, Zendesk, New Relic, and Box have brought this model squarely into the mainstream. What has made the broader investor community finally warm to the idea of recurring revenue-based business models?
They now see that their subscription-based business models give SaaS companies advantages in growth, predictability and competitiveness. Let’s start with growth.
Growth
In a traditional business model, your revenue resets at the beginning of every financial quarter. You sell your product, you recognise the revenue, and ninety days later you start all over again at zero.
But in a recurring revenue model, you begin every quarter with guaranteed revenue. It’s similar to the difference between salaries and royalties. You have to work for every penny of your salary, and it stops when you leave your job. But royalties accumulate over time as you produce more work, leading to a larger and larger income base.
As a result, the path to growth for subscription companies is much simpler. There is less effort in chasing after every dollar, and more focus on monetising ongoing relationships. As long as a subscription company has a positive recurring profit margin, it can choose to invest aggressively in growth while prudently managing expenses.
That’s why the median growth for SaaS subscription companies is over three times that of traditional enterprise software companies. Box’s revenue last quarter was $62.6 million (up 61% year-over-year), but its bookings were $82 million (an increase of 33%). The bookings figure is your real growth metric – it’s a forward-looking number that allows Box to manage its costs effectively.
Predictability
Next fiscal year, Box expects their revenue to be in the range of $281 to $285 million. That’s an exceptionally tight range! How can they make such a narrow estimate? Because they can precisely calibrate losses against guaranteed future revenue.
Infact, that’s why subscription businesses are more comfortable running at temporary losses. Those losses don’t stem from the vagaries of the market, they are completely premeditated. Box knows that next year they can bring their expenses down as needed. As long as that money is spent on growth and market share, it’s a good investment.
What’s more, it’s one thing to acknowledge that customer success is important, but it’s another to orient and define your company around it. This isn’t about surveys and thank you calls – smart recurring revenue-based businesses like Box build their entire corporate DNA around ongoing customer outreach and a laser-like attention to customer usage patterns.
In today’s subscription economy, widget-based metrics like units, margins, and inventory have been replaced by relationship metrics like renewals, upsells, and churn. And investors recognise that with greater customer visibility comes greater fiscal predictability.
Competitiveness
When you market a stand-alone product – a mobile phone, an automobile, or an electronic device – you’re also selling it to your competitors. They are happy to wait in line outside your store, purchase your new product right off the shelf, then hand it over to their R&D people and reverse-engineer it for their customer base.
Unfortunately, not all your customers are as enthusiastic as Apple fanboys. As a result, they’re often sitting on older models of your product, and are vulnerable to switching over to your competitor. If I’m going to spend the money on an upgrade, why not try something new?
But with a subscription service, as long as you keep investing in innovation and fine-tuning your service, your customer gets used to things getting better and better on their own. There’s no reason to switch – in fact there’s every reason to stay.
Not only that, subscription services have invaluable insight into their customers through their usage data: what features you use, when and often you use them, what new services make sense. That’s information your competitors simply do not have, and cannot replicate.
Box’s paying customers include over 50% of the Fortune 500 and over 22% of the Global 2000. Their clients keep renewing, year after year. They are clearly a mission-critical service. As a result they have “negative churn,” meaning the upsells from their existing customer base more than makes up for the revenue lost from defecting clients.
Conclusion
I’ve discussed why subscription models are more competitive than widget-based businesses by an order of magnitude. But lastly, I think a big reason that mainstream investors are jumping into subscription models is because they see a marked difference in their own spending habits. From transportation to software to media, consumers and enterprises alike are shifting from static products to ongoing services. And like all astutely managed subscription companies, Box will continue to grow more valuable over time – to the markets and their customers.
While my last piece focused on Box’s post-IPO product plans, in my next piece I’ll be tackling the big debate facing the SaaS industry today: profits versus growth.