Software may be eating the world, but CIOs and IT leaders today understand that subscriptions are increasingly eating software.
It’s clear to many CIOs that the software-as-a-service (SaaS) model is rapidly overtaking traditional on-premise licensing. Just look at the numbers. On-premise software license revenues are projected to shrink more than 6.1% by 2024, while software subscription revenues are set to grow by a compound annual growth rate of 16.6%, according to IDC.
With the dominance of several SaaS stars, it may seem like every software company today was born in the cloud. But as most IT leaders know, the reality is that there are still many other enterprise companies -- both hardware and software -- that started out using traditional licensing models.
Many of those enterprise companies are working hard to add a subscription element to their business. Yet, others lack a strong imperative to move away from the on-premise model, either because their customers are satisfied with their current arrangements or IT imperatives prohibit it.
The reality, though, is that the subscription model is quickly becoming a business necessity. A recent CIBC World Markets study found that, on an annual basis, SaaS stocks outperformed the mature software names, with an average stock price return of 83% vs. an average year-to-date mature software return of 22%.
SaaS providers enjoy higher valuations because subscription earnings are more predictable, and companies that offer them can generate more revenue over the long haul. Eventually, many enterprise companies will also offer their products on a pure consumption or per-usage basis so customers can try new products for a very low cost (or even free) and expand usage as their needs grow, though usage-based consumption is still in the early stages.
Moving to SaaS is not a “flip the switch” exercise. It requires a total shift in how management thinks, operates and compensates, and everyone -- from sales and marketing to operations and finance -- needs to be rowing the boat in the same direction.
For enterprise companies making the transition from on-premises to SaaS, here are four things they should prioritize to set themselves up for success.
1. Develop the right pricing and bundling strategies
Even as they transition to a SaaS model, many enterprise companies don’t have formal programs, strategies, and methods in place to profitably price and measure their offerings. What’s more, some of these companies may have customers that are happy with the way they buy IT products and services. As a result, they must provide a compelling value proposition to persuade their customers to make the switch. This can include lowering the total cost of ownership, enabling greater speed to market, supporting faster innovation and the ability to easily consume a greater number of products across an enterprise company’s portfolio.
Another key imperative is to move away from product-based pricing and toward new value-based pricing schemes. As products and delivery methods evolve, enterprise companies must also choose which markets make the most sense to serve. EY research shows that many companies have not done a proper customer segmentation analysis to determine which markets they can operate in profitably, or of the capabilities they need to serve them. Success requires that enterprise companies incorporate data-driven customer segmentation early on as they develop their strategic road maps.
2. Reimagine the sales organization
As they move toward a SaaS model, enterprise companies must completely rethink how they incentivize, measure, and equip their salesforce and third-party sellers. This is particularly difficult if they offer a mix of both traditional and subscription options.
Wrestling with how to calculate compensation, including commissions and bonuses, in a way that appropriately balances the needs of the salesforce, customers and the larger enterprise goals is key. Sales training is equally important since most salespeople are still accustomed to selling licenses.
While leading practices are still emerging around sales compensation, most enterprise companies recognize the need to move away from a “sell things” mindset to one that’s more focused on nurturing long-term relationships. This is vital because it can take up to two years to cover the cost of sales and begin turning a profit.
Enterprise companies also are finding that establishing a “customer success” organization -- one that monitors and reacts to the needs of customers along their journey -- is a powerful tool to help enhance and maintain those critical relationships. Companies with well-developed customer success organizations use sophisticated data tools to understand customer behaviors, which can drive powerful upselling opportunities.
3. Change the operating model
Many enterprise companies are unsure about their organizational readiness as they embark on a transition to a SaaS model. It is critical to implement an integrated operating model capable of supporting a combination of new and existing offerings across the enterprise. From sales and marketing to product activation, customer care and billing, every new product (or combination of products) must be enabled and supported throughout the organization. Another frequently overlooked organizational change is the partner ecosystem currently utilized by these companies. SaaS offerings will impact these business partners and failure to consider those implications can be detrimental to success.
Often, companies making the transition to SaaS lack well-developed product usage and adoption metrics, which can create significant blind spots when gauging the success of current products and limit the visibility into upselling opportunities. By developing these metrics, companies can improve their internal performance, drive product sales and marketing, and better establish long-term investment priorities.
4. Use KPIs to gain stakeholder buy-in
It’s critical for companies to develop and use relevant and tangible KPIs to explain to external stakeholders how the transition to SaaS will impact their near- and long-term performance. This includes creating a narrative around the long-term benefits of shifting to a SaaS model, since it’s likely that the change will not be revenue-neutral -- at least in the short term.
For enterprise technology companies to mitigate any possible negative share price impact, full transparency is a must. A necessary first step is holding regular meetings with investors to explain how the new KPIs demonstrate enterprise value, along with clarifying the accounting and revenue implications of moving to a SaaS model. Another leading practice is educating CEOs, CFOs, and communications staff on how to speak the “subscription and consumption language” with investors.
Beyond the four critical components listed above, the transition away from traditional licenses to a SaaS model requires a fundamental shift in mindset, as well as an entirely new perspective on establishing and nurturing customer relationships. For those that are ready to transform their business, now is the time to build the foundation for long-term success.
Ken is a Principal with EY Consulting and leads the Technology sector for North America. He and his team lead global technology companies through major business transformation programs, including the development of growth strategies as well as operational cost improvement initiatives. In his previous roles, Ken transformed a consulting offering portfolio toward cloud solutions, advanced analytics, and digital solutions, including IoT offerings for the technology industry. Additionally, he developed new markets and solutions for strategic shifts, with a focus on business and industry advisory services. Ken holds a BS in Mechanical Engineering from the University of California at Davis.
The views expressed by the author are not necessarily those of Ernst & Young LLP or other members of the global EY organization.