Subscription Economics

Chapter 1

Chapter 1 Subscription Economics: How Recurring Revenue Changes Everything By Tien Tzuo Tien Tzuo is widely recognized as one of the original thought leaders in the software as a service (SaaS) industry for the critical role he played in deﬁning the service and business models that helped Salesforce become the most successful enterprise SaaS company in the world. In 2007, Tien left Salesforce to start Zuora, a company devoted to solving the complexities of running a subscription-based business. As Zuora’s CEO, Tien has not only built one of the fastest-growing SaaS companies around, he’s also evangelized the shift to subscription- based business models across industries — coining the phrase “subscription economy.” All SaaS founders need to be grounded in the fundamentals of building and running a subscription business. Subscription economics is all about understanding what the new metrics of success are, as well as the business drivers needed to achieve this success. Congratulations. If you’re reading this book, you’ve put yourself in the right place, at the right time. The business landscape hasn’t seen these kinds of changes since the Industrial Revolution, and huge opportunities lie ahead. Now it’s up to you to grab them. What are these changes I’m talking about? We all recognize that over the last 16 years, software as a service (SaaS) has become the dominant model for distributing and consuming software. Who wants to own soft - ware and deal with the headaches of buying the hardware, installing the software, backing it up, bothering with upgrades, and getting calls in the middle of the night when it breaks? Once you try Salesforce, there’s no going back to Siebel. 99

Chapter Chapter 1 1 WhileWhile most most people people think thi ofn SaaSk of SaaSas stri acstly stri ac tlytec ah nteologychnology vehi cvehile, itc’s le, it’s givengiven rise torise a ftoar am forear m funoredam funedamntale cnhtanal cghean, anged, thanadt’ sth theat’s b theirth bofirth a of a new businenew business modelss model — su — subscriptionbscriptions. Whens. W whene st wartee sdta Srtealeds Sforalecesfor.cocme .icn om in 1999,199 we9 re, wealized rea lizedwe were we weren’t sellin’tn sgelli prongduc protsduc anymorts anymore. Wee w. Weree w aserekin ag sking companiecompanies to subs tosc subribesc torib ae stoervi a cseervi wece w weree w cererea ticnrega. tiBungt . herBuet ’hers thee ’s the thing:thi Todang: yT,oda in 201y, in7 ,201 this7 b, thiusisn beusiss mneodelss m iodelsn’t li ismnite’t lidm toite SaaS,d to SaaS, it’s ac ittu’sall acy tually presentpre insent every in every part ofpa yort ofur yolifeu. rT olif seee. To how see thihows i sthi happes is happening,n letin’gs ,w letal’k s walk through through a littlea littlehistory his letorysso len.sson. The Industrial Era and the The Industrial Era and the Tyranny of the MarginTyranny of the Margin For basiForc basially ctheally e thentire e n20tireth 20cethnt uceryn, twuery lived, we livedin a proin ad uproct deucoctn eocmoyn. omy. shippeds iphycal thisicanlg this undngser und an er an CompanieCompanies dessigned designed, built, ,b soluiltd,, soland,d sahippend d phy assetasset transfer transfer mod elmo. Bduseli.n Beusssi nwaesss awabosu at boinveutn intorveyn, torshelviy, snhelvig, andng , candost- cost- plus plupricis npricig. Theng. relTheatio relnsatiohipns bhipetw beeetnw seeellern s ellerand buandyer bu wasyer baswase dbas on ed on discretdisec, retoftene, often anon aymononusymo tranuss tracantiosnsactio. Thens. sTheign sbyig nthe by cas theh casregihs teregir ster summsumed mit edup :it All up S: aAllles S Fialenals .Fi Enaalrly. Eretarlyail ret pioailn eerspion lieerske S liekaer sS Reoearsbuc Roek buck and Macyand Macy’s had’s mi handi mmialn iinsmalight ins iightnto winhoto wwhoas ac wtasua acllyt uabuyillyn bguyi theirng theirprod pro-d - ucts, oruct hows, or howthey they werew usereing us theingm the. m. WhenWhe Hennry He Fornryd ’Fors ﬁrds’ts mﬁrovingst moving assem assblyem linbely wlinene tw intoent operinto aopertiona itionn in 1913,1913, it wa its rewaallys re juastlly an ju stex anten esioxtenn ofsio mann of ufmanactufuringactu priringnc priiplencs ipleﬁrsts pﬁrust t put into plinatoce pl dauringce during the In thedu sIntridual sRtrievolutioal Revolution of then of 1 the800s. 18 The00s. assThee mbassley mbly y throduighscrete discrete repetitiv repetitive e line wlineasn w’t asjustn’t ajustbout a bmaoutximizi maximizing eﬃngc ieeﬃnccyie thronc ugh tasks;t aits kwas; its awa mets aa metphora phorfor how for howa co ma paconmypa’s prony’sduc prot duccant dcanictate dic ittates its supplysupply chain chains, manus, manufactufarincgtu proringc eprossecs,e sdseistribs, diustiotribnu ctiohannn chelanns, andels ,ma andn ma-n - agemageent lmaent lyersa. yers. The proThed uproct waducst the wa so thenly goveronly governing prininncg priiplenc — ipleit — orgitan orgizedan everythiized everything ng acrossacross a perfectly a perfectly straight stra liightne. Theline. aThectua alct peopleual people involve involved in mad inki nmag, king, buying,buying, and selliandn sellig theng pro theduc prot ducweret were entirely entirely dispo dsabispolesab. Helen.ry He Fordnry ’Fords ’s customercustomers coulds could famo fuamslyo piuslyck apinyck Mo anyd elMo T dcelolor T c theyolor theywanted wan, ateds lo, nag s long as it waas it was blacks bl. ack. The resTheu ltres ofu altll of thi asll relentlethis relentless eﬃciess eﬃciency wasncy thwasat Hethantry He Fornryd ’Fors cods’st cost per upernit droppeunit dropped predc ipitoprecusipitoly, usallowily, anllowig hinmg tohim ﬂood to ﬂood the matherk maet wrkiteth with cheapche butap d butura bledur caablers. caMors.d elMo Tsd oeln Tlys camonlye cam in belac ink b blacecausk beecaus withe wonithe one line every three three minute mis,n utethas,t wasthat thewas o thenly only automoautomobile cbomingile coming oﬀ the oﬀ li thene every color thcolor that wouldat would dry f asdryt eno fast enough. ugh. 1010 1010

Subscription EconoSubscription Economics: m ics: How HoRecwu Rrring ecurring ReveRneveue Cnhaue nCgeshan Everythinges Everything g ThenThen, once, o Fornced Forestdab elishestabdlishe command commanding dimangrk maet srhketar es,h theyare, theycoul d could start tostart gently to gently raise rtheiraise theirprice prices ands ma ankde ma mokne eymo oﬀney the oﬀ d theiﬀeren diﬀerence, orc the, e or the marginmargin. The .m Theargi mna rulergind rule everythingd everything, and , aa nlittled a littleplan npleadn onbesolesd obsolescence cence nevern heverurt. hurt. It’s dItiﬃcult’s diﬃcult to overstto overstate theate pothew erpo wtherat thbigat post-big post-war waAmr ericAman erican corporcorporationastio had.ns Theyhad. Theyorga nizedorganized thems theelvesmselves arou nadrou strictlynd strictly delin deaelitend eated productpro ddiviuctsion diviss andions d andidn’ dt hidanve’t htoa vean toswer an stower an toyo anneyo. Therene. There were were no cal nol call centercenters, no cs,u nosto cmustoer smerviceer service reps, repands, i nan mand iny man casesy c, asnoes ret, nour ns,ret uperiorns, period. d. This mThisod elm oddideln ’dt iwdnork’t w porkartic pualrticarlyu wlaellrly wwhenell w ithen cam ite c amto ceus toto cmuserstom likerse like you or yomu or e, bumte ,it shippe but it shipped unitd sunit ands k anept d kbept oardrooboardrooms happms happy. y. emergenmergence of cOer ofacle O renterpriseacle enterprise resou resorce pluracnnie plnagnni (ERP)ng (ERP) syste systems ms The The e in thein 198 the0 198s only0s onlyexacer exbaacertedba thiteds pro thisb lepromb. Thelems. eThe sysstee symsste dmsid a d gooid ad good job ofjo mb eofas murienasguri operng aopertionaationl eﬃacl ieneﬃccy ien—c ry aw— rmaawteri maalsteri, inaventorls, inventory, pury, p-ur - chasec horderase orders, shippings, shipping, payroll , pa—yroll and— aand lousy a lousy job ofjo bm eofas muringeasuring actua acl tual custocmuserto emxperiener experience. Bcuet . cBoumt pcaoniesmpa niestend tento dman to ageman wageha tw theyhat theycan can measmureeas, aurnde, soan exd soec uextiveecu tetiveams te bamsecam bece amhopelese hopelessly proslydu proct-focduct-focused, used, both borgotha nizorgaationiznaatiolly ananllyd str anad tegicstrategically. ally. This dThiecas dede caalsode s aawlso the saw as thecen asdceannced anof cesu pplyof su chaipplyn chai econon ecmonoics.m Thicse . The goal wagoasl to wa mas totc mah sutcpplyh su pplyand d aenmad dnedma wnithd wtheith le theast leinasventoryt inventory poss ipobless. ible. It waIst nwairvsa nnirva foran ae nforgineers engineers and maandn amagenmaentgem coentnsult conansultts, anwhots, wwhoere were electroncictro pronicd uproctsd anucdts eﬃandcien eﬃccieiens ccoiems ingcom ouingt out threathreteneadte bnye dthe by n theew new ele of Japofan Ja. pan. “Just-in-Ti“Just-in-Time” imnventorye” inventory meant m ethaantt wtharehouat warehouses fullses of full stu ofﬀ stjustuﬀ sitti justn sittig ng arounadro uwerend were the utheltima ultitema enetem eney. “mToty.a “l TQotuaal lityQu aMlityan aMgeanmaent”gem ent”mea nmt eant that thethat w theork w ofork im ofprovi improving proceng processes wssesas neverwas never over. oveMicrh. Miaelc Dhaellel bDuellilt built an emanpire embapire sed abaseround ad rounthisd dthiisciplis disnciplie. ne. ThenThen, aroun, adroun 20 dye 20ar sye agaros, acorporgo, corporate Aamteeric Ama ericwoake w uopk eto u thep to re theal rea-l - izatioizna tiothant thalla tthis all relethisn reletlessn tlefocssus foc onus pro ond uproctivityductivity was cwaoms ingcom aingt a at a cost, cnamost, elynam theely reltheationship relationship betw beteenw theeen venthed venor adnord theand ctheusto cmusetor. mer. The cTheusto cmustoer wmaers aw coas ma pletecomplete unkn unkown,no awn, rec aept reacceptle aact lethe a ten thed ofen a d of a distridbistriutionbution chain ch whoseain whose sole spurposeole purpose was towas c otons ucomnse utheme prodthe uprodcts uct s compcaoniesmpa mniesad me. ade. t, many ma ofny the ofse the neswe cneonsw umconsersum wersere w hereaving ha vingdiﬃc duiﬃclty ulty As it tAsurne it tdu rneou d out, gettinggetting their theirnew neprowdu proctsdu toct sw orkto w. Anorkd. Anhodw hodidw cdiorpord corporate Aamteeri Acma erica 1111 1111

Chapter Chapter 1 1 discoverdisc overthis? thiTheirs? Their receptio receptionists nwiserets w gettiere ngettig anngryg an phogry nphoe canlles. caSo lls. So whatwhat did the did big the c bigomp canompiesan doie sto d oad todre assdd thisress prothisb lepromb? leTheym? Theyset u sp et up customercustomer service service depart departmentms.ents. WhenWhe in ndo inu btdo, ububtild, bu anotherild another verti cavertil silcaol. sTheyilo. Theylaun chelaundche madr kmaet rket servicesservices, techni, technical sucpportal support lines ,li wanesrr, anwatyrr ancotyntr caconts,tr acantds, maandin matenancintee nance groupsgro. Theups . cTheusto cmuserto hmader trulyhad trulyarrive ad —rrive sd —he h sadhe herhad ow hern owdepna drtepmeanrtt ment now. noAndw. thatAnd depthata deprtmeanrttm wasent lowascate lodca watedy dwaowny d oawnt the a tf ather e ndfar ofend th e of the supply chsupply chain, juastin , pastjust thepast lo theadi longad dioncgk d. ock. For wForhat w ithat’s worth, it’s worth, all the all mtheajor m MBAajor MBAprogr programs amswere w juseret ajuss wt iads wi-d - get-obget-obsessedse,ss ated le,as att lemiasnte mi wasne. Iwas was. I t wasaught tau thghtat thetha tf undamthe fundamentale gontaal l goal sellman as yman unitys un of its of of buofsin buesssi nisess to cisreate to create a hit apro hitdu proct.du I thect. nI thehadn tohad sell to a s that productthat product as po asss iblpoess, therebyible, thereby spread spreingad minyg ﬁ xmedy ﬁcxoedsts c overosts overas man as y many unitsunits as I c oasu lId c,o soul dI ,c soou lId c ocoumld petecom peteon the on a thell-po awll-poerfuwl erfmaurgil man. rgiAlln. I h Allad I had to doto w doas deploywas deploy SAP bSetterAP b etterthan theveryoan everyone elnsee. elIt swase. It awasll co amll pletelcompletely y worthlesworthless advics advice. e. The Shift to Monetizing RelationshipsThe Shift to Monetizing Relationships As theAs elevenththe eleventh hire ahiret Sa alet sSaforlecesfor, I cwea, sI privilegewas privileged to db eto a blebe atbleo to help helpbuild b nuotild junsott aju nstew a nkiewnd kiofn dcu ofsto cumstoer relatiomer relationshipns mhipana mgeanamegent ment (CRM)(CRM) tool, tool,but a bu wthole a w holenew napproew aacpproh toac ehn toterpri enterprise applise acapplitionscatio. Mnsan. y Many of usof early us earlyemployee employees hads bheacdo bmeec odimsille usdiiosillnusedio overned overthe s thetate softa teth e of the enterprienterprise softsew softarew inaredu strindy.u Astrs yw. eA sa pprowe aacpprohedac thehed t uthern oftu rthen of c theent ucreyn, tury, dlessly companiecompanies likes Olirkace lOe,r acSieleb, elS,ie andbel, othersand others were w cererea ticnrega ati nngee ad nleeessly complicatedc atedprod ucprodt thucatt thwaast wasolds sbolyd a bmy era cmeneraryce nsaaryle s saforlecs efor ancd e and compli promprootedm botedy a par by aas paritic sasyitistemc syss temintegrs inategrtion aintiodusn intrdusy. try. EveryoEveryone maned ema mdoen ey mo— ney th— at iths, aeveryot is, everyone exnceept ex ctheept cu thesto cumstoer. mHaelrf . Half the installations would never see the light of day, and even those that the installations would never see the light of day, and even those that werewere deemed deemed a succe a suss wcceeress w hereate d bhatey thed by e thend us end users. Theers .i ndTheu sindtryu hsatryd had completelycompletely lost sight lost sight of its ofcus ittomers customers: whos: wtheyho theywere w, werhea,t w theyhat theydid o dn id on a daily basia daily basis, what they lis, what they liked akbeodu at their bout their work sywork systems,ste andms, w andhat pis whast pised sed themthe oﬀm. It o wﬀa. sIt ti wmae fors tim a e forchan a chgean. ge. At the same time, we looked on in wonder at this new experience At the same time, we looked on in wonder at this new experience beingbei introng duintroceddu bcedy the by inter the ninteret. Thinets. iThis whs iast wh wea want wete wand: tote bud: toild bu a neildw a new as aseas byu asy buy- - kind ofkin udser of euxperieser experience, wherence, where using us softingwa softrewa woulre wd oulbe ads b eeas y ing a book oing a book on Amn azoAmn.azon. 1212 1212

Subscription EconoSubscription Economics: m ics: How HoRecwu Rrring ecurring ReveRneveue Cnhaue nCgeshan Everythinges Everything g But asB uwte as got we into got itinto, we it re, walizee reda lizethisd require this required us tod usch toange cha ongeur w oholur we hole way ofw aythi ofnki thingn. kiWneg h. Wade tohad re-ev to re-evaluatealu theate w thehole w holepurpo psuerpo of sae softw of a software are compcaonmy,p chanaynging, changing the fun thedam funentdamalent queasl tioqunes frotiomn fro“Homw “ Homawny ma pronyd uprocts ducts can I casell?n I” s toell? “W” toha “tW dhoesat dmoesy c ustomy cmustoer wamernt wa, anntd ,how and howcan I cdaneliver I deliver that that as anas in tuitive an intuitive servicseervic?” e?” It wasItn was’t junst’t abjusotu abt juosutt sjuhiftist nshiftig unitngs u anitnysm aornyem. Itor wase. It awasbou at bogroutw groing wing and mandonetizi monetizing a dnegd ai cadetedd icacteustod cmustoer bmasere .base. WhatWh abaoutt ab theout StheaaS SmaaSod elm ofordelce ford ucse dto u thinks to think of cu ofsto cmustoers?m Serusr?e , Sure, technologytechnology drove d roveus to u oﬀers to oﬀerwhat w whea dit wde over did overthe inter the ninteret. Anfteret. A afterll, th ae ll, the visionvision was as wa esa assy easa sybu asyin bgu ayi bnookg a b onook A maon zoAman. Bzoun.t th Bautt reqthaut irereqduired u us to s to thinkthink of w hofat w whea dt iwde as d iad saservic a seervic, some,ethi somnethig thnagt peoplethat people subs csriubbescdri tboe, d to, and thandat forcethat forced us tod u psu tot ourselves put ourselves in a position in a position where w herewe w weree w alerewa yals ways pleasingplea thesing c theusto cmustoer. Allme ofr. All a su ofd ade sun,d dewen, ca wreed ca lesresd ab lesouts ab wouthat w prohadt prod- - uct feuacttures features soun sodeudn coolded , cooland, waned fo wceu sfoedc uosned w ohna tw chuastot cmustoersm wersere were using,u wsing,hat they nee what they needed. ded. As a resultAs a result, we di, wden ’dit sdtnart’t swtaithrt wa ithlist aof li simt ofpres imspresive-sounsive-sounding dproding uprodct uct featuresfeatures. We st. Wartee stda wrteithd wlotiths of lot qsu ofestion questions. Mas.rc M Bearcnioﬀ Be nwasioﬀ liwaske a li oknee a- one- man mcoanns umconersum surveyer su operrvey aopertion.a tioHisn. pitch His pitch meetings meetings were were more m aorekin tao kin to focusfo groupscus groups. He wa. Hes c waonsst caontlynsta pepperingntly peppering his prospe his prospects wcithts questionwith questions s so he coso he could eunlgineer d engineer a killera killerprodu proct.duct. Over Othever ptheast pdaecstad deec, adthee , intheternet internet, spre, aspread d by mboyb ilemo technologiebile technologies, s, has forcehas forced mored m aorend m anored m boreusin besseusinsesse to ssta tort sthinkingtart thinking the sam thee sam waye, twao y, to take ata ckues ato cmuser-ﬁrsttomer-ﬁrst mind mset.ind Aset.ma zoAman, Netﬂizon, Netﬂix, andx, Zipc anda Zipcr all areir anllvente reinvented d whatw theyhat theydid a ds iad s aervics a seervic. Theye. Theytrack etrdac ckuestod cmustoer preferenmer preferences, tcaesilore, tad ilored their theiroﬀerings oﬀerings to ind toivi indduivial needuadl nees, andds ,a alwand yaslwa tookys tookthe lo theng-ter lonmg-ter viemw vieof w of creaticnrega lifetiting mlifetie cumseto cumserto vmalerue v. aThelue .focu The sfocu shifteds shifted from frothem tr theans tractioansn action to the to the custocmustoer. mer. So inSoste adinste ofad selling of selling static s tproaticdu proctsdu thctast evthaatpor evaatepord aafterted afterchec kcheout ckout (along(a longwith wtheirith theircustomers) customers) or “set-it- or “set-it-and-forget-itand-forget-it” on-pre” on-premise minisseta lins-tal - lationlastio, bunsis,n buessisesnes coulses dc ouloﬀerd oﬀerongoing ongoing service services thast rethsaultet redsulte in sdma inrt s, mart, responressponive relsiveation relastionhipss. hipsRun.ni Rungn nionn ga onsubs a criptiosubscription modeln model, they, theycoul d could oﬀer oﬀerlower lo upfrontwer upfront costs costs, contin, continuou uously imsprovely improve their theiroﬀering oﬀering, and, leandarn learn way mworeay m aorebou at btheirout theircusto cmustoersm throughers through usage u saanged baehnda bvioreha aviornalytic anaslytic. s. The cuThesto cumser towasmer nwaso lo nnoger lo ntheger ghost i the ghost in the ERn the ERP. P. 1313 1313

Chapter Chapter 1 1 The Subscription EconomyThe Subscription Economy TodayT,oda everythiy, everything is nmgoving is moving to a subscto a subscriptioription econn eocmoyn:o mmeyd: ima, etrdania,s tran-s - portatioportation, agrin, caultgriucreult, uherea,lth he acalthre , cacorensum, consumer gooer ds,goo andds, andeduca education. tion. CompanieCompanies haves havewoke won ukpe nto u thep to f acthet thfacatt peoplethat people want wan outct omeoutcs,ome not s, not ownershiownership. Theyp. Theywant wan custot cumsizedtom eizedxperie experiences,nc andes, theyand theywant wan contti cnountin-u - ous improvementous improvement, not pl, nannot pleannd obsed oleobsscoleencsce.ence. One simpleOne simple but eﬀe butc tiveeﬀe cwativey ofwa lookiy of nlookig atn thig as ti sthi thsa its cthomatp canomiepsan haievse have startedstarted to sell to out sellc omeoutcs,ome usings, us theiring theirproduc prot ducas at m asea ans m eato nsan to end. an Ubend.er Uber and Landyft sell Lyft yo sellu theyou rid thee, ridnote ,the not c thear. C caaterpillr. Caterpillar useadr utose sdell to m sellover msover to s to constructionconstruction compa companies. nNoies.w Notheyw theyask them ask them how homucw hmuc dirth they dirt theyneed need moved.moved. Health He traalthck ertrasc areker sthro are wthroingw inin theirg in theiractu alac protuald uproct dforuc tfree for ifreen in returnret forurn afor 12 -am 1onth2-m onthsubs criptiosubscription to ntheir to theiranalyti anacslyti plcsatfor plm.atfor Tem.sla s Teslas updaupdte theatem theselvemselves withs wtheith lathetes tl atetecshnologiet technologies ands bandeco bmeec osmame rtesmar rter over overtime ,tim so eyo, sou dyoonu’ td noeen’td n toee bud toy abunothery another car. A camar. zoAman izos rollin isn rollig ount g out retailret tecahnologyil technology that letstha tyo letsu wa yolku waintolk ain stotor ae s, torpicek, uppic kw uphat w yohaut n yoeeud n, eed, and leavande leav. e. In short,In short, this ithisn’ts ias nsoft’t awa softrewa storyre s antoryymor anymore. Thee. tTheable t abstaleke sst ahkaevse have beenbee raisned for every raised for every indu sindtry.ustry. The New PrioritiesThe New Priorities We useWe thi uses di thiagras dimagra a lotm aat lot Zu aort aZ.u Itor saumma. It summarizes rizethe ss hiftthe. sOhiftn the. On lef thet left side, sidcome,p caoniempsa uniesesd utose fod custo fo ocusn getting on getting a pro aduc prot ducto mat tork maet — arketlig — aninligg ning their theirsales salesand distri and distributiobun ctiohannn chelanns aroelunds aro sundpec iﬁspec prociﬁducc prot liducnes.t li Tnoedas. yT, oday, they theyrecognize recognize that custhatomert customers spesnd spe theirnd theirtime tiacmroe ssac manross yman channy chelanns, els, 1414 1414

SubsSucription Ebscription Econocmonoics: m ics: How HoRewcurri Rencurrig Revenng Revenue Changes Everythinue Changes Everything g and wandherever wherever those tho cusstoe cmustoersm arerse, th araet,’s th waheret’s w herethey stheyhoul sdhoul be md beeeti mneetig ng their ctheir customustoersm’ neeersd’ nees. ds. The gloryThe glory days dofa ythes of soulless the soulless, all-po, all-powerfuwl erfcorporul corporationa atioren long are longgone go. ne. IBM iIBs stillM is a still gre aa tgre coamt pcaonmy,p buanty ,it bu’s nott it’s the not evil the e evilmpire em frompire from“Halt “ anHad lt and CatchCa Firtceh” Firaney”m anoryem. Itor’s eki. nItd’s ofkin ad cliché of a cliché now, nboutw the, but 198 the4 198 Apple4 Apple ad wa as d was actuallyact uveryally presveryc presientc: theient re: thebel reallibel ancealli ahnceas w honas .won. CompCoaniempsa hanieds toha dch toang chea, ngbece,au bseec aupeoplese people did. Tdiodad. yTo’sda cuys’sto cmusertos mers are maorere m inorefor mineford manded deandman dedimanng dibyn ga nb yor adner or ofd erma ofgnitu magnitude. Modes. tMo of st of themthe havem haveresea rerchesead,rche assed,s assesed,s asendd, c aantegorizedd categorized you b yoeforeu before you eve youn even say hellsayo hell. Ando. toAnd m ostto m ofost the ofm, the esm,peci esapecilly youngerally younger ones, one owns, erownshiper jusshipt just isn’t thisna’t it thmaportt imaportnt aanynt maornyem. ore. P People eople increinascinreglyasi vienglyw viethew prospect the prospect of bu ofyin bgu syionmgethi somnethig asn manag as manag -g - ing theing d theecli ndeecli ofn ae physiof a physical prodcal uprodct. Theyuct. Theywant wa thingnt things to hsa toppe han,ppe non,t not stuﬀ stotu mﬀ anato mganae. Thgaet. ’sTh wahyt’s mwhyost m ofo thest of b theig d binoig sdainour retsauarilers reta Iilers grew I grew up up with wareith e axtinre ectxtin nocw:t n Circuitow: Circuit City, TCitowy,er To Rwecorer Rdecors, Blodsc, kBbulosteckbur, Bsteordersr, Borders, , VirginVirgi Megan Megastores. torAnde. the Andma the llsma are llsd ayire ngd, toyinog., too. Why Whyare G aooglre Geoogl, Amae, zonAma, andzon , Appleand Apple three three of the of b theiggest biggest com pcoaniemps anies in thein w theorl dw rightorld rightnow ?no Herw?e ’Hers a hinte’s a — hint you — pro youbab prolybab havely haa personve a personal ID al ID with wallith three all three of the ofm. the Theym. ’Theyve pl’avece pld aance dinstitution an institutional preaml preiumm onium ow onn ow- n - ing theing c theusto cmuserto relmeratio relnashitiopn. shiBupt .a Breu tyou are wayoulki wanglki arongu nadro withund witha Nik ae Nike ID? AI DCo? kAe Co IDk?e A I DToyot? A Taoyot ID? aO InDe? daOnye yo dauy willyou, orwill those, or those c com ompaniepsa wilniel s will fade into irrelevafade into irrelevancy. ncy. CustomerCustomers arens ’at rerelegn’t relegated atote sdervice to service depa drtepmeanrttms anenytsm anoryem. Theyore. ’Theyre ’re centralcentral to your to yourorga nizorgaationizn.a tioTodan. yT,o peopleday, people expe cetx peservicect services to provis to provide de immediimmatedie, ongoiate, ongoing funlﬁllg fmulﬁllentm, froentm, froridmesh riadresesh atores stre toam streingam serviing cservies ces to sutobs criptiosubscription boxne s.bo Theyxes. Theywant wa tont b eto h abppilye happily surprise surprised on da onreg au lregar ular basisb. Anasids. ifAn youd if d youon’ td moneet’t m thoeetse tho expese cetxpeatiocntastio, yonus ,get you d getroppe dropped, notd, t o not to mentiomenn trtioashen trd asheon d sociona socil medial ma. ediIt’s tha. Iat’t s thsimaplt seim. ple. This mThieans ms ethanats everythi that everything hansg ch haans chgeand: hogewd: youhow d youesign design your yoserviur cservie, ce, how hoyouw e younga egeng waithge wyoithur yocustour cmustoersm, howers, howyou ma youn amagen yourage yourcom pcoanmy, pany, heck,heck, even ho even how youw d yoeﬁun de eﬁwhnae t rewhaally t recaonlly stitutesconstitutes a com a copanmy paannyy manoryem. ore. This bThiooks b iooks de disi cadeteddica tote edxplori to exploring theng ne thew nerulew rules s of buildingof building not ju notst just a SaaaS SaacomS pcoanmy,p baunty ,an buyt co anmy pcoanmyp inan they in s ubthescriptio subscription econn eocmoyn. oInm thy. e In the 1515 1515

Chapter Chapter 1 1 followingfollowing chapters chapters, you’,ll yo leu’arlln w leahrn wat ith taatk eits t toak egets to in getitia iln tritiacationl trac, tionhow, howto to spin up spina de up ma deand mgenand sgentrateg strya, and butegy, and build a killerild a sakillerles sateleams te. am. But asBut a ﬁrass ta steﬁrspt , steletp’s, sletta’rts swtaithrt wsoithm ethisomnethig mnoreg m fundaore fundamentmeal. nLetta’ls . Let’s exploreexplore the b the basic eacsiocn eocmoicsno bmehiics bndehi thinds un thiiqs unue niqeuwe nbusewin busessi nmeossd elm.odel. The New Income StatementThe New Income Statement ThereTher’s a lote’s ofa lot great of great materi maal teriouta lthere out there on sub ons csubriptionscription econ oecmoincs.om I’m ics. I’m goinggoing to sta tort thisstart d thisiscus dsisioncus bysion boili byn boilig everything everything downgn d toow an s itom aple sim fraplem efram-e - workw. Lorket’s . sLtetart’s wstithart wtwitho i ntwcoom ine costmatee mstaenttems —ent thes — old the ver oldsus ver thesus ne thew. new. Here’Hers a etra’s daitio tranaditiol pronaducl prot ducincot mince ostmatee mstaetentm thenatt theythat theyteach te inach an iy n any BusineBusiness 101ss c 101lass c(nulasmbs (nuermbs deliers ndelieatedne ain mtedillio in mnsillio): ns): Net SNetales S ales $100 $100 Cost of Goo Cost of Goods Solds d Sol(COd G(SCO) G S) (40) (40) GrossGro Incssom Inecom e $60 $60 SalesS & Malesa & Mrketianrkgeti ng (20) (20) Gener General & Aadml & inistrAdministrativeativ e (10) (10) Resear Recshear & Developch & Developmentme nt (20) (20) PrettyPretty straightfor straightforward,wa right?rd, right? This saThiyss yosayus s yooldu osolned or on me oreor m unoreits un of ita s of a productpro datuct a tot at aal totsaleal of sa $1le of00 $1 m0illion0 m.illion The .i ncTheom ince ostmatee mstaenttem bentrea kbsre oaukt s out the costthes cost thats thwent iat went into thatnto un thatit. unit. There There are foaurer f foundaur fundamentmeal cnosttals c: osts: 1. How much it took to make that unit (COGS), including the raw 1. How much it took to make that unit (COGS), including the raw materials, production costs, and so on.materials, production costs, and so on. 2. How much it took to sell that unit 2. How much it took to sell that unit — commissions to sales — commissions to sales people and money for the channel, for example.people and money for the channel, for example. 3. How much overhead management 3. How much overhead management — ﬁnance, human resources, — ﬁnance, human resources, and executives, for example and executives, for example — needed to run the company. The — needed to run the company. The more units you sell, the lower your overhead cost per unit.more units you sell, the lower your overhead cost per unit. 4. How much R&D the company is spending to create the next hit 4. How much R&D the company is spending to create the next hit product.product. The mTheoney money you reyouceived received for the for pro theduc prot,duc lesst, theless c theost cofo sthet of pro thed prod- - uct, isuct the, is grosthe sgros incoms ince,om othere, otherwise wkniseown kn oaswn the as grosthe sgros masrgi man wrgihen n when 1616 1616

Subscription EconoSubscription Economics: m ics: How HoRewcurri Rencurrig Revenng Revenue Changes Everythinue Changes Everything g expresexspresed assed a peras ac entperacgente. Inag thee. In ol thed econo old economy, thismy ,i sthis one is ofone the of m theost most importimanportt manargit mnargis. ns. UnfortUnfortunateluny,a thitelsy pict, thisu pictre isu erentirely is entirely wrong w rongfor a sforub ascription subscription busine busssine, ss, for threefor three main m reaainson reas:sons: 1. It’s a backward-looking picture. This is a preterit framework 1. It’s a backward-looking picture. This is a preterit framework — — it’s all it a’sb aollu at mboount mey oalreaney dalreay eardnyed, ear enxed,pen exsepens already pses already paid, aid, actionsac tioalreans dalreay takedyn t.a Sukebnsc. Suriptiobscription busn inbeussseins aessree s aall arebo allu at bout forwaforwrd viasrdibility visibility: how: mhowuch mmucoh neym oI nkneyow I k In cowan Ico can uncot onun overt on thovere the next 12ne xmontht 12 months, so Is c, saon Ia cccan ounacct,o plaunn,t, plaandn, s anpedn sdpe acncdor adcicnorglyd.ingly. 2. Sales and marketing are matched to past goods sold. It’s 2. Sales and marketing are matched to past goods sold. It’s essentially a sunk cost. I’ll get into this later in the chapter, but essentially a sunk cost. I’ll get into this later in the chapter, but subscription businesses need to think strategically about sales subscription businesses need to think strategically about sales and marketing spend going toward driving future business.and marketing spend going toward driving future business. 3. This statement does not diﬀerentiate between recurring and 3. This statement does not diﬀerentiate between recurring and nonrecurring dollars. That’s a fundamental oversight. That’s like nonrecurring dollars. That’s a fundamental oversight. That’s like saying there’s no diﬀerence between a dollar and a dollar that saying there’s no diﬀerence between a dollar and a dollar that keeps happening every year for the next 10 years.keeps happening every year for the next 10 years. SmartS masubrts csriptioubscription businesn businesses dosesn’ tdo thinkn’t think like this like. Ithisnste. adIns teofad reve ofnu revee, nue, they fotheycus fo mcoreus m ooren an onnu anal renucalurring recurring reven revenue (ARR)ue (ARR). Here. ’Hers a nee’sw a inencowm ine come statemstateentm, ewnhta, tw whea t cwalle ac asllu bas criptionsubscription econo economy inmcyo minec ostmaete mstaenttem, ent, which illustrwhich illustrates thiatess: this: AnnuAnal Rneucaurril Rencgurri Revenng Revenue (ARR)ue (ARR) $100$100 Chur nChur n (10) (10) Net ARNetR ARR 90 90 Cost Cof ostGoo of dGsoo Soldd s Sol(COGd (CS)OG S) (20) (20) Gener Gaenerl & Aadml & Ainidmstriniative (straGtive (&A)G&A ) (10) (10) Rese aRrch &esearch & Develop Development (mRent (&D)R& D) (20) (20) RecurringRecurring Proﬁ tProﬁ t 40 40 Sales Sa & lesMa &rk Metianrkgeti ng (30) (30) Net InNcoetm Ineco me 10 10 New AnNewnu Anal Conuanl Cotractn trVaaluect V (aAlueCV )(AC V) 30 30 Ending AREnding ARR R $120$120 1717 1717

Chapter Chapter 1 1 ARRARR Let’s Lbreaket’s break this dothiwn.s do Thewn. ﬁrThest thiﬁrsntg thi ton ngoti toc neoti herece hereis that is ithatnste adins teof ad of startingstarting and enanddi neng dwinithg wincitho mince,o nomew, nowew’re w set’rearti sntga rtianndg eandndi negnd winitgh with ARR, or ARRannu, or aannul recaulrri recngu rrirevengnu revee. nue. That’sThat beca’s usebeca smuseart sm suartbs criptionsubscription busin busessiense kssneosw k nthoawt nthota ta nllot rev aell reve- - nue isnue recurring is recurring reve nreveue, njusuet , lijkuse tyo likue anyodu Ian kndo Iw k nthereow there is a d iiﬀeres a diﬀerence nce betwbeteenw aee one-tin a one-time pmaymee panymet anndt aan redcu a rrirencug rripanygm peanyt.m Smaent.rt Sma subsrt crisubsp cri-p - tion butiosnine busssesine aresses ob arese ssobesde sswithed wARRith, ARRwhich, w ihichs the i sam theou amnt ouof nrevet ofnu revee nue that they that they expectexpect their i their install nsbastall e basto repee to repeat everyat every year. year. WhileWhile in a tr inaditio a tranditioal ﬁnnancal ﬁniaancl staiatel mstaetentm, reveent,nu revee inundieca intedisca hotews homucw h much revenuerevenue you myouad em, inad ae , subin ascriptio subscription econn eomycon omyinco mince ostmatee mstaenttem, ARentR , ARR d-looking number — subser — subscriptiocription econon ecmonoy commyp canomiepsan actieuas allcty ually is a forwaris a forward-looking numb start the yestart the year knoarw kinnogw winhat theirg what their revenu revees anuree s agoiren ggoi ton bge to. be. In theIn e xtheample example abov aeb, theove c, othemp canomyp wanithy $1with00 $1 million00 m illionof ARR of can ARR c canoun ct ount on thaton moneythat money at the a tb theegin bnegining nofin everyg of every year. yeThaart. Thﬁgautre ﬁg isu sretab isle st aband le and predictapredbictale. Thblaet. Thmeaanst me itans can it pl canan betteplan better, forer,cas foret mcasoret m accuore raccuatelyr,a anteld y, and rarely miss itrarely miss its mons thlymon nthlyum nberums.bers. The sameThe same cann cota nbneot sa bide saof ida of$1 00a $1 m00illio mn illiobunsi nbeusssi nweithss wnitho ARR no . ARR. That Thatcom pcoanymp haanys to ha sst atort sthetart ye thear yeat azerr aot , zerando, sandlow lyslo scwrlyat cschr aittsc hw aity s way back backto $10 to0 $10 millio0 mn.illio Of n.course Of course it can it ma canke ma sokmee so premed iprectiodnsictio bansse db aosn ed on past perforpast performancme,a buncte ,it bu doet its ndoe’t hsanve’t haa cveon atra cocntuatrallyct uaobllyligate obligated revednu revee nue ion plans aro.und. stream tostream to base baamsbe itioamus bitioexpus ansexpioansn plans around For aFor su basc sriptionubscription busines buss,ines mores, m soreo tha son thacasnh coras hreve or nurevee, nuARRe, iARRs is the truethe itruendic aintordic ofator a cofom a pcanomyp’san heya’slth he. aBultht .her Buet ’hers thee’s thi theng: thi accng:o unacctoun-t - ing ruleings ruletodays today don’ td reoncognize’t recognize ARR. ARRIn fac. Int, accfacto, unacctionung sytinsgte symsste doms n odt o not diﬀerentiatediﬀerentiate betw beteenw aeen doll aa dr ollthaart threcaurt res caurnds aa nddoll aa dr ollthaart thdoeats dnoeots. not. AccountiAccounting systeng systems tomsda yto adare yb aureilt bounilt the on sam thee sam doube dle-eoubnle-etry snttryand sartandd ard createcred a50te0d ye 50a0rs ye agoars b aygo Luca by L Pucaacioli Pac toioli help to helpVeneti Veanneti meranc merhanctsh tranatcsk track the salethe of salespices of spices. And . Ainnd thaint s thysteat sm, ystea dm, ollaa dr iolls a dar iolls a dar iolls aa rdoll is aa dollr. ar. ChurnChurn In its Insi mitsple simst plesensst es,e cnshuern, c hisu thern is num the benumr, ofteber,n ofte noten dn otein reved in nurevee, nuof e, of subscriberssubscribers who wwhoill nwotill renotne wre. nTeypiw.ca Typilly, cadollywns, doellwnss aellre sa alsreo faalsctoreo factored d to yochurnur churn num bneumr. Ifb ae cusr. If ato cusmerto cmhuerr nsch autr nsthe a te thend of end the of ye thear, yetherar,e there into yoinur 1818 1818

Subscription EconoSubscription Economics: m ics: How HoRecwu Rrring ecurring ReveRneveue Cnhaue nCgeshan Everythinges Everything g will bwe ill no ibe mnpo iact onmpact on that ye thaart ye’s revenar’s revenue, but it ue, bwut it ill imwpill iacmt your ARRpact your ARR. . ChurnChur sucnk s,su bcutks, evebutn eve if yon u’if veyo u’gotve thegot be thest beoﬀerist oﬀering inn theg in ma therk maet, rket, you’llyo stillu’ll hsatillve hcauvesto cmuserstom wersho wlehoave le yoaveu: yotheyu: theyswitch sw bitchusines business mosd mo-d - els, yourels, yourcom petitorcompetitor poac pohesac thehesm the withm wa ithsham a sheleamss eledisscsount disc,ount they, theygo go undeur.n Sdoe, r.in S othe, in topthe litopne youline’ llyou nee’lld nee to dsu tobtr sacubt tryouract yourexpecte expected chudr n churn from froyom ur ARR for theyour ARR for the year toye agetr to a getnet a ARRnet. ARR. Now letNo’ws lettake’s ata look ke a alook t those at those costsc. osts. Recurring CostsRecurring Costs In a SIanaS a ScoaaSmpa conmy,pa thereny, there are re aarelly re juasllyt three just three sourc soesu ofrc escost ofs cost: peopls: people, e, data dceatnate cer, nantedr, saanleds sandales maandrk maetinrkgeti. Inn gthe. In s ubthescription subscription incom ineco stmatee stat-e - ment themenst thee cosse cots are stsa lloare caatellodca into four ted into four key bkueyck betsuc: kets: 1. Costs of revenue,1. Costs of revenue, otherwise known as costs of good sold otherwise known as costs of good sold (COGS), which is how much you need to spend to actually (COGS), which is how much you need to spend to actually provide the service. In a SaaS company, this typically includes provide the service. In a SaaS company, this typically includes the data center, the hardware, the data center folks, customer the data center, the hardware, the data center folks, customer support folks, and so on. In an IoT company, these expenses support folks, and so on. In an IoT company, these expenses include the costs of your hardware and connectivity. In a include the costs of your hardware and connectivity. In a subscription box company, they include the costs of the subscription box company, they include the costs of the products you ship.products you ship. 2. Research and development (R&D).2. Research and development (R&D). This includes all the This includes all the developers and product managers.developers and product managers. 3. General and administrative (G&A).3. General and administrative (G&A). This includes primarily the This includes primarily the ﬁnance and HR folks.ﬁnance and HR folks. 4. Sales and marketing.4. Sales and marketing. This includes the sales and marketing This includes the sales and marketing departments and supporting personnel, and any money spent departments and supporting personnel, and any money spent on marketing programs. Notice how in the subscription income on marketing programs. Notice how in the subscription income statement, sales and marketing costs comes after recurring statement, sales and marketing costs comes after recurring proﬁt margin. I’ll explain why later.proﬁt margin. I’ll explain why later. traditionaitiol innacolm ineco stmatee mstaentstem tentsake thesetake these cost bucosctk etbusc anketd s and Now Nmoowst m ost trad map mtheapm the to mreven to revenue tou gete to a get ma rgia man. rgiRevenn. Revenue muineus m cinoussts c ofos revets ofn reveue, nue, for exforam eplxame, ispl youre, is yourgross gross margin ma. rginAnd. aAtn thed a the theart he ofa trrtad ofition tradaitionl ﬁnaanl ﬁnciaal ncial accouacntingcounting is the is c theonc eptcon cofept ma oftchi mantchig. Whenng. When $1 is $1sho isw shon aws nreve as nurevee nue on theon i nthecom ineco stmatemee statement, it nshot, itws sho allws of athesell of these ﬁxed ﬁcostsxed costs that wtheantt w inetno t into making thmaking that oneat one dolla dr.ollar. 1919 1919

Chapter Chapter 1 1 UnfortUnfortunateluny,a thetely , wthehole w holeconc eptcon cofept ma oftc mahintgc histnagrt sst toart bres toa kbre doawk n down for subfors criptionsubscription busin besussi mnesods elmso. dWeles’re. W goie’ren ggoi ton dgo to so dmoethi somnethig diﬀereng diﬀerent nt and candompare compare these these costs co tos tARRs to. ARRWhy. WARR?hy ARR? Becau Bseecau ARRse repreARR represents sents revenuerevenue acquire acquired in dprevio in previous perious periods, whids,c hwhi isc nho iws nrecowu rrirecngu.rri Sungre. , Sure, you neeyoud nee to kdeep to kseepervi csierving yocinugr yocuustor cmusertosm, sero COGs, so SCOG andS Gan&Ad Gsho&Au sld hould matcmath toc ARRh to. ARR. How Howabou at bRo&uDt ?R W&Dell? , Wtheell ,tr theaditio tradnaitiol vienawl viesayws satheys pro theduc protsduc yotu’s ryoe u’re sellingselling today today are alrea are dalreay dodnye do, andne ,yo andu’re yo inu’veres itingnves itingn res iena rercshe toar cchre toat ce reate innovationsinnovations that drivethat drive future fu satulesre .sa Bulest her. Buet ’hers thee’ sthi theng thi: theng cus: thetomer customers of s of SaaS SaacomSpa conmiespa diniesdn ’dit sdignn’t upsig nfor up a sforta tiac s servitatic cservie thacet ntheverat n getevers bgetettes br.etter. u knowethi somnethig abnogu abt SaaSout SaaScom pcoanmiespan, theyies, ’theyre ob’rese ssobesde sswitedh with If youIf know yo som keepingkeeping their theircusto cmustoersm hersapp hy,a ppto yk,eep to ktheeepm the bumying bu yingthe s theervic seervic, aned , and they invest inthey invest in R&D a Rg&Dain astg athinastt gothaatl. goal. At SalesforcAt Salesforce, wee , swtartee sdtarte namd ingnam releing asrelees aswithes withthe stheeas osns,eas ofons,r for exampleexample the Winter the Winter 2013 2 R013eleas Relee, toas ceo, ntovey co nthevey c onthes tcanonts rtaantet w raete ex wpee cet xpect to adtod enhan add enhancemecnemets ton thets to pro theduc protsduc. Thtast.’ sTh wahyt’s Iw lihyke toI li kthie tonk thi of nRk& ofD aRs &D as being beimnatg cmheatdc tohe ARRd to. ARR. SalesSales and m anadrk metianrkgeti is nwghere is w ithere gets it igetsntere instereting.s Itif nyog.u Irf yoARRur repre ARR represents sents todaytod’s reveay’sn reveue thatnue yothatu e yoxpectu ex pectto re cuto rre, thecurn, theyounr yospeundr spe onnd sa onles saanled s and markmaretingketing is going is going towa tordwa growird growing ARRng, ARRto ac, qtou airicnqgu irifuntureg fu reveturenu revee thnuaet that marketi exnpeg nsexepes nses is notis yet not in yet ARR in. ARRIn other. In other word ws, ordtods,a ytod’s saayle’ss saandles maandrk eting are matched toare matched to future reve future revenue. nue. In traInd itiontradaitionl accaountil accounting linnggo li, nyogou,r yosaleurs saalends maandr kmaetinrkgeti nnogw nacowts acts moremore like a li ckapitale a capital expe ndexpeiturnde,itur or cae, pore xca forpe sxhort for s. hortIn the. In ol thed manu old manufactufar ctu-r - ing winorldg w, orldyou ,investe you invested in ad b inig a fa bcigtory fac totory bu toild bu a bildunc a bhunc of whi dofget wisd, getand s, and you syoupread spread the co thest ofco thst aoft fthacatoryt fac otoryut over out overtime tiams yoe aus myoadu em aadnde saolndd sold those thowisde getwis dovergets overtime . timThate. ’s caThatlled’s ca dlledepre dcepreiatiocnia. tion. SimilarlySimilarly in the in s uthebsc sriptioubscription econn oecomyn, oyomuy ,i nyoveus itn iven ssatles in sanalesd ma andrk maetinrg keting to acqtou ireacq cuuiresto cumsers,tom aners,d yoanud reyocognizeu recognize revenu revee fromnue fromthose tho cusseto cusmertos mers over overtheir theirlifeti mlifetie, wmhie,c hw hioftench often can bcae nthre be ethre, ﬁvee,, ﬁv10e ,ye 1a0r s,ye orar s,mor or emor. e. HoweveHowever, accor, unaccotingun ruletings ruletodas yto doda yn otdo letnot yo letu spreayou spread, or d,depre or depreciate, ciate, les m anardk metiarngketi consgts co oversts overtime ti—m thoe —u ghtho suomegh s omecom pcanomiespan amiesortiz ame ortize sales saand commiscommission costssion costs over theover c othentr cacontetrdac tertem.d ter Them. b Theig diﬀere big diﬀerence isn thcea its yo thu at you generallygenerally expect expect ARR to ARRconti to cnuontie bnueyoe bndeyo the indn the iitial ncitionatrl cacont trtermact .term. 2020 2020

SubsSucription Ebscription Econocmonoics: m ics: How HoRewcurri Rencurrig Revenng Revenue Changes Everythinue Changes Everything g That’sTh wahyt’s wwehy d owne’ td mona’tcht m saatchles saandles ma andrk maetinrkgeti ton currentg to current ARR. ARRWe ti. We e tie it to a it to verya iverymport imaportnt maetricnt m: etricyour re: your recurrincgurri proﬁt ng proﬁt marginma. rgin. Recurring Profit MarginRecurring Profit Margin Your Yrecouru rrirecngu rriproﬁtng proﬁt margin ma (RPM)rgin (RPM) is sim isply sim theply dtheiﬀere diﬀerence bnetcew beeetn ween your yorecuurrir rencgurri reveng nurevees nuaneds yourand yourrecurri recurring consgts co. Its’sts your. It’s yourARR mARRinu ms inus your CyoOGur SC, OGR&DS,, Ra&ndD ,G a&And, G bu&At b, bueforet before the spe thend spe onnd sa olesn saanlesd ma anrdk maetingrketing. . In theIn i nthecom ineco stmatee mstaenttem abentov abe, itov’s e$, 40it’s m $40illio mn,illio whichn, w represehich represents a nverts y a very healthy heamalthy rginma. rgin. This isThis the is number the number that fundsthat funds growth. growth. As long As longas your as yoursubscription subscription companycompany has ahas positive a positive RPM, RPM, you canyou choosecan choose between between growth growth and and proﬁtabilitproﬁtability. If youy. If spendyou spend less thanless thanthe RPM,the RPM, you’ll you’ll grow grow less, less,but be but be proﬁtablproﬁtable. If eyou. If spendyou spend more more than thanthe RPM,the RPM, you’ll you’ll grow grow mor emor, but e, but lose monelose money. y. RPM RPMis als ois hugelyalso hugely import imanportt wanhent w ithen co mit ecos tom efsu tureto fu btureudget bud agetlloc aalloc-a - tion. tioIf n. If you you start sttheart ye thear yewithar wa ithﬁxe ad ﬁamxedount am ountof ARR of, ARRthen, thenyou’ llyo knou’llw know whatw yohaut cyoanu scpenan dspen on dCOG on SCOG, R&SD, , Ran&Dd, G&Aand G&Ain or diner or toder arrive to a rriveat a at a speciﬁspecacllyiﬁ dcaellysire dde sRPMired .RPM Rem.e Rmbemeermb, thiser ,is this a forw is a aforwrd-lookiard-looking stanteg mstaetentm. ent. Now Nowwhat w’s htheat’ sn theum bernum thatber d thaticta tedicts howates muhowch mu yochu ca yonu s pecann dspe onn sdale ons sales and manardk metiarngketi? Thisng? iThiss another is another num bnuerm thatber yothatu wo yonu’ two ﬁnnd’t o ﬁnn dthe on in thecom ine come statemstateent,m beunt itt, b’su ht itugely’s hu importagely important. It’sn yot. Itu’sr growth your growth eﬃcie eﬃnccyie inncdeyx i.ndex. Growth Efficiency IndexGrowth Efficiency Index Let’s Lsetay’s yousay speyound spe $1nd m $1illio mn illioonn s aolens, s amales,r kmaeting,rketing, and candusto cmusetor mer successusc — cesins — otherin other word ws, oryourds, youreﬀort eﬀorts intens idn tento grod tow gro neww bneusiwn besusis,n froesm s, from new ncueswto cmuserstom orers ol d.or Hoold.w Homawny ma nenyw nerecwurri rencgurri revenueng revenue dolla drsoll doearss does that bthatuy yo buyu you? ? This isThi yours is yourgrowth growth eﬃcie eﬃciency inndcyex in (GdEexI) .( YGoEuI)r. GYoEuI tellsr GEI yo tellsu you how homuwc hm youcu’hll gro you’ll grow. w. GEI isG cEaI lcisu claatelcudl aaste grod asw groth ewxpeth nexpese/nnewse/ nAewCV. AIfC yoV. uIfr yoGEuI ri sGE greI isa tegrer ater than tha1.0,n yo 1.u’0, reyo cu’urrentlyre currently spen dispengn dimnoreg m mooren eymo onney ne own nebusiwn besusis nthesan s than you’reyo tu’akingre ta kingin. If inyo. uIfr yoGEuI ri sG leEIs iss thleassn th1.a0n, you 1.0,’ reyou spe’rend speingnd leingss thleassn than you’reyo tu’aking inre taking in, whic, hw ishi clech aisrly clea agoorly a dgoo thindg thi. ng. EﬃcieEﬃcient subnts csriptioubscription comn pcoanmiespan naiestu rnaallytu rtaallyrget ta arget GE Ia of G E1I.0 of or 1 .0le ssor, less, thoughtho initiugha initilly theally cothest coof snt ewof nsaewles smaalesy mabe yhighe be higher, as ther, as ctheom pcaonmy pany 2121 2121

Chapter Chapter 1 1 investsinvests in a ciqnu airicnqgu iristrateging strategic cusctomer customers whos swhoe revese nurevee, nuande, proﬁtand proﬁts, s, won’two bnuild’t b uuildntil ulantertil layeterar s.ye Naoters. N thoteat ththeat grethea tergre atheter GtheEI, theGEI , lethess less eﬃcienteﬃcient the c theom pcanomyp isan ayt aisc tauat allyct uagrollyw groingw itings sa itless — sale js —ust the jus toppo the opposite site of whatof what you’d you ex’dpe cetx.pe A clot. wA GloEwI meGEansI me thansat thfora tthe for samthe esam numbe number of er of dollars,dollars, you’ll ge youn’ll geeratener moreate more sales sa, andles th, andat’ ths a agoodt’s a good thing thi. ng. In theIn stheubsc sriptioubscription incnome inc omestate mstaetentm abenovt abe, ovyoeu, hyoaveu haa vere cua rrinrecug rring proﬁtproﬁt of $4 of0 m $4illio0 mn illioon na begion a nnbegiingnn ARRing ofARR $1 of00 $1 m00illio mn.illio Don yo. Duo t yoakeu thtae ke the $40 m$40illion m illionoﬀ the oﬀ t atheble t aanbled b aooknd b itook as proﬁtit as proﬁts? A 40s? %A a40n%nua anl proﬁtnual proﬁt mar ma-r - gin isginn’t bisand’t. Thebadn. The aganin, a gyoaiun, w yooun ’wt seeon’ tas see muc as hmuc grohw groth asw thyo asu w yoouu lwd oif uld if you re-iyoun vestere-invested in yod inur nyoeuwr reve newnu revee gronuew th levers. growth levers. Instead, let’s be bullish and invest $30 million back in sales, marketing, Instead, let’s be bullish and invest $30 million back in sales, marketing, and cuandstomer customer succ essus—iccenss—i othern other words w, orgrowthds, growth. With. Witha GE Ia of G E1I. 0of, yo 1.u’0,l l you’ll book $30 million in net new annual contract value over the course of the book $30 million in net new annual contract value over the course of the next yeneaxrt ye, leaavir, nlega you vingw you ith w$12ith0 m $12illio0 mn illioin ARRn in . ARR. ACVACV AnnuAnnal counaltract con tractvalue v (aAluCeV) ( AisC reveV) isnu revee bnuroeu ghtbro uinght by i nne byw cusnewto cusmertosm, ers, or cuorstomer customers upgras udpgraing dorin reg nore wreinngew theiring theirexisti enxgis ctiontrng cacontrt. Itac correlt. It caorreltes ates to a bookingto a booking, in whi, inc hw ahi cuchs toa cumserto cmomerm comits tom itspes tond speingnd a isnpeg ac iﬁspec acmiﬁocun amt ount of moneyof money with w a coithm a pancomy.pany. The kTheey d kiﬀerenceey diﬀerence is tha its ath baookit a bnookig inn ag subs in a criptiosubscription mond elm oisd goiel ins g going to addto to add that to repeatithat repeating revengnu revee snutreeam, stre wam,here washere onase-ti omne-tie bmookie bnookigs dno gs do not not. The beauty of subscription businesses is that they get the bulk of . The beauty of subscription businesses is that they get the bulk of their theirACV fro ACmV frotheirm theirexisting exis ctinglien tc baslienet basupgre adupgringad toing better to b etterservi cseervis. Bucet s. But you should also invest in sales and marketing to drive new ACV, because you should also invest in sales and marketing to drive new ACV, because in combination with upselling, this increases your ARR. in combination with upselling, this increases your ARR. Future GrowthFuture Growth If youIf r youun this run play this yeplayar overyear overyear, yeyouar’,re you gro’rew groingw biyn g20 b%y 20annua% annually as lly as long longas you as m youain mtaainin anta ieﬃn ancie eﬃntc GEienI tr aGEtioI r(ifatio yo u(ifr yoGEuI ris G leEssI is th leanss th1.0an, yo 1.u 0, you growgro evenw even more). m ore).And wAnhedn w thehen time the timecome cos tom eﬁsna tolly ﬁ nastallyrt tsatakirtn tga proﬁtsking proﬁts, , you’re workiyou’re working oﬀn g oﬀof a muc of a much biggerh bigger recurri rencug reverring revenue snutree amstre. am. NoteNote that thithats isthi as basis aic bas overvieic overview of wthe of bus thei nbusessi nmeodelss m.odel There. There are are otherother factors factors at play at: playtota:l totaddalre adssabdrelessab malerk maet, one-tir m ket, one-tie samlees saandles c andosts costs impaimpcts, athects eﬀects, the eﬀects of ch ofur cn houn Grn EoI. I’n GmE sI. I’immplifyi simnplifyig forn cgl forarit cy.larity. 2222 2222

SubsSucription Ebscription Econocmonoics: m ics: How How Recurri Rencurrig Revenng Revenue Changes Everythinue Changes Everything g The Beauty of Predictable RevenueThe Beauty of Predictable Revenue The bTheroad berro adpoiern tpoi herent hereis th aits prethadt ictpreabdictle abrevenle revenue streueams stre camsreate cre a ate a compoucomndpouingnd groingw groth eﬀectwth eﬀect. That. ’sTh whyat’s awhy doll aa dollr thaatr ath saubt ascription subscription com co-m - panyp baringsny brings in is typic in is typically conallys iconderesidd ereto bde to w orthbe w uorthp to u sipx to tim siex sti asm emus asch much as theas d theolla dr ollbroughtar brought in by i na bcoym a pcaonymp thanyat getthast getmoss tm ofo sitts of m itoneys money the the old waolyd, thwaayt, iths, upfrontat is, upfront. Havi.n Hga thvinagt stthaablet st plableatfor plmatfor of mrec ofurring recurring revenu revee nue also aallolsow asllo forw sa llfor sort alls sortof csre ofa tivecre aativend loanndg-ter lonmg-ter thinkingm thinking, inste, adinste of ad of scrambscrling over ambling over day-to-daday-to-y isdasuesy is.sues. CompCoaniempsa aniere su asingre u ssingubs criptionsubscription mod elmso todel asttra to catttra andct k andeep kcueepsto cumstom- - ers loernsg loterngm, ter constm, caonstntlya addntlyi naddg minoreg m aorend manored m servicesore services that thatcrea tce reate morem revenore revenue opportue opportunitieusnitie as wells as wellas a amores a more cohesive cohesive relation relastionhip, ship, thusthus d dramarticamaallytic reallyduci rendguci theng potethe npotetial nfortia lchur for nchur. Alln of. All these of these factor facs tors contricbontriute btoute s ubtoscriptio subscription valun avtioalunastio thnast thareat muareltiples multiples of tr adof itiotradnaitiol nal product prodcompuct caompniesa. nies. A decAad deec froadme fronomw , neocwon, eocmoinstosm wisillts look will lookback bacandk saanyd th saayt sthtoactki sntog cking shelveshelves ands hopi and nhopig cunsgto cmuserstom buyers wa buys a wa 20sth- a 20centuryth-century busine busssine mossd elm. odel. CompCaoniesmpa wniesill m weilla smureea ssuurecc esusscc notess b noty c obuynting counting how homanw yman proyd uprocts ducts they theysell b sell ut bby hout bwy ho mawny ma high-vny high-value, amluoen, thlymon suthlybs csuriberbscsriber they hs they have. ave. Implications for EntrepreneursImplications for Entrepreneurs In orIdner or toder s uctoc eesucd cieen dto idan yto’sda suyb’ss csuriptionbscription econ ecoomyn oyoumy hyouave htao ve to be abblee abto lesell to, masellr,k maet, raknetd, daelivernd deliver base dba osen da oclen aar cleunadrerst undanderstinandg oif ng of custocmuser tobmeher abvior ehabvior y doingby d oingthe follo the followingw: ing: • Pulling the right levers.• Pulling the right levers. Instead of SKUs and purchase orders, Instead of SKUs and purchase orders, you’re going to have to think about growth eﬃciency, churn, you’re going to have to think about growth eﬃciency, churn, and recurring proﬁt margins. And you’re going to have to be and recurring proﬁt margins. And you’re going to have to be maniacally focused on growing your ARR.maniacally focused on growing your ARR. • Relentlessly learning.• Relentlessly learning. Netﬂix looks at millions of plays a day, Netﬂix looks at millions of plays a day, including when you pause, rewind, and fast-forward, as well as including when you pause, rewind, and fast-forward, as well as user ratings, searches, geolocation data, viewing times, device user ratings, searches, geolocation data, viewing times, device information, and social media feedback. What are your user information, and social media feedback. What are your user plays? How are you learning?plays? How are you learning? • Creating an amazing subscription experience.• Creating an amazing subscription experience. Overnight, Overnight, Tesla magically gave its cars autonomous driving capabilities. Tesla magically gave its cars autonomous driving capabilities. Overnight, Apple magically gave its phones voice recognition. Overnight, Apple magically gave its phones voice recognition. 2323 2323

Chapter 1 What’s your magic? How do you happily surprise your customers on a regular basis? I hope I’ve mapped out the fundamentals of subscription economics, but all of this, of course, is just the tip of the iceberg. In the next chapters, you’re going to learn the basics of SaaS sales and marketing: segmenta - tion and hub strategies, sales and marketing alignment, growth funnels, content marketing engines, and much more. All of this information is vitally important, but never lose sight of your north star — ARR. 2424