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If your enterprise software brings revenue it is worth a lot more than if it just cuts costs – the revenue model shift from Subscriptions to Transactions June 4, 2014

Posted by Bernard Lunn in Corporate Strategy, Enterprise Sales, SAAS, start-ups, Strategy Workshop.
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Historically, the objective of enterprise software was to make employees more efficient by automating tasks. The software industry moved from cutting G&A costs to making people at the front line more efficient through software such as CRM, Marketing Automation, Business Process Management and Collaboration.

In all cases, the business model was licensing. The licensing model moved from perpetual to periodic (monthly or annual). Seen in this context, SAAS is just an evolution of the old licensing model (plus bundling the hardware into the price). Consumerization of software is a natural response to the risk/reward shift of periodic pricing in SAAS. When vendors got all the money upfront, they could afford an expensive sales process. SAAS shifted the risk to the vendor who got investors to fund the cash flow gap. Investors were happy funding that cash flow gap because periodic SAAS revenue is more predictable and therefore more valuable. To reduce the cost of sale and therefore minimize dilution, entrepreneurs created consumerized services and Freemium.

That about brings us up to date.

So, what’s next?

What’s next is usually an evolution when it comes to enterprise. There may be a disruptive 10x technology shift driving the change, but big companies tend not to make big disruptive shifts. There are exceptions of course, the most famous being Intel’s shift into semiconductors under Andy Grove. That is such a compelling story (told in Only The Paranoid Survive) and so many enterprise executives reference it in glowing terms that we can easily believe that it is the norm. It is not the norm; it is “more honored in the breach then the observance”. Enterprises have built-in inertia, because senior managers are incentivized to optimize short-term profits.

The next iteration will continue the risk/reward shift that was started by SAAS. This will change the revenue model from licensing to % of transaction/revenue (in any shift we see hybrids of old and new so many ventures will mix subscriptions with transaction revenue). I am observing a few innovators who are combining digital consumer marketing techniques with selling a partnership model to enterprise. This is where the puck is going. These ventures get their revenue from a % of the transaction/revenue. This is obviously highly scalable. These ventures take on more risk and have to generate more value before they get paid, but if they can get there they have great scalability and moat.

The idea is simple. You create a consumer service and get enough users that you prove the proposition. Then you scale by partnering with enterprises. One way to look at this is as a technique for crossing the chasm. You can easily find early adopters online. (I say easily, it is of course not easy, but the techniques for doing so are well understood and documented). However, scaling beyond that is hard. Only a tiny % of ventures, blessed with great virality and addictiveness, cross the consumer chasm. As always exceptions (such as Facebook) prove the rule while blinding us to the rule with their brilliance. Many other ventures will cross the chasm by partnering with enterprises. One reason that enterprises are so big is that mainstream consumers trust these large enterprises.

If you prove the proposition directly with consumers you have created a lot of value. You can exit at that point. You can sell to a company that can cross the chasm to the mainstream consumer. Or you can partner with the enterprises that have access to those mainstream consumers in a shared revenue model and scale to become a large enterprise. You will typically be making one or more of these propositions:

  1. Get more revenue from their existing customers. You are accessing their customer base and they are using your service to get extra revenue from those customers.
  2. Bring them new customers. This is where the big $$$ prize lies. If these new customers represent the early adopters, the enterprise will be worried that eventually their mainstream customers will “see the light” and want to switch to your model. If they see that they will buy you for a big premium or partner on terms that are more advantageous to you; in this situation you have real clout.

You can create these partnerships on a white label or co-branding basis. Obviously you get higher margins if you get co-branding. There is a spectrum of co-branding. The more traction you have with consumers, the more clout you will have in those co-branding negotiations. Once again, Intel was the thought-leader, with their Intel inside campaign. These negotiations are fundamentally about “how big is my logo vs your logo?” Screen real estate is precious, so this matters. If you have 1 million consumers and the enterprise has 1 billion consumers you have reasonable clout if your 1 million represent early adopters and they can see their 1 billion moving to your model at some point. If you have only 1 thousand consumers, you will be limited to offering a white label service.

Back in the days of the Dot Com Boom/Bust era we saw the concept of B2B2C. Like many concepts from that era, it is easy to ridicule this one, because it did not happen then. That may simply be related to the % of people online. Now that more than 50% of the global population have mobile phones, the concept of tiny ventures getting millions of consumers directly is no longer a pipedream. However it is not wise to ignore the power of the incumbent enterprises. Rather one should get enough traction with consumers to have some clout when negotiating revenue sharing partnerships with those enterprises.