As technology companies transition to a subscription-based economy, they may observe a decline in traditional product and service revenues. However, this shift also presents a promising opportunity for future profitability. Companies can navigate this evolving landscape by embracing as-a-service offers and potentially thrive. 

The landscape of technology sales has become challenging, with low growth and low-margin outcomes. It’s not just your company; the data shows that even born-in-the-cloud computing companies often grapple with profitability despite enjoying double-digit revenue growth.

The TSIA Cloud 50 Index, which tracks the performance of 50 of the largest cloud companies based on publicly accessible data, highlights this trend. So, how can your technology company get back on track to profitable growth? TSIA’s recommendation is clear:

• Embrace as-a-service offers, as this is where the revenue is shifting.
• Focus on business outcomes rather than feature functionality, which is becoming commoditized.
• Develop a customer engagement model that cost-effectively drives adoption, expansion, and renewal of your offers, addressing a common failing point for many tech companies.

This blog will explore the economics of shifting to profitable subscription offers and explore recurring SaaS revenue strategies. This blog will cover the following:

• The Challenges of As-a-Service 1.0
• Building a Profitable Subscription Business Model
• Your Key Takeaways
  

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The Challenges of As-a-Service 1.0

Many cloud computing companies need better profitability because they focus solely on market share and top-line revenue growth. To dominate the market, “as-a-service” technology providers heavily invest in sales and marketing to attract customers. The prevailing belief is that the platform with the most customers will eventually be profitable.

This belief is often illustrated by the “wedge model,” frequently referenced by consulting firms and industry analysts when discussing the cloud business model.

Related: The Year of Profitable SaaS

The Wedge Model Explained

The wedge model’s idea is simple: A cloud provider must spend money to build a platform and acquire customers. As the customer base grows, revenues will eventually surpass expenses. While cloud companies are increasing their top-line revenues, they need help to become profitable. For example, despite having been public for over a decade and generating over $10 billion in revenue, Salesforce still needs to turn a profit consistently.

Contrast this with Oracle’s history. When the company went public in 1986, it was already profitable, with $55 million in revenue. It continued to grow its revenue to over $500 million within four years, maintaining quarterly profitability. Today, Oracle generates an operating profit north of 40%.

Several key pressure points affect the current subscription-based business models:

• High spending on sales and marketing
• High vulnerability to customer churn, impacting growth and profitability
• Difficulty securing multiyear contracts without significant discounts
• Eroding gross margins due to higher-than-expected service costs
• Overall pricing pressure on subscription prices
• Giving away or heavily discounting services creates a profit drag
  

These challenges are significant but solvable. However, many companies make a critical mistake: They offer “all-in” services supported by legacy sales and service models, exacerbating profitability issues. You must fundamentally rethink your economic engines and operating capabilities to overcome these challenges. Doing so allows you to break through the current industry conundrum and achieve sustainable profitability in the subscription-based economy.

Related: The REAL State of Profitable SaaS

Building a Profitable Subscription Business Model

To overcome the common pitfalls of an as-a-service business model, you need to follow a few guiding principles that will shape a profitable subscription business model:

• Wrap premium annuity services around core subscriptions: Adding premium services to your core technology subscription will boost revenue and margins.
• Utilize consumption analytics: Your product platform should provide insights into customer usage. These analytics enable cost-effective strategies for customer retention and account expansion.
• Adoption services are essential: Leveraging consumption analytics, these services will help retain and expand accounts. Some services will be monetized, while others will be offered for free to monitor and accelerate product adoption.
• Expand selling through customer success: Focus on expanding sales through the customer success organization for long-term profitability. This approach is more cost-effective than traditional direct sales and should underpin most of your revenue generation. Lower customer barriers to entry and adopt systematic approaches to account expansion.
• Profitability of project-based services: Ensure they are profitable or eliminate them.
  

By adhering to these principles, your subscription model will differ significantly from the current one, where 90% of a cloud company’s revenues come from an 

“all-you-need” subscription price and only 10% from additional services. Profitable cloud companies will monetize value-added services, creating a more balanced revenue mix.

Revenue mix for profitable SaaS:

• Premium annuity services
• Project services
• Transaction services
  

The margin profile of these revenue streams will be crucial for sustainable profitability. While core subscription margins may decrease due to competitive pricing, the margin dollars from profitable annuity, project, and transaction services can offset this pressure.

To drive profitable growth in the cloud, you must diversify your economic engines and adjust your cost structure.

Transitioning to a subscription-based economy presents challenges and opportunities for your technology company. While traditional product and service revenues may decline, embracing as-a-service offers can position your business for future profitability. You can build a sustainable and profitable subscription model by focusing on business outcomes, leveraging consumption analytics, and expanding through customer success.

Related: The Journey to a Profitable SaaS Business Model

Your Key Takeaways: 

• Embrace as-a-service offers for growth: Transitioning to as-a-service offers is essential for your technology company. This shift allows you to adapt to the changing landscape and positions your business for future profitability. By adhering to these principles, your subscription model will differ significantly from the current one, where 90% of a cloud company’s revenues come from an “all-you-need” subscription price and only 10% from additional services.
• Leverage consumption analytics: Consumption analytics can help you understand customer usage patterns. This insight enables you to implement cost-effective strategies for customer retention and account expansion, driving long-term success.‍
• Focus on Customer Success: Expanding sales through the customer success organization is a cost-effective way to boost revenue. By focusing on customer outcomes and systematic account expansion, you can create a sustainable and profitable subscription model.