Benefits of Productized Services

Here is a list of benefits of productized services for companies that sell cloud-based software to business customers (e.g. Salesforce, Workday).

1.    Reduce customer concerns related to implementation costs. Mid-tier customers view the open-ended hours based cost model of consultants as a risk, which creates friction in the sales cycle. However, they view fixed-cost packaged services as less risky. Packaged services will reduce the sales cycle and increase pipeline velocity, resulting in lower customer acquisition costs.

2.    Easier to train employees. Packaged services are more defined, and as a result, training employees who deliver packages will be more defined so training employees will take less time. As a result, training costs will be lower and utilization rates will increase, which will contribute to higher margins. Furthermore, it may be possible for less expensive resources to be used, which will further contribute to margin expansion.

3.    More efficiently deliver services at higher quality.  Packaged services are repeatable and less variable. Employees will more quickly move up the learning curve increasing efficiency.  In some cases, automation tools may be used, which will further increase efficiency. Increased efficiency will positively impact margin. Improved efficiency will also enable more consistent delivery of services at a high quality level, resulting in more satisfied customers.

4.    Increased renewal rates. Mid-tier customers, who avoided traditional hour-based consulting due to concerns about cost and ambiguity of value, will purchase packaged services. This increases the likelihood that these customers fully take advantage of the services and achieve a higher level of success. As a result, renewal rates should increase.

5.    Increased service revenue. Packaged services should result in a higher attach rate if targeted at customer segments that currently don’t purchase services, as a result, overall service revenue should increase. However, cannibalization of existing services needs to be taken into consideration. I will address cannibalization in a future post.

6.    Revenue Recognition. Revenue recognition for packaged services that are not priced as a subscription and delivered over time can be recognized immediately, resulting in increased short-term revenue. However, cloud-based companies are viewed favorably due to their predictable revenue, and care must be taken to ensure increases in short term revenue recognition don’t result in unacceptably higher likelihood of revenue variability.

7.    More predictable demand. Demand for productized services are more predictable allowing better matching of demand to resource supply, which result in a higher utilization rate. This will improve overall margins.

8.    Higher margins for services. Many of the benefits described above, such as, higher utilization rate, increased efficiency, reduced training costs, and lower customer acquisition costs, will contribute to margins. Packaged services can further enhance margins by leveraging value based pricing where hourly priced services tend to use cost plus pricing that result in lower margins.

There are a number of addition issues to take into consideration when productizing services, such as, risk of cannibalizing of existing service revenue, and impact on partners. I will address these issues in a future post.

 

Related posts coming soon:

1.    Mitigating risks associated with productized services

2.    How does product management contribute to productized services?

3.    Ideas for productized services and increasing customer success

SaaS 101

This post introduces basic concepts behind the SaaS (or Cloud if you prefer) recurring revenue business model. The purpose is to provide a basic understanding of key performance metrics that drive a SaaS business and as a foundation for future posts covering more in-depth topics. Initially, I’m going to keep things really simple. We’ll cover Customer Acquisition Cost (CAC) and Customer Lifetime Value (LTV).

Basic SaaS Metrics:

• MRR – Monthly Recurring Revenue 
• ACV – Annual Contract Value (Bookings)
• OTR - One Time Revenue (One Time Bookings) 
• Churn – Lost MRR Revenue or ACV (%) 

MRR & ACV

Monthly Recurring Revenue (MRR) is the revenue a customer pays per month for access to a service. Annual Contract Value (ACV) is the value of a signed contract over a year. So, if a sales rep signs a 2-year contract for $100k, the ACV is $50k, while the Total Contract Value (TCV) would be $100k.

One Time Revenue

One Time Revenue (or One Time Bookings) is non-recurring revenue. Common examples typically involve services like set-up costs, integration, etc. At Delve, we had several services that fell into this category. Here are a few examples:

• Video Migration – Migration of video from the where the customer to Delve platform in the cloud. This involved uploading video files, encoding each file into different video formats and bit-rates, and handling pre-existing meta-data. We charged based on the number of videos migrated.
• CDN Connection Fee – If a customer wanted to use his or her own CDN contract from a different vendor then we charged them a connection fee.
• Video Player Customization - We would customize the standard video player based on a customer’s requirements. We had a Basic Customization option that was capped at 20 hours and an Advanced Customization option, which was based on the total number of hours.

These can be thought of as packaged services or “product-ized” services. They are recognized as revenue in the month they were delivered.

These services are often viewed as a form of sales enablement that not only helped close the deal but also increases sales velocity by reducing the sales cycle.  Reducing the sales cycle is important because increases the efficiency of your sales team, which the customer acquisition costs. Customers who used these services tended to be more satisfied. There services also made the Delve sticky by increasing switching costs. 

Churn

There are different types of churn:

• Customer Churn - A customer fails to renew her contract. This results in complete loss of MRR for this customer. 
• Feature Churn – A customer renews her contract, but chooses an edition of the product with fewer features, which results in lower MRR for this customer.

For example, Delve included basic analytics in the Standard Edition butmore advanced analytics came with the Enterprise Edition. If a customer concluded there was no value in the advanced analytics they might still renew but for Standard Edition. The customer isn’t lost, but there MRR is reduced.

How Churn Hurts

To start with a simple example, let’s take a company that starts off the year with $1B in MRR and compare the negative impact of churn at 2.5% and 5% over the course of 12 months without taking anything else into consideration. 

• Churn of 2.5% reduces $1B MRR to $738M MRR by the end of the year. 
• Churn of 5% reduces $1B MRR to $540M MRR by the end of the year

That 2.5% difference in Churn, which might not seem like much, results in an additional loss of 26.8% in MRR. In order for MRR to stay constant over the course of a single year the lost MRR with with new new customer bookings (ACV). Early on the difference isn’t significant, but as a company scales, mitigating churn with new customer bookings will become increasingly difficult.

MRR Expansion

MRR Expansion can be thought of Good Churn (or Negative Churn) where MRR instead of decreases. There are a few basic ways to achieve MRR Expansion. 

Usage Expansion 
Revenue increases as a result of a customer’s increased usage of the product. In the case of Salesforce Sales Cloud this could be adding additional seats. Dropbox charges more per month as the volume of storage increases. At Delve, we charged more based on how much video was streamed.

Up-Sell 
Customers are sold an enhanced version of your product with additional benefits. For example, a customer upgrading from the Professional Edition to the Enterprise Edition to take advantage of additional features like Custom Application Development or Salesforce Identity. An Up-Sell doesn’t always have to be about new features in the product itself. Instead, it could be purchasing a higher quality of service. For example, upgrading from Salesforce’s Standard Success customer support to its Premium Success customer support package.

Cross-Sell
Customers are sold an additional product. So, sticking with Salesforce as an example, this would be selling a customer Work.com or Data.com after they’ve  purchased Sales Cloud.
This can be very attractive for a company with a large installed base.The rational is that is costs more to acquire a new customer than to sell an additional product to an existing customer.

Increasing ACV

All three of the methods for achieving Good Churn (Usage Expansion, Up-Sell, Cross-Sell) can also increase the ACV when initially signing up a customer. For example, at Delve our sales reps would often attempt to up-sell a prospect from the Standard Edition to the Professional Edition if she felt it would better meet the customer’s needs.

Net Bookings

Net Bookings = New Bookings(ACV)+Expansion Bookings(ACV)+One Time Bookings – Churn(ACV)

Here is an example for Net Bookings using Salesforce Sales Cloud:

New Bookings 

• 1 new customer, ABC Inc., who purchased Sales Cloud Professional (@ $65/month/user) for its 10 sales reps 
• New Bookings = ACV = $7,800 ($65 * 10 users * 12 months) 

Expansion Bookings

• 1 customer renewal, ACME Corp., renewed their Sales Cloud Professional contract with 5 users and added an additional 10 users. 
• 1 customer renewal, XYZ LLC, renewed their Sales Cloud Professional contract with 10 users and upgraded from Standard Success support to Premium Support (20% add to ACV). Since Premium Support is a subscription it is spread out of the 12-month term of the contract.
• Expansion Bookings = ACV = $9,360 = [($65 * 10 users * 12 months) * 1.20] 

One Time Bookings = $0 

ACV Churn 

• 1 customer lost, WOW Corp., failed to renew their 10 user contract for Sales Cloud Enterprise (@ $125/month/user)
• ACV Churn = ($125 * 10 * 12) = $15,000

Net Bookings = $7,800 + $9,360 + $0 - $15,000 = $2,160

Ending MRR

Ending MRR = Starting MRR – MRR Churn + MRR Expansion + New MRR

Translating the above Net Bookings example to Ending MRR:

• Starting MRR = $10,000 (MRR from the previous month)
• MRR Churn = $1,250
• MRR Expansion = $780
• New MRR = $650 
• Ending MRR = $10,000 - $1,250 + $780 + $650 = $10,180

Ouch, loosing Wow Corp. really hurt. Despite renewing 2 customers and adding a new customer, MRR barely increased.