(There's No) Accounting for the Subscription Economy

It's taken over 10 years to get the idea of the subscription economy into our noggins, nevertheless we've barely started internalizing what it takes to support it and report on it as a business. Wall Street types are very accustomed to companies selling products to put it more exactly than subscriptions. Subscriptions have a mixed bag of revenue recognition ideas that challenge the status quo

The subscription economy from previous posts

You may remember the subscription economy from previous posts. It's one way to make sense of cloud computing and the many new and very different ways of doing business on the Internet. We're most familiar with Software as a Service and how different it is from conventional licenses; so familiar, to tell the truth, that I don't need to describe it for you here.

But subscriptions as a way of doing business are just about everywhere; they're not just in tech anymore. To illustrate, if you want, you can get your clothing as a subscription, and not only that however men have sites dedicated just to them. You know the trend has arrived when something like men's clothing is available as a subscription.

Nonetheless, we've so so glossed over everything below the waterline in this new approach to business. It's taken over 10 years to get the idea of the subscription economy into our noggins, nevertheless we've barely started internalizing what it takes to support it and report on it as a business.

The financial analysts

The financial analysts and other Wall Street types -- whom I have thoroughly nothing in common with -- are very accustomed to companies selling products in other words than subscriptions and collecting the money net 30 or whatever and moving on to the straightway opportunity. Subscriptions have a mixed bag of revenue recognition ideas that challenge the status quo significantly. Product companies don't have much when it comes to reliably forecasting future revenue streams, however subscription companies are just bristling with information. Take the Salesforce revenue numbers from last week's revenues call as an illustration, and here is where I am indebted to Tzuo for his insights:

If you are reading this, you have for the time being an intuitive understanding of revenue, however deferred and deferred and unbilled revenue deserve explanation, because who in effect cares about unbilled deferred revenue -- isn't that complete vapor?

As Tien Tzuo said to me, think of it this way: You do a deal with a company in which you agree to supply your service for three years for $36,000, or $1,000 per month, and you agree to invoice once annually, in advance, for $12,000. At the very beginning, at the time, you have $24,000 in unbilled deferred revenue and, since you bill in advance, you as well have $11,000 in deferred revenue and $1,000 in real live revenue which you can recognize.

This $1,000 is as well known as "MRR," or "monthly recurring revenue." Theoretically, if you add up all the MRRs on the books you can get very close to the forecast for the quarter. However there's as well an upside opportunity that you'll sell something else. If you do and you invoice for it, you'll add to that pile of money. Unfortunately, there is as well a opportunity that some of your MRR will go away either because the customer quit or because they didn't renew or whatever. We know this as "churn," so you as a matter of fact need to discount the MRR by the churn rate to get a better sense. Life would be simpler if we could all agree on using a metric called the "annual recurring revenue," yet curiously, ARR doesn't exist but.

So, all this has the potential to drive Wall Street types nuts. They're good with the $1,000 in MRR, and they can tolerate the $11,000 in deferred revenue because it's in hand, and the $24,000 in unbilled deferred revenue is sort of OK because there's a contract in place that defines the annual billings. Yet this does have one effect that many financial types like -- it smoothes out the revenue stream for months in advance. Bookings might fluctuate, nevertheless the monthly revenue stream should be or rather predictable.

Today, the quarterly incentive is largely gone due to monthly recurring revenue, nevertheless people nevertheless obsess over bookings. What if bookings go down for a few months? The logical answer is that future revenue would in the long run feel it, yet it's evenly true that bookings could recover previously real revenue took a hit, in which case the fluctuation in bookings would not be seen. Call it seasonality.

Let's summarize all this. Salesforce has $1.38 billion in deferred revenue, which I presume will be realized in the then 12 months. While that time they are advising us that the company will have earnings of between $2.92 and $2.95 billion. This means that they have about 47 percent of at once year in the bank. They as well have $2.2 billion in accordance with contract to be invoiced, and some of this invoicing will be done at some point beyond the at once year. In the last quarter, Salesforce had $632 million in revenue, which grew at 38 percent year over year. At some point in the next twelve months, Salesforce could have a quarter in which it books revenue of $750 million, which would give it a forward-looking run rate of $3 billion.

Uphill battle explaining revenue recognition

It's for all that an uphill battle explaining revenue recognition and the difference between conventional companies and subscription companies, however at least there's a lot of black ink to do it with.