Few of us are passionate about crunching numbers on a spreadsheet for a prospective investment, so it’s critical to be able to do some quick calculations to get a sense of your ROI. In the case of subscription management, this can become tricky considering how many moving parts a proper subscription management platform handles. But before we get to the math, the first step is understanding when is the right time to invest…
WHEN IS THE BEST TIME TO INVEST IN SUBSCRIPTION MANAGEMENT SOFTWARE?
Based on our own customer feedback, we found that the typical range for when companies start to run into subscription management pains is between $3M to $7M in ARR. Obviously, this varies for different businesses as it ultimately depends on the volume and complexity of transactions your subscription-based company executes.
In general, we like to say better too early than too late. Transitioning too early does mean you could be paying a little extra in the first half of the year. However, if you’re too late and wait until your company starts running into growing pains, you would start losing revenue at a pivotal time when the company should be focused on sustaining your growth. Plus, at this point, the onboarding process is typically more costly given more accounts and likely a messier system to migrate from. A proactive approach is always preferred to a panicked search for a miracle cure.
THE NAPKIN MATH FOR ESTIMATING ROI
Now that we know it’s the right time to look for a solution, what do the numbers look like? For a subscription management platform, there are 3 major ways it can improve your operations.
1. REVENUE LEAKAGEEY estimates that companies leak 1 to 5% of EBITDA by not having their contract management and account receivables in order. In the case of recurring revenue, this problem is amplified as the issue transforms into recurring revenue leakage. With a centralized monetization platform, this can be vastly reduced as automation and built-in analytics help identify the root cause. Some of the most common sources include: missed upsells, mishandling of contract changes, missed renewals, and incorrect invoices.
Although subscription-based companies are more prone to high revenue leakage due to the aforementioned reasons, we’ll take the optimistic value of EY’s estimate at 1%. In the report, EY also projects a 90% recovery after their program: due to the nature of subscription-based companies, a large portion of leaked revenue is actually recovered from having a subscription management solution since it solves these most common sources mentioned above. To be more cautious, we’ll say 50% of projected recovery can be attributed to a proper subscription management platform.
Assuming a 1% leakage with a 50% reduction in this leakage for a company with an ARR of $10M that translates to an estimate of $50k of revenue recovered in one year:
(.01) (0.5) ($10M) = $50k
Automation means less time spent on billing and subscription management— but more importantly, it means that the process is scalable. Instead of hiring 1-2 new controllers or analysts when your revenue increases from $5M to $8M, your existing finance team can easily handle that growth with an automated billing platform. At a conservative estimate, the average cost of an employee is about $100k, and assume just 1 controller will be enough:
(1) (Average Cost of Employee) = $100k
(Side note: Looking to the future) We won’t include this in the Napkin ROI but further down the line, the volume that a new controller can handle is significantly more with a subscription management platform. This means instead of hiring a 3rd and 4th controller, just one more should keep your financial operations in order.
3. BUSINESS INITIATIVESA subscription management platform is more than just a financial back-end: utilized to its full extent, it also props up your revenue operations. Accurate metrics can fuel all sorts of business initiatives by pinpointing areas of growth in your operations. One of the most common examples of such is pricing: an automated platform permits the company to experiment with pricing models to obtain value-based pricing that maximizes revenue without significantly increasing the workload of your finance department. In other words, the typical trade-off of more time spent adjusting manual financial processes when trying new prices is virtually non-existent. In this report McKinsey published on the power of pricing strategies, they emphasize the importance of advanced analytics:
“In B2B companies, existing analytics capabilities are often not sophisticated enough to create the right kind of pricing opportunity algorithms to cope with the large amounts of data available. Too often, we see managers make broad pricing decisions (e.g. proportional price increases) armed with little more than an Excel spreadsheet.” (emphasis added)
Price increases are already a must to capture your full potential revenue with US inflation at a 40-year high. Understanding pricing in an inflationary period makes things especially more complex: thus, to execute a well-informed pricing model, accurate subscription metrics are necessary to gauge market resistance. With real-time metrics available at your fingertips, we expect FP&A analysts to subsume a model that captures an additional 5 to 10% growth in revenue. Of course, this process takes time to master, usually paying dividends further in the future. Thus, we’ll also use the lower estimate of [5%] and attribute [10%] of that to optimized pricing:
(.05)(.1)($10M) = $50k
FINAL ROI ESTIMATE
Since these are all independent cash flows, we can simply sum up the 3 streams of Revenue Leakage, Headcount Savings, and Business Initiatives. In summation, our projected ROI for a sample company of $10M ARR ends up as:
$50k + $100k + $50k - Cost of System
= $200k - Cost of System
The cost of a subscription management platform varies greatly from company to company based on what features are necessary to maximize your return on investment. As an example, let’s say the cost is about 0.6% of ARR with a one-time implementation cost of 15k to yield a net income of $125k:
$200k - (0.006)($10M) - $15k = $125k Net Income
Even with conservative assumptions, that’s a 67% return on investment for just the first year for a company with $10M ARR.
$125k/$75k = 1.67 ROI Ratio
EXPANDED ROI EQUATION
Here’s a look at the final sum of our 3 categories.
ON COMPANY VALUATION: SAAS MULTIPLES
A subscription management platform can improve your company’s revenue indirectly as well. Integration of a platform typically means the transformation of multiple, disparate data sources into a single source of truth (SSOT) data structure. This means from Sales to Finance to C-suite, all the data is synchronized and processed in one place.
Why does this matter? Operating with multiple sources of truth intrinsically means multiple sources of error — any point where data needs to be transferred is a vulnerability, especially if that involves manual work like importing spreadsheets. As a result, many companies find that their ARR or ACV that’s used in valuation is inaccurate and lower than the true value.
For public SaaS companies, revenue multiples have recently fallen on average by 40% from their 12-month highs with the median below the pre-COVID era. More worrying for private B2B SaaS companies, SaaS Capital estimates the public-to-private valuation discount to have widened from 28% to 50% (i.e. if the public multiples were 10x, it would now be 5x instead of 7.2x). As a result, investors and VCs are tightening their purse strings and intensifying the vetting process: in this market, having predictable, reliable revenue metrics in order and accurate enterprise value can make or break a pitch. A system ensures this and demonstrates initiative in taking control of your subscription-based business.
IN SUMMARY
At the end of the day, the ROI of a subscription management and billing platform is what you as a company make of it. If you are merely looking for a solution for subscription management and automated billing, you’re missing out on how a platform can become central to your revenue process. In the aforementioned McKinsey report, an article on Big Data highlights two critical weak points:
1) “B2B companies tend to manage data rather than use it to drive decisions.”
2) “Implementing new prices is as much a communications challenge as an operational one.”
Making an investment is about improving your company’s future, not returning to the previous operational condition before your company started to run into problems. Organized, SSOT data is there not just to generate metrics but to drive informed-decision making for revenue-generating business initiatives. Features like streamlining Quote to Cash aren’t merely to reduce billing times, they can be used to solve the communication barrier between sales and finance to jump-start pricing growth. I may have only listed 3 avenues to generate a solid return on investment, but your company can take it to the next level by putting in the work to re-imagine and innovate how your organization is run.
