Monday, February 4, 2008

Confusing revenue recognition with SaaS

There's an article in Seeking Alpha today RightNow proves "Software as a Service" isn't perfect - but as often the case the article confuses the revenue recognition model with the service delivery model.

Joe Panettieri is right - SaaS has had been advertised as immune to downturns - but this is only the case if it is pure SaaS - that is both the delivery AND the revenue recognition are treated as subscription (see my primer on revenue recognition here).

RNOW is going through a tough revenue transition. For years they had billed themselves as a SaaS vendor because their service was on-demand (ie. hosted at a data center and accessed via the web), but in reality they were selling perpetual licenses. While unlying growth was strong this was not a problem but last year RNOW decided to start to change to subscription licenses - which would certainly help them compete with Salesforce who have been subscription all along - and which are popular with customers in tougher times.

Now, as I would have predicted, the market demand for subscription has increased beyond their expectations - as the Susan Carstensen says in their earnings transcript "We now know that the market is moving away from perpetual licenses, even faster than we had anticipated. We've seen it in our results and in our pipeline. To give you a good idea of how fast it is happening, compare the full year 2005 to 2006. While our bookings grew 50% and recurring revenue grew 38%, perpetual sales were flat. The trend was particularly evident in the fourth quarter as more and more customers selected the subscription option. We believe this is a direct result in the market's accelerated adoption of on demand especially among large enterprises."

I am very sympathetic to how hard it is to steer Wall St through this transition. Having been through it at my previous companies, and having made the decision that FirstRain would be 100% subscription from the time I took over, I am very aware that the Street still misses the forest for the trees. When you transition your revenue model it creates the appearance of slowed growth, but in reality it may have nothing to do with real growth (customers, annual future revenue commitment) and everything to do with you stopping to practise of taking revenue up front. I've blogged on Cadence's challenges here as they've done the opposite recently and are now paying the price - and Salesforce and Synopsys both now enjoy the incredible revenue visibility that comes with 100% ratable models - even though Synopsys is not SaaS.

Good for RNOW that they have the courage to make the move to 100% subscription and take their lumps.

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