Home » Blog » Subscription Considerations

Subscription Considerations

Software as a Service

When are Subscriptions Right for You?

Are you considering subscribing to software, cloud services or anything these days? Subscriptions are now available for everything from doctors and lawyers as well as software and have invaded almost every industry. From cars to heating and air conditioning, a lower upfront cost and predictable payments drives customers towards subscription.

Subscriptions complicate the evaluation of buy versus rent as they typically include services as part of the model.

  • What is the true value of included maintenance and support?
  • What is the time value of money over the life of the product?
  • How do you know when subscription is right for you?
Unravelling the SaaS puzzle.

What does subscription really mean?

First and foremost, subscription is a rental model. In a subscription you do not own the underlying product. The consumer pays a fixed monthly fee for a combination of products and services for a set term. The services are often referred to as entitlements. These entitlements may be limited to a certain number of hours, miles or service calls per period.

As compared to a lease, ownership does not transfer at the end of the term, so all payments are typically expensed by the consumer and recognized as earned revenue as paid. This treatment does not only impact income taxes, but often excludes a transaction from sales tax. In order to qualify as “recurring revenue” a subscription contract typically requires 3 elements:

  1. Standard contractual terms for all customers
  2. A fixed contract term.
    • Term is clearly defined and may be auto-renewable (i.e.: month to month, annual, or # years)
    • Payments may be up front or monthly.
  3. Use or lose entitlements without carryover to future periods.

HVAC as a Subscription

When our air conditioner dies, we obtained three quotes from three reputable dealers that represented different manufacturers. Although the idea was to get quotes based upon brand, what we received were three different purchase models.

  • Dealer one presented three options based upon quality of equipment.
  • Dealer two offered three options based upon quality of equipment with a 4 year “same as cash” financing model.
  • Dealer three offered their equipment as a service with two options based upon quality of equipment. The price was a fixed amount per month for 8 years. The dealer would maintain ownership of the equipment and would accordingly be responsible for all maintenance costs. A purchase options was offered with an upfront purchase price was similar to dealer 1. A fixed amount was required at the end of the term to buy the equipment or we could enter into a new subscription at the end of the contract.

These three options are financing equivalents to traditional purchase, lease with a buyout option and subscription. These options are available for almost any capital expenditure. Many leases offer buy out options which may incur additional costs based upon usage. In this case, the subscription option was unique in that it offered not only a rental but also, upfront purchase and buyout options during the term and at the end of the subscription.

Subscription Considerations

When evaluating a subscription there are several key factors to consider:

Subscription Term and Product Life

  • In my experience, the subscription terms tend to be considerably shorter than the products life. Software subscriptions tend to be 1-3 years, but the life of an ERP system can be 7-10 years or longer. In the HVAC example above the equipment anticipated useful life was 15 years and the warranty was between 5-15 years depending on the components. Accordingly, you must understand renewal or replacement terms. If you anticipate flipping a vehicle every 3 years for the latest equipment, a subscription shorter than the useful life makes complete sense.

Included Services

  • Almost any software sale or subscription will include upgrades, patches and bug fixes. Whether the subscription includes end user support, training and other consultative services depends upon the contract. In the HVAC example, covered all parts and materials and an annual preventative maintenance service. The dealer and their supplier own the equipment and have determined that the cost of maintenance is more advantageous than having to replace a broken machine.

Cash Flow and Cost of Funds

  • A dollar today is almost always worth more than a dollar in the future. This is especially true if you don’t have the funds. Subscriptions do not have associated interest rates so you must use your own cost of financing to determine the net present value (NPV) of future payments. NPV becomes more complicated when you have to impute the value of services which you may or may not use.

Environment Dynamics

  • – Subscriptions may offer the ability to scale up or down over time. Most subscriptions only allow for consumption increases during a term. If the term is month to month, then the subscription is dynamic enough to meet seasonal fluctuations or similar changing environments. When compared to purchasing a server with fixed capacity, a cloud services subscription can be extremely advantageous in dynamic environments.

With the rise of subscriptions, some products and services are only available via subscription. In business management software, cloud native products like Oracle NetSuite are only available in a subscription model. Alternatively, SAP Business One offers perpetual licensing or software as a service. The key consideration when buying software is fitness for use. The value provided by the products and services will be the key determinant of your return on investment.

Choosing your Financing Model

When making your financing decision, it will likely require an evaluation of all four subscription considerations discussed above. These considerations can vary greatly based upon the type of purchase and conditions being evaluated. Below are two recent examples of subscription considerations for buying software and equipment.

ConsiderationERP SoftwareHVAC Equipment
Subscription Term & Product LifeInitial and renewal terms and conditions.
Cap on renewal price increases.
Ability to scale up and down.
Product life and warranty
Included ServicesAnticipated use of post implementation services.
Anticipated additional services required and related cost.
Anticipated use of equipment maintenance services.
Inclusions and exclusions such as refrigerant, filters, etc.
Cash Flow and Cost of FundsAvailability of up-front funds.
Need for predictable cash flow.
Imputed interest rate
Availability of savings.
Current earnings rate of funds.
Total cost over life of contract.
Environment DynamicsStability of company and projected growth.
Seasonality and peak usage requirements.
House is not being expanded.
Anticipated cost of electricity of time.
Efficiency gains in equipment and available tax credits.
Subscription Consideration Examples

Subscription Consideration Examples

Subscription terms are usually negotiable or available within a range of 1-5 years to fix costs based upon budget and services required. In the HVAC example we had terms of 1, 4 and 8 years available. Since the product life will almost always extend passed the subscription term, understanding renewal terms is critical. In software, we have seen limits on subscription cost increases tied to CPI or fixed at 3-5% per year. With an 8-year subscription on the air conditioner, the assumption is that the consumer will either buy at approximately 1/3 the initial price, or just sign up for the latest and greatest unit.

Required services are difficult to anticipate over the life of an ERP system. However, a company can build their support team differently with a subscription than with a purchase of licenses. A subscription model lends itself to outsourcing more services to experts. Outsourcing with a well-designed contract enables consumptions of resources at dynamic levels for a fixed cost. Developing service capacity in-house requires a commitment to payroll and is well suited to stable companies who anticipate little change. Considering that my prior equipment only required 2 service calls over a 17-year period and that we are not planning to build onto our house, we could only impute minimal value to annual maintenance.

Cash flow, cost of funds and return on investment (ROI) is one of the most difficult calculations in an ERP selection process. Each company must make their own associations between value to cost to calculate an anticipated ROI. What is the value to be attributed to improved customer service? How do you value saving 4 hours per week per customer service representative? Calculating the net present value of future cash outlays is simple in a lease versus buy calculation, but far more complex in subscription considerations.

In the ERP example, a dynamic and fast-growing company can often benefit from a subscription contract that includes a high touch service component. A well run services organization creates customer satisfaction teams that are assigned to companies to increase satisfaction with the software and services offered through Software and Services as a Subscription. Although I have promoted services as a subscription for over 20 years, I also recognize and have customers in very stable family-owned businesses that have had a much lower total cost of ownership through perpetual licensing.

Next Steps In Subscription Consideration

The four dimensions of subscription considerations are applicable in many circumstances. I-BN focuses on the business requirements first, the deployment options second and the financing options third in systems selection projects. Choice of implementation partner is a key component of deployment. When subscription is your choice, implementing with a Services as a Service partner is advantageous. If looking to capitalize your systems cost, a partner who specializes in fixed fee arrangements or a time and billing option may be preferable.

To learn more about subscription considerations, our selection process, or system selection services, visit our website.  Contact an I-BN executive for a no charge System Selection Explore session.

Leave a Reply

Your email address will not be published. Required fields are marked *