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How the Nascent Subscription Economy Impacts Traditional Partners

The traditional, upfront sales model has been the modus operandi of economics for thousands of years. It's no wonder partners' heads are swimming trying to transition to recurring revenue.

If you remember your Economics 101, you know that the creation and sale of tangible goods has been cited as the primary driver of economic growth and prosperity since Adam Smith outlined the idea in 1776. For the history of human civilization, the basic economic structure has remained relatively unchanged: a buyer exchanges a valuable good for a product.

When you think about it in such a historical framework, traditional channel partners’ reluctance and trepidation to switch from upfront sales to recurring revenue seems a lot more understandable, despite the increasingly loud warnings coming from analysts.

It’s only been in the last several years—a blip on the radar of economic history—that anyone other than newspapers and milkmen operated on a recurring revenue model. In channel IT, the model was, until recently, quite simple. Providers sold a perpetual license to a box of software and/or a piece of hardware to run and store it on. In contrast, recurring revenue introduces a whole other world of complexity.

“The subscription economy is a lot more complex than simply taking the sale amount in full. As a result of the cost to transition to a recurring revenue model, traditional partners are reluctant to make the switch,” says Craig Gass, CEO of payment processing platform provider Qualpay.

Gass says that nearly every stage of the transition to recurring revenue contains complexity. Partners have to work out the pricing structures they’ll offer, how the new revenue stream will keep the lights on, and how to manage subscription-based payments from customers.

Consider a recent survey by billing platform Zuora of 350 of its customers. In 2016, The Subscription Economy Index showed a 900 percent growth in subscription companies over a five-year period than sales for S&P 500 companies, and subscription-based sales grew 500 percent faster than the total U.S. economy. Clearly, the future of economic success lies in the consumption-based economy.

But even partners who are converts to the superiority of recurring revenue models over one-time sales models are struggling to make the transition, and it’s easy to see why. Channel shops that count on receiving 20 or 30 percent margins on upfront sales are watching that cash influx dwindle rapidly as vendors move to lower margins on a recurring basis. That kind of hit can be extremely difficult to choke down.

It’s not just the hit to the balance sheet that hurts, either. Accounting standards for subscription-based models are vastly more complex and at times seemingly completely arbitrary, and we can expect them to become even more so next year when the new Accounting Standards Codification 606 takes effect. Under the new standard, software solutions packages that combine added offerings like maintenance, security, implementation services, and customer support will have to be broken apart into individual transactions. In many cases, these supplemental offerings don’t have set individual prices, which means that any values assigned to them will pretty much just be guesses.

Digital transformation and the emergence of the consumption model undoubtedly provide vast opportunities, but those are accompanied by a bevy of pain points for partners that built their businesses in a pre-cloud world.

As end users increasingly desire a fractional IT ownership model that relieves much of the pressure of cost, commitment, security, and other responsibilities, however, channel firms have to take the plunge if they want to stay relevant. Otherwise, they risk being replaced by the slew of “emerging,” born-in-the-cloud partners such as digital agencies, marketing firms, SaaS providers, and IT consultancies whose native language is that of cloud-based recurring revenue.

“These [traditional] partners lack the flexible products to meet these [customer] needs,” says Gass. “This has given rise to new, modern partners that are able to help their customers support the subscription-based models they’re demanding.”

According to IT analyst firm CompTIA’s IT Industry Outlook 2017, much of the traditional channel is scrambling to find a niche in the services and solutions market, oftentimes finding success in hyperspecialization across specific vertical and horizontal focuses. In the end, says Gass, no matter how painful, traditional partners are going to need to bite the bullet and make the switch.

“The complexity of supporting subscription-based payments will ultimately drive a business to look beyond traditional partners. As they fall further behind, businesses will look to younger, more modern partners that are rising to replace and provide subscription-based services in a dynamic, customer-driven way.”

 

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