Thread by @Finstor85

Let's try to understand why technology product companies have historically been non-sequential in QoQ growth. Some call it cyclicality, some called it nature of the business. I will try to clarify a few things in this thread.

To understand this, you have to look at how software as evolved over last decade or two. We have moved on from bulky software that needed on-premise installations to cloud today. Naturally, revenue realization practices have changed too.

Historically, license sell for a large bulky on-prem software used to result in non-sequential growth for technology product companies. Revenue realization used to be jerky. One Q will have huge revenue, while other could be poor.

Hence, it was advised to look at YoY numbers. That's about license sales. Annuity revenue or ARR is another part of the revenue which primarily depends on license sales. Hence, ARR, despite seemed steady, used to fluctuate as well.

SAP used to be such bulky software which transitioned from transaction to application & launched its cloud/fiori solutions. Clients no longer needed to buy entire software even if they use only 10% of the features. They buy only feature they need. Hence transaction to application

Once cloud offerings stabilized, we started seeing subscription based offerings. Where key metric is PUPM - Per User Per Month. What is your revenue per user per month? That's key metric for cloud based subscription solutions.

The margin profile does not change with change from license sale to subscription model. However, something interesting happens. It smoothens out the jerky revenue realization that license sales used to bring in.

However, it also means that it takes time for a company to determine - what is my average PUPM? So guidance on revenue is not very easy to provide. Analysts get it wrong precisely here. They think Subscription revenue should be similar to license revenue. It won't happen!

Subscription model is a very high gross margin business. Which also means as we move to newer software consumption models, ARR segment will slowly come down. Since there is no on-prem maintenance, I can negotiate my ARR.

Doesn't mean the maintenance contracts completely go way. Just that the ARR revenue subsides a bit, subscription revenue takes over & fills the gap. Allows wider reach, volume profile improves. Margin profile remains the same.

Then comes - "Pay as you consume" which a tad different from Subscription. Subscription frontloads the revenue, Pay as you consume doesn't necessarily. This model makes it even harder for companies to give any stable revenue guidance during the transition phase.

Pay as you consume mainly caters to software sizing/infra needs of the client. The pay as you consume brings the seasonality into picture. For e.g. Retail clients will contribute more to revenue during festive times, contribute less during non-festive times.

Pay as you consume is AKA PPU - Pay Per Use. This means a custom makes fixed price purchase with you initially, but may or may not do any new business. This brings predictability for customers.

Now let's see how this will reshape the domain. Since costs are front loaded in subscription & PPU model, new companies find it extremely difficult to generate +ve cashflow. Unless they have significant parallel source of money, new companies will find it hard to survive

Existing legacy companies transitioning to Subscription/PPU have a customer base so their cost frontloading is not an issue. So the domain shrinks! Focus on companies that have already smoothened out SaaS/Cloud subscription revenues. You will make max money there

Customer stickiness improves if subscription pricing is affordable. Think of this - you have both netflix & prime subscriptions. You may not watch both daily, but have you unsubscribed either? Customers tend to ask for discounts in lean period & stay with you.

The way we consume enterprise software is changing with emergence of DevOps - CD/CI methods that results in near zero downtimes during upgrade. Customers don't even come to know their software is being upgraded.

But this transition also means that new entrants find it even more difficult to sustain in absence of positive cashflows or funding. Low-Code No-Code software are primarily sold as subscriptions & companies that have a stable/mature pricing will keep growing significantly more.

In my last startup, we built an enterprise components for on-prem system. We found it extremely challenging to make a sale. We then moved on to Subscription model but the paltry cashflows prevented us from moving forward.

Then we were asked for PPU & we weren't prepared. We spent months trying to bring out a sustainable pricing model & this tread is an outcome of my learnings from my startup & tech/product experience I have had so far. Hope you enjoy this!