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How to transition your IT business from product sales to subscriptions and recurring services

Jan 3, 2020 11:57:36 AM Stacy Nethercoat financing, TaaS, new business models

The reason your customers are screaming out for technology as a service

More and more, businesses are choosing to purchase technology as a service. Given the obvious benefits, it is easy to see why. By paying a third party for a clearly defined service, organisations can unburden themselves from having to develop, maintain and evolve complex aspects of their IT estate. Fundamentally, as they only pay for what they use, there is a strong argument that IT budgets can be made to stretch further. Being free from large financial investments also enhances an organisation’s agility allowing them to adapt, change, switch, amend and focus on accelerating innovation. Plus, outsourcing to specialist third party organisations is a good way of getting immediate access to the very best technology, expertise and resources without any of the upfront development costs or lengthy timeframes. This is certainly true when it comes to cybersecurity.

 

What this means for you and your business

IT providers of all types are having to adapt and change to stay relevant to their customers. This means providing them with technology that can be consumed as a service.  The most successful IT providers will have a blend of services in their portfolio consisting of unique services they have developed themselves, plus services developed by distributors and technology vendors they can resell.  For some, such as traditional IT resellers, this shift requires a complete rework of their business model. Rather than revenues originating from traditional product sales, the business needs to adapt to revenues coming in smaller amounts, but on a repeated basis. This might seem simple, but in fact commissions, cashflow and financial management tools all need to be re-engineered.  

 

When it comes to financial management, the secret lies in the rule of 78

It’s a major business challenge to maximise profitability from the subscription-based model. The good news is that an 80-year old financial principle applies well to the demands of today’s subscription-based financing. It’s called the Rule of 78.

Don’t worry if this is the first time you’ve heard of it, it’s a surprisingly simple concept to grasp. Created in 1935, the Rule of 78 was originally used in the banking industry to model the expected cash flows from interest across payment periods.

The chart below shows how the Rule of 78 applies to a subscription-based model where a new subscription is added every month. Where a traditional sales model would net 12 billing events for the entire year, with a subscription model, the billing events grow exponentially. This results in 78 total billing events through the year (if you don’t believe us, count them).

 

So, in this example, where each billing is worth $1,000, the total revenue is $78,000 as opposed to $12,000 in the traditional product sales model.

 

 

Rule of 78 and your “Subscription Go-To-Market” finance strategy

So, what does an arcane banking model have to do with today’s subscription investment planning? The investment models normally applied to gauge expected returns on traditional market opportunities tend to underestimate the lifetime value of subscription-based services to an audience that isn’t familiar with the nuances.

’s where the Rule of 78 comes in. It’s a disruptive way to illustrate investment and expected returns of a subscription model. It enables all types of IT organisations to gain a clearer understanding of the financial complexities inherent when tackling the IT as a service opportunity.

t to note that this application of the Rule of 78 typically results in the organisation breaking even after sales commissions are paid at the end of 12-16 months. Then, starting the following year, the organisation carries over those subscriptions’ net of attrition and continues to earn profit dollars with greatly reduced sales and administrative costs.

 

What to look out for when implementing the Rule of 78

Looking at the diagrams above, you may be wondering why more companies haven’t already switched over to a subscription-based plan.

Many IT organisations are hesitant to migrate away from traditional models because they’re accustomed to investment frameworks that support short-term cash flow from large one-time lump sum customer billings of service or product. Switching to a subscription-based plan challenges the core investment models these organisations use finance operations and growth strategies, as well as disrupting their expected cash flows.

 

Opportunities with the Rule of 78

Switching to a subscription-based as a service model doesn’t need to be an either/or proposition. Industry research suggests hybrid infrastructure will be the technology model of choice over the near term. So, it makes sense to adopt an investment strategy to support subscription profit flows alongside more traditional IT plans.

Some companies have switched all their products to subscription-based services in one go. Almost overnight, Adobe transitioned from selling annual software licenses to selling programs as a monthly subscription-based service. However, this isn’t the norm.

That’s the great thing about the Rule of 78 – it’s ideal in a “one-off” instance, supporting investment planning for a specialised business unit that focuses on as a service technology, while the wider business relies on existing traditional processes.

 

Is your company considering a major investment in subscription and services delivery?

You can leverage Tech Data’s comprehensive cybersecurity and next-generation technology portfolio, with the Cybersecurity team. Plus, you can access highly effective enablement though Tech Data’s Practice Builder methodology. Then by tapping into a partner transformation programme that adopts the Tech Data Practice Builder methodology, you can have a tailored enablement path based on your current capability to transformation and sell next generation solutions - putting you in control.

If you’re an existing partner and want to learn more about Tech Data, or if you’re looking for a valued partner to help accelerate your business, get in contact with your local team today.

Share your own thoughts and experiences of transitioning into the subscription-based services and let us know what you think about the Rule of 78 financial model.

 

Stacy Nethercoat

Written by Stacy Nethercoat

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