The subscription model isn’t going anywhere. In fact, it has proven to be a predominant force in the software market with an increasing number of success stories.
There are the heavy hitters like Zoom, Adobe, and Salesforce. Then there are the more emerging services such as Fair—which offers medium-term car subscriptions—and BetterCloud—an operations management platform that monitors and secures data for SaaS applications.
The reason the subscription business model is so popular? It can be a dynamic growth tool.
Whether your SaaS or subscription-based business is operating on a monthly or yearly subscription model—or even a combination of the two—you may be wondering which is truly best for your business and its future success.
While there are choices when it comes to your business’s subscription model, there’s no choice when it comes to the accounting process. It needs to be done properly to ensure accounting compliance and avoid unnecessary financial risks.
Let’s explore the benefits and disadvantages of both the monthly and yearly subscription models with regard to your business, your customers, and even potential investors. We will also cover how to ensure proper revenue recognition in both cases.
Monthly subscription model
From start-ups to established SaaS businesses, when it comes to the subscription industry, many offer the monthly subscription model exclusively for a variety of reasons.
1. Simplicity and flexibility.
First off, from a business perspective—as well as a customer perspective—the monthly model is simple and flexible. You charge your customers a fee each month for the services you provide. As your business and its offerings evolve, customers can easily evolve their subscriptions accordingly, and likely without having to involve your sales team in negotiations.
2. More lucrative.
The monthly subscription model also tends to enable your business to charge customers over longer periods, which ultimately means more cash in your pocket over time.
3. Faster growth.
Another benefit of this model is that a monthly subscription option reduces the commitment new customers face in order to get started using your SaaS. The resulting reduction in sales friction can ultimately make it quicker and easier to build up your customer base. Your business can also save time and money on the efforts of your sales team, as pitching a yearly service often involves a much longer sales cycle.
However, this reduced customer commitment can also be a disadvantage. Businesses that use the monthly model often have a higher churn rate as customers can easily move on after a few months of test driving your service.
4. Reduced barrier to entry for customers.
From your customers’ perspective, the cost of your services appears much friendlier when they’re paying monthly rather than yearly. Instant access at a minimal investment can effectively navigate the price pain point for even the smallest customer.
5. Investor appeal.
Finally, the quick customer-base growth the monthly subscription model can facilitate looks very appealing from an investor perspective. After all, 10,000 customers on the books always appears better than 1,000 customers and the recurring revenue increases business valuations.
However, keep in mind the increased churn rate the monthly model can encourage creates a more unpredictable flow of revenue, which is the opposite of what investors like to see. Losing customers is never fun, and quick turnovers can create extra stress on your business as you may not have even yet covered the cost of acquisition.
To counter this, businesses offering monthly subscriptions need to put concerted effort into nurturing and maintaining their customers. This likely means building out dedicated customer success teams to prevent churn.
Annual subscription model
In contrast to the monthly model, the annual subscription involves a yearly fee for services.
1. Increased investment capital.
The annual model can be a popular option because it provides your business with an entire year’s worth of revenue up front, allowing for reinvestment into growth and development. Customers may also commit to a year’s worth of service but pay monthly to break up the cost.
2. Higher customer retention.
Either way, the annual subscription model is beneficial from a business perspective because it ensures you’ll retain your customers for at least a year. This gives your SaaS business ample time to demonstrate the real benefits of your product.
The larger commitment of this model often means customers have put more time into making their purchase decision. As a result, they’re typically invested in getting the most out of their purchase.
3. More opportunity to encourage customer loyalty.
A downside to the annual model is it also often involves a lengthier sales cycle, which means a higher customer acquisition cost (CAC). This likely means it will take longer to build up your customer base. But that doesn’t have to be a bad thing.
By investing the time in acquiring annual subscribers, your business has the opportunity to build a more loyal, committed customer base. This ultimately means increased cash flow, improved customer retention, and reduced churn—all important contributors to future success.
4. Increased convenience and customer savings.
From a customer perspective, the biggest benefit of the annual model is they’ll only have to go through the procurement process once a year. It can be a huge burden to make a large purchase decision on behalf of one’s employer, so reducing this burden can certainly appeal to some customers.
Normally, customers also save money by signing up for a prepaid annual contract—a positive for any budget.
5. Revenue predictability.
From an investor perspective, there’s nothing more appealing than stable, predictable revenue. As mentioned, this model is ideal in this regard. Upfront payments make it much easier to provide a full picture of the financial status of a business, which makes it easier for investors to buy in.
This can also make it easier for businesses to have a clear understanding of their own cash flow situation, which is obviously important information when it comes to decision making and future planning.
On the other hand, the higher cost and commitment up front means annual billing can sometimes dissuade potential customers from signing on. Large, infrequent lump-payments can also lead to clients mistakenly disputing bills, or refusing to renew contracts.
At any given time—regardless of the model it’s using—a subscription business must be able to see how much revenue it has collected from its customers. The business also needs to know how much of that revenue is deferred because the service has not yet been fully delivered, and how much has been fully recognized.
Why? There are a number of reasons.
From a business perspective, accurate revenue recognition affords reliable business intelligence. If your business has an accurate account of its cash flow and recognized revenue, it can make better decisions with regard to its growth and development.
Properly tracked deferred revenue also ensures properly calculated corporate taxes. This gives a business a clear picture of how much deferred revenue it will carry into future periods. And from a compliance viewpoint, businesses need to be able to properly recognize their revenue to comply with the ASC 606 standard.
While revenue recognition almost certainly isn’t on the radar for customers, it may be of some consequence to them when it comes to the annual subscription model. This is because accurately recognizing revenue makes it simple for businesses to determine how much customers should be reimbursed in the case of plan adjustments and cancellations. Most monthly models aren’t reimbursed.
Finally, in terms of the investor perspective, revenue recognition is crucial because it shows transparency.
Deferred revenue is a liability rather than an asset, so having full and accurate visibility into your business’s financial situation can make investors feel more secure in their decision to get involved.
And if your business has a goal of going public, ensuring your revenue recognition is up to snuff is a must. You must be able to show financial statements that properly track your deferred and recognized revenue.
Maybe you now have some idea of which subscription model is best for your business—or perhaps know that what’s best is a combination of both annual and monthly subscription models.
But how do you ensure revenue recognition and accounting compliance?
There are multiple approaches your business may take. The first—which is certainly not recommended—is to do nothing. As mentioned, a passive approach can lead to financial risks and compliance concerns for your business.
The second is to use spreadsheets and perform manual tracking. Not only is there no audit trail with this approach, but also there’s limited reporting and forecasting capabilities and a heap of required labor that results in a flat collection of data. Having a more relational database is much more useful.
The third approach is to use standalone revenue recognition software. While this approach can work, it limits your business in terms of integrations with other software you may be using. This may require manual entry or importing. These types of specialized revenue recognition software also often result in unexpected costs in terms of initial development and ongoing maintenance. It’s a challenging route to take if you’re looking to scale up.
The final option is to implement a cloud-based automated billing system that can enable proper revenue recognition and accounting compliance no matter how big your business gets.
A robust subscription billing software can manage the full breadth of challenges either subscription model can present, from reporting on acquisition and churn, to ensuring ASC 606 compliance and identifying refunds for cancellations and subscription changes with full clarity.
Such software may also include capabilities with regard to some operational complexities, such as managing payment flexibility, pricing negotiations and discounts, Net D payment terms, and more.
The right adaptive automated billing system can also facilitate seamless integration with software your business is already using, and it can provide you with in-depth capabilities when it comes to reporting and forecasting. These abilities ensure you’ll be collecting the right data toward the growth of your business.
In conclusion, after you weigh the benefits and challenges of each subscription model and determine which is best for the future of your business, make sure you’re set up properly to recognize your revenue accurately and in compliance with accounting standards.
Managing and tracking all aspects of a subscription-based business can be complex, but it doesn’t have to be with the right infrastructure.