At some point, the speed and nature of modern subscription deals simply outpaced the traditional quote-to-revenue tools that the software industry grew up with. So what happened?
Given the combination of contracts involving various products, terms, entitlements, and revenue recognition schedules, complications can always arise as to when revenue can be recognized. There are various ways to recognize revenue depending on the types of products that are sold and the nature of the industry a company operates in, including sales basis, percentage of completion method, installment method, completed contract method, and cost recovery method. For SaaS businesses, the complications of recognizing revenue are further compounded due to the ever-changing life cycle of a subscription.
While SaaS businesses are typically paid in advance for access to the software that will be used throughout the contract term, complexities in recognizing revenue can arise in a number of instances, including:
- Subscription cancellations prior to the contract end date
- Upgrades from basic plans to top-tier plans
- Downgrades from top-tier plans to basic plans
- Early renewals that are coupled with upsells
- Cancellation of a contract to be restructured to another
- Combination of different contracts across entities
- Unique contract terms that result in a deferral of revenue
Most SaaS businesses offer a variety of subscription plans and pricing models, such as minimum commitments, usage-based, hybrid billing, dynamic billing, or a combination of various models. For example, many SaaS companies offer usage-based pricing and bundles to promote customer adoption of their solutions. Dynamic deal structures, such as ramp deals that increase annually, entice customers with increasing discounts over time as usage grows.
When selling a SaaS product, companies commit to continuously delivering service every month throughout the term of the contract. Companies need to start recognition of revenue upon provisioning of the service, accounting for all the changes that occur throughout the lifecycle of a subscription. The timing is critical. Recognize revenue too early, and you risk over-recognizing revenue in a period. Recognize revenue too late, and you risk under-recognizing revenue. Both instances are in violation of ASC 606’s guidance on delivery.
Recognizing SaaS revenue is even trickier under rapidly changing market conditions. Recognizing revenue is particularly complicated when contracts need to be updated over the course of their term. Disruptive market events such as pandemics, supply chain shortages, and recessions, will trigger updates to existing and future deals.
For instance, as line items in a ramp deal, your customer has committed to adding 100 licenses to its subscription next year and to purchasing a regional-specific product as part of its geographical expansion plans. But because of a down market, the customer isn’t growing at all and needs to have its contract amended. To update the contract, you need to edit those line items and create a new quote, order form, and invoice to ensure revenue is correctly reported.
Challenging market conditions often prompt companies (and likely your competitors) to offer bigger discounts in order to close deals. Customers may also ask for higher discounts in order to renew or upsell. Internally, many organizations have protocols and processes requiring CFO or senior leadership approval for discounts above a certain threshold. In these cases, not having an agile quoting system can delay and muddle the sales process.
Finally, many SaaS companies will offer various versions of their more popular products at different price levels to balance business needs with the financial considerations of their customers.
While the product packaging strategy is sound, adding new SKUs and configuring billing and quoting systems often involves time-consuming, inefficient, and manual processes requiring multiple members of the finance team.
This blog post is an excerpt from our eBook "The Quick Guide to Seamless Revenue Recognition for Saas Companies." To read more, download the full guide here.