The subscription economy requires specific financial services

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Even in Manufacturing, companies like Wärtsilä or Sandvik offer nowadays Uptime-as-a-Service solutions, SKF has its Rotation-for-Life programme and a growing number of OEMs (Original Equipment Manufacturers) are even considering pay-per-use models as an alternative to selling the machinery equipment.

So, evolution or revolution since it is often about a dilemma of disrupt or be disrupted?

Companies having adopted subscription models benefit in many ways

Because a subscription model allows companies to build loyal, long-term relationship with their customers, it offers many advantages to the more traditional “product economy” that relies on one-time transactions. To start with, It is a more sustainable model that delivers customer centric services. Also, because it is renewable, it is predictable, as opposed to non-subscription businesses which have to start every quarter from zero to get to the revenue target.

In fact, according to the Subscription Economy Index, companies embracing these new business models have grown six times faster than traditional businesses in the S&P 500 index during the 2020 pandemic. In addition, the valuation on a euro of recuring revenue is significantly higher than on a euro of revenue from a one-time sale and, according to the same source, pure-play subscription companies are valued 2 to 3 times higher than their non-subscription peers.

The subscription economy is not about new pricing models or financial constructs, it is a fundamentally new way of creating a relationship between a company and its customers. The base of predictable revenues is built on the loyalty that has been established with the end customers. It requires to move from product centric business models to customer centric ones, from selling products to helping customers to achieve an outcome. Another way to put it is that companies have to focus on their business models as a consumption based model, not one built on units sold.

Three ways to move to a subscription model

According to Zuora, a subscription management platform provider active in the Nordics, companies have basically three ways to move to a subscription model:

The first is to offer new services on top of the hardware or machines. Those services are enabled via connectivity, cloud and increasingly AI software. For instance Kone Cranes has built predictive maintenance services on its connected heavy-lifting equipment and they use the data gathered from the IoT devices to offer maintenance on a subscription basis.

The second way is to repackage the existing offering into a recurring one. It is not driven by new technology but consists of transforming an historical transactional model into a recurring and value-based business model. For instance when upfront traditional license costs are replaced with recurring payments spread over the term of the agreement, with the flexibility to “pay-for-what-you-need”.

In the third model, customers can subscribe to specific needs whilst the service provider owns (or arrange for third party ownership) the product through its lifecycle, i.e. from design to recycling. In this case, the solution is intended from its inception to be sold as a service, unlike the “repackaged to recurring” one. A striking example is that of Volvo Cars which earlier announced that they are aiming at 50% of their cars to be driven on the “Care by Volvo” subscription service by 2025, creating millions of direct consumer relationships.

For more information on this topic, please go to the following link:  https://www.zuora.com/resource/reaping-recurring-benefits-industry-4-0/

Subscription based models need specific financial services

From a corporate treasurer’s perspective, a subscription model poses specific challenges, from pricing, billing and invoicing to revenue recognition and account reconciliation. Especially companies that have relied on their ERP to manage the invoicing and payment process face the fact that, although ERPs are sufficient for a linear invoicing work-flow, they are not built to manage a recurring, events-driven and usage-based invoicing process with complex rules. They then need to turn to a subscription facilitation platform to add those capabilities.

From their banks, companies moving to a subscription model firstly need good services for the processing of recurrent digital payments. In the B2B space, payments need to move from traditional single account-to-account transfers to a wider set of payment options which can be automated based on the specificities of the subscription contract, like currently for B2C cases.

For the subscription models based on data from IoT devices (which indicate for instance how much the equipment is being utilised), banks have to be able to connect to that usage data and transform it into billing and payments, preferably in real time. The use of virtual accounts, which can be set for each piece of equipment, is then a pre-requisite.

And when companies morph their business model from selling assets to selling consumption of those assets, like OEMs with machinery equipment, they usually require financing and ownership solutions. They can certainly experiment such business model by keeping the asset on their balance sheet, but when they scale up, they need an off-balance structure that permits the recognition of a true sale on the P&L. A dynamic form of leasing can be a solution, but to reach the flexibility required by the equipment manufacturers and their customers, it is more likely that an SPV structure will be a better solution. By that I mean a shell company acquiring a pool of machinery, for instance trucks or mining equipment, and which ownership and financing could attract Private Equity companies and institutional investors wishing to diversify into this new financial asset class.

Each of these three plays can co-exist and need to be applied depending on the unique positioning of the manufacturer, the product and the customer segment.

For more information on the themes discussed in this blog, please write to Jean-Francois at jean-francois.tapprest [at] nordea.com (jean-francois[dot]tapprest[at]nordea[dot]com).