On April 17^th, Tensoft hosted a webcast with Silicon Valley software revenue recognition expert Jeffrey Werner entitled “Structuring Software Sales Transactions for Optimal Revenue Recognition.”  This post covers Jeffrey’s responses to audience questions posed during the webcast. 

(If you missed the live webcast, you can still view it any time by clicking here.)

Question: If a perpetual license is sold along with support, do you get to recognize the license revenue up-front or ratably over the support period?

Response: This depends on whether you have vendor-specific objective evidence (VSOE) for the support.  In the case where you have VSOE, you would defer that amount for the support services based on the VSOE and you would recognize the remaining amount -- or the residual amount -- on delivery of the license.  If you have a perpetual license which you’re selling with support, and you don’t have VSOE, then you’re going to recognize both the license and the support fees ratably over the support period.  This is why it is so critical and so important that you establish VSOE if you have software licenses because most software companies sell their licenses with support in the initial transaction.  

Question: How are companies accounting for sales of apps through their online app store?

Response: In the four principles of revenue recognition, we’re going to look at delivery.  When someone logs into that application store and downloads the app, that would generally be the point in time where we consider delivery to have occurred.  Then we would need to look at the price that the company will receive for that app, which is generally less than the full retail price.  In general, public companies or other companies that are selling apps through an online application store recognize the net revenue from the sale of the app. The company would generally recognize revenue at the point the app was delivered or downloaded by the user, provided all the other revenue recognition considerations are met. Here are some examples of other considerations:  1) Collectability - Is the app store credit-worthy such that the company is going to collect the fees? 2) Delivery - Are there any other future obligations as part of that transaction?  If so, revenue would need to be deferred for those obligations.

Question: Can you highlight any best-practices for companies that have value-based pricing on software?

Response: With regards to discounting, most software companies have list prices but the net sales price has significant discounts.  So, your pricing methodology is going to be based on the value that you think you can get from your customers, or that your customers are willing to pay for, rather than the list price. Therefore, you are typically going to find your software licenses at a discount or at a significant discount from their list prices.  One of the best practices that companies do is price their support and maintenance based on the net license fee, rather than some other set dollar amount or a percentage of the list price.  We’ll talk about some other aspects of how to structure and price the contracts so that you have clear and understandable arrangements and can get the desired outcome. 

Question: Can you describe the difference between subscriptions vs. SAAS?

Response: With SAAS the software isn’t actually licensed to the customer, it’s just accessed by the customer or the user over the internet; it’s clearly a service.  A subscription would be where a software license is licensed and transferred to the customer and is hosted by the customer on their server. The customer has a software license agreement with the vendor and they are allowed to use the software on their server over a period of time.  As I mentioned, a lot of folks use the terms “term license” and “subscriptions” as if they’re synonymous but there can be significant differences.  “Term license” is a license used for the software over a specific period of time, and a subscription sometimes includes whatever is available during a particular time period, such that the customer subscribes to a suite of software over a period of time. In a subscription, if new elements are added to that suite, the customer gets those elements without an additional fee.  I use the analogy, it’s like the subscription to a magazine. You get whatever is in the magazine in each issue for the next 12 months if you subscribe for a year. That’s similar to a company that has a subscription license where you get over that period of the subscription, whatever elements, modules or apps that are in this particular family.  Subscription and SAAS arrangements generally both have ratable revenue recognition, but the subscription is a software license and therefore follows software revenue recognition rules while a SAAS arrangement follows the relative selling price method.   Those are the significant differences between a subscription and a SAAS. 

Question: Have you observed any cases of auditors requiring valuing an indemnity as an element?

Response: Generally no, I haven’t.  Generally, indemnification for intellectual property rights happens when the vendor says: “You, the user, are indemnified if a third party comes and declares that you’re infringing on their software or intellectual property by using the product of the vendor.”  Typically the vendor has indemnified their customers and the vendor is responsible for either defending against the infringement situation or reimbursing legal costs of the customers to defend against the infringement claim.  Typically those intellectual property indemnifications are excluded from revenue recognition. There may be other indemnifications other than intellectual property rights that are associated with levels of service or performance that have a revenue recognition impact.   

  On April 17^th, Tensoft hosted a webcast with Silicon Valley software revenue recognition expert Jeffrey Werner entitled “Structuring Software Sales Transactions for Optimal Revenue Recognition.”  Thanks to everyone who attended, and especially to those who actively participated by submitting questions before and after the event!   If you missed the live webcast, you can still view it any time by clicking here. 

This post covers several of Jeffrey’s responses to audience questions posed after the live webcast.  So keep those cards and letters (well, emails actually) coming!

Question 1: Best Way to Establish VSOE for Fixed Fee Services?:

I attended the software revenue recognition session on Apr 17^th, and I have a question.  What is the best way to establish VSOE for Fixed Priced Services? For T&M pricing, it should be relatively simple by using the hourly price times the hours.  But for Fixed Fee pricing, I would like to know how it is being done by other companies.

Response to Question 1:

Generally, unless the fixed fee services are for a standard service that is the same in most or all customers, it would be difficult to establish VSOE. This is because you would not be selling that service separately to meet VSOE requirement. You would most likely use contract accounting for the entire arrangement if the services were significant. 

A number of companies have fixed fee services like a Quick Start program where the vendor provides the customer with bundle of 1 day installation and 1 day of consulting/training. You could establish VSOE for this Quick Start service since it is the always the same bundle. The bundle VSOE rate could be established by an analysis of historical pricing for the bundle or the combination of the VSOEs for one day installation and one day consulting/training.

I hope this helps. Thanks for joining us today.   Please consider attending the online Revenue Recognition course sponsored by Tensoft in June. We will be going into issues like this in detail with examples using facts and amounts.

 Question 2: VSOE and Software Subscriptions:

I have a few questions that I hope you can help with.   The first is, if a deal contains perpetual license, term license and software subscription, would VSOE need to be established for the term license and software subscription in order to take the revenue for the perpetual license upfront?   The second is, if there's no VSOE for the term license and software subscription, the revenue for the entire arrangement should be taken ratably, correct?  If so, what period would the revenue be taken over if there's no end date specified for the software subscription (i.e., revenue would be taken over the longer period of the term license or subscription period)?

Response to Question 2:

If these are software transactions under Software Revenue Recognition, you need VSOE for any undelivered elements. 

The term license may or may not have an undelivered element depending on whether there is support.

The subscription license most likely would have an undelivered item, so you would need VSOE in order to apply the residual method.

If there is no VSOE for the subscription, the entire arrangement would be ratable over the longer of the subscription period or the support on the term license.  

We will be addressing issues like this in much more detail the June Revenue Recogition course - please contact marketing@tensoft.com for more information.

Author and professor Jared Diamond published an essay in The New York Times a few months ago called “That Daily Shower Can Be a Killer.” In this essay, Diamond argues “the importance of being attentive to hazards that carry a low risk each time but are encountered frequently.” He points out that Americans do the opposite – we overestimate the risk from events that are beyond our immediate control, and underestimate the risk from events that are within our control.

American baseball seems to me to be an exception to this tendency. In baseball, it’s often said that the team that masters the routine play wins the game. While it’s exciting to see a spectacular diving catch, it’s a good bet that same player has spent a lot more time drilling on more routine plays than diving. The team that doesn’t execute well on the routine plays has little hope of making up for this with their superior ability to make great barehanded double plays.

The same is true for ERP implementations. The biggest risk to successfully getting things done isn’t the failure to handle the 2-10% of transactions that are exceptions. It’s the failure to deliver well on that 90-98% of the transactions that should be a routine play. And yet, at the start of a new project or during the evaluation phase for a new project, risks that are relatively uncommon -- but could cause devastating consequences -- may get undeserved attention, while frequently occurring low-risk hazards may be all but brushed off.

It’s human nature that we want to find solutions to the toughest or most unique problems. It’s a challenge, and most of us enjoy overcoming challenges. But, if you really want a successful ERP implementation, keep your eye on how you can consistently execute on the routine plays.

 While it can be difficult to plan for some kinds of "hockey stick growth," the rapid growth that may occur as a result of acquiring a successful product line comes with a bit more warning.  This is exactly the situation the Tensoft's newest customer, GEO Semiconductor found themselves in, after they acquired the digital video processing from Maxim Integrated Products, Inc. (NASDAQ:MXIM).  Instant volume production for instant new customers though.....  Could be a "mixed blessing," if GEO hadn't planned ahead!

Luckily, GEO's management team had the foresight to ensure that their new "instant" customers would be well taken care of, and started planning to scale their infrastructure and processes ahead of the ramp.  GEO's CFO, Eric Erdman, contacted Tensoft to initiate the process, having had a successful partnership with Tensoft in the recent past and knowing that we excel in rapid implementations for this niche market.   

Tensoft is excited to be able to contribute to this stage of GEO Semiconductor's growth.  To read the full press release, click here.

Subscription billing is popular in both the investment community and as a business model today.  However, it would be a mistake to assume that all subscription businesses are the same, and that a one-size-fits-all solution will work for all businesses who use subscription billing to do business.  In fact, there are the same sort of business model variations that occur in many other kind of businesses.   You still need to start by asking “what is your go-to-market model?” or “how do you interact with your customer?” 

On the relatively simple end of the scale are consumer-oriented subscription businesses that may just sell a single item with a single SKU.   For them, the primary revenue recognition requirement is that it needs to be “hands-free” since there may be millions of transactions involved.

For business-to-business subscription billings, there may be a set-up fee involved.  Now you have both a multi-element arrangement - two different types of SKUs on the same order - and two different revenue recognition periods.   This quickly gets more complex.

Then, there are subscription billing models that are every bit as complex as an enterprise agreement too.  These may have overages, minimums, price true-ups, professional services, etc. 

If you look at even in the simplest e-commerce models, there really needs to be some automated way to handle revenue recognition.  If not, you’re both dumping the revenue recognition responsibility on some poor soul – or souls - in your finance department, and you’re negatively impacting your organization. 

Manual revenue recognition slows down the speed and availability of critical information and increases the need for headcount to manage it.  If you’re a subscription business, give us a call – we can help you make sure that your revenue recognition processes aren’t slowing you down.

 As hard as it may be to believe, Mother's Day and Memorial Day will be here before we know it.  And, sandwiched right between those spring holidays, Tensoft will be holding our 8th Annual FSM User Conference, Momentum 2013.  What better way to reflect on 1H of 2013, and re-energize for 2H? 

This year we'll be back at a favorite venue in downtown San Jose, convenient for our local and out-of-town customers alike.  Look for more training labs, lots of great content, and plenty of opportunities for networking with your peers in the semiconductor industry.  Whether you're a Tensoft FSM User Conference alumnus, or will be attending for the first time this year, Momentum 2013 promises to be thought-provoking, informative and fun for all!

   The Global Semiconductor Alliance recently published a paper co-written by Tensoft, one of our fabless semiconductor customers, and Amkor Technologies entitled Anatomy of a Successful Supply Chain Integration.  Since many of the semiconductor companies that I talk to on a regular basis have become habituated to living with and working around inadequate or nonexistent supply chain vendor integration, they sometimes have trouble envisioning the benefits that real integration can bring.  I often hear “We already get our WIP data from our vendors.”  Well, we can do a lot better than that!

When we’re talking about vendor integration, we mean automating the process of getting vendor data into your manufacturing/supply chain management (SCM) system and automatically updating production transactions.  Many companies do this manually for production completion transactions.  In addition to getting more data through supplier integration, true vendor integration delivers significant benefits to the Operations, Finance, Production Procurement and Customer Service teams, as well as faster data access for the entire company . . . all the way up to the executive level.

These benefits can be grouped into three key benefits: productivity, information velocity, and visibility:

PRODUCTIVITY

If you’re notified that you have a receipt or a production output transaction (something that says that inventory is changed or moved, in the sense of major production stage, not an in-process stage) or that you have to pay for something now, you’ll need to get that information into your SCM system because that data is critical to knowing the true state of your manufacturing process (where it is at major inventory points , whether it’s OK for accounting  to pay it, and when inventory value and ownership changes occur).  You can choose to manually enter that data, or you can choose to have that data streamed in, so that it can be reviewed, accepted and automatically entered into the SCM system.  Once you have enough significant transaction volume, the decision to automate this process is a simple business case that compares the cost of manual entry (in terms of both data entry time and also the time needed to re-interpret data) compared to the cost of adding a system that can automate this process.  The productivity enhancements that result from vendor integration offer benefits to both your company’s operations and finance departments.

INFORMATION VELOCITY

When information is entered manually from supply chain vendors, continual communication is needed to make things happen.  In this scenario, data moves slowly across your organization.   Alternatively, if you can depend on the supplier’s shop floor or manufacturing execution system to kick out a file that says “change – or a paypoint or receipt transaction -- has occurred” and you have a system like Tensoft FSM Vendor Bridges that can bring that data into your SCM/ERP system, you can simply log in and accept the transaction. The data then moves through the system much more quickly because your system is being triggered by the process itself rather than waiting for someone to manually enter the required data.   Increased information velocity helps the entire company, right up to the executive level. 

VISIBILITY

The basics for SCM inventory change requires production change or receipt transactions previously described.  These can be done manually in a spreadsheet, by manual review of invoices or other methods, but at some point, you need real transactions in your SCM system.  In-process data is not required for the SCM system to move forward, but if you’re a member of the production team who is either monitoring manufacturing activity internally – either from a shop floor system or externally form an outside supplier – and you’re also responsible for getting materials to your customers on time, how then do you know that a work center is going to deliver on time?  The WIP or in-process updates pushed out by suppliers tell you the production out-date, so that you can more readily anticipate answers like: Are things going to slip? What is the impact on my plan? When do I need to call the vendor or more directly engage to resolve issues?   Integration gives you insight into the process to take corrective action, which can greatly benefit the quality of your company’s customer service.  This provides a strong benefit for your operations, production procurement and customer service teams. 

With vendor integration of process data, you can answer key questions such as: When is the vendor promising things? Have they changed their promise date, and when?  How often do they change it?  Do they hit it on-time when they ship?  This is information that would be very difficult to collect manually, and with it, you now have hard data that you can use to talk to your vendors to improve their performance and execution. 

So, visibility into this process helps both in terms of monitoring and providing access to data that you can analyze and use for vendor performance, cycle time and yield, vendor change in terms of how long processes are taking, etc.  In addition, you’ll also have the ability to collect attribute or production information about the product – a very challenging and error-prone activity if done manually.  Many Tensoft FSM customers use the FSM vendor integration service to collect ten or more production statistics from each vendor and include that data in their product genealogy -- a vital facility that would be nearly impossible to do manually. 

As you can see in detail in the GSA Forum article that I mentioned earlier, the benefits of total supply chain integration are innumerable.  If your SCM is integrated with your outsourced vendors, as it is for Tensoft FSM customers using FSM Vendor Bridges, this is an entirely automated, accurate and pain-free process.

  If Gartner’s Jim Sheperd is right, “Multi-Enterprise Commerce” could be the next evolution of ERP.  Luckily for Tensoft FSM customers, they’ve already got some of the key elements for this in place, thanks to Tensoft’s integrated solution for the semiconductor industry! Here’s how Sheperd describes the current situation: “The real business problem that today’s manufacturers and distributors are struggling to manage takes place between companies, not within them.” Anyone in the semiconductor industry knows this business problem well.  In fact, the fabless semiconductor model offers some of the most complex supply chain scenarios today.   ERP systems were designed to handle traditional manufacturing not an outsourced model with multiple suppliers at each stage of the process.

Sheperd’s “Multi-Enterprise Commerce May Be What Comes After ERP” suggests that a solution to the inadequacies of today’s ERP would have elements of today’s e-commerce, sourcing and supply chain solutions, but would also need to “include finance, asset management, traceability, order management, and service.” And, the new solution needs to be “cloud-based services, rather than a series of on-premises systems hidden behind various firewalls,” although Sheperd emphasizes that the cloud alone doesn’t solve this issue

One key element of this solution is solved with Tensoft FSM’s Supplier Gateway, a service that allows Tensoft customers to automate an integration between their ERP systems and supplier data.  This is a huge time saver operations and finance teams, as well as customer service.  And, because production activity data is available so much more quickly and more accurately, the benefits flow through straight to the executive level.  

Tensoft’s solutions for fabless semiconductor manufacturing solve most – if not all – of the issues Sheperd raises, including cloud-based delivery, which has become almost a necessity for most of the companies in this industry. We’ll be interested to see if the term “Multi-Enterprise Commerce” catches on. We’re ready for it in case it does!

 In the technology industry, it often makes good sense to sell through a distributor channel.  It can pay off to give some advance thought to how these relationships are set up.  Here are some key considerations: 

1)    What types of distribution relationships will you have?  The "Sell through" model is one option.  This is when you are selling to a distributor while you already know the end customer.  A second model is "Sell to"   For this model, the distributor collates demand, and you do not know the end customer.  The first model is often chosen as a matter of convenience, or it may be chosen to meet international requirements, such as selling into Japan, or customs in China.  For the second model, your distributors need to anticipate demand, which requires that they take on more risk.

2)    You'll also want to consider the uniqueness and price of your product.  Commodity-type products typically will have one set of important variables for the distributor – price guarantees as their market value fluctuates, for example.  Higher end or unique products have another set of important variables.  For them, stock rotation or price rebates may be critical. 

Incentives to the distributors, and acknowledgement that their customers are not all the same, are also important considerations.  If your distributor is selling to "Major Player X," they will not get the same terms or pricing they will from "Minor Player Y."  Ship and debit agreements can set rebate targets for you to help your distributor deal with these market realities, giving them rebates on volume by product or rebates on sales to specific target customers.

 If there are major players in your industry that will be buying from your distributors, it is often helpful to know who they are.  Receiving point of sale (POS) data from your distributors on a regular basis can be extremely helpful, allowing you to see who their customers are for market and pricing analysis, and giving you some idea of how much inventory is in the channel as a demand or market health indicator.  The information you want from the distributor should be part of your negotiation with them.

Finally, you'll want to spend at least a small amount of time considering the realities of how your agreement will be tracked.  Overly-complicated methods that require extensive tracking and detailed computation may have the illusion of providing you with more revenue, but be realistic about the administrative cost required to track them.

 While marketing promotions vary widely across software companies, SaaS providers, hardware appliance vendors and other tech 2.0 companies, the effects on revenue recognition share one common theme – added accounting complexity. Working with a myriad of technology companies, we regularly find the need to define revenue recognition rules to accommodate promotion types spanning offers as diverse as subscriptions with 90-day “free” cancellations, maintenance bundled in the purchase of a perpetual license or added  months of service to a term-based agreement (13 months for the price of 12).

One such marketing promotion deferring revenue recognition into future periods is the product upgrade offer. An excellent example of this promo type may be found in a recent Microsoft announcement of a limited-time Office offer whereby purchasers of the current version will receive the next generation upgrade for free. Microsoft will recognize revenue once fulfillment is established, regularly at the point of license agreement activation (a.k.a. product acceptance), or upon the program’s expiration date (to capture the revenue on user accounts opting to not upgrade product versions in an orderly timeline). In Microsoft’s case, the total deferral is pegged at over $100 million.

Microsoft’s official press release may be read in its entirety at their corporate website: http://www.microsoft.com/en-us/news/Press/2012/Sep12/09-17OfficePR.aspx