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.

   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.

 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.

 I recently wrote about Warren Savage, CEO of IPextreme, and his work as the chairman of the Global Semiconductor Alliance's IP Interest Group. Warren is also spearheading the "Capital Lite Working Group."  This group's objective is to redesign the fabless funding profile, by reducing upfront costs to create a more attractive risk:reward ratio.  As a means to do this, they've created the Cap-Lite Resource Portal, a website which allows fabless start-ups to IP, tools and services from providers that utilize Capital Lite principles.  

For more information about Cap-Lite, please visit: http://www.gsaglobal.org/capital_lite_working_group/docs/20120326_resource_portal.pdf.  This seems like a no-brainer to me - looking forward to seeing the results. 

 I had lunch and a very interesting conversation last week with Warren Savage, CEO of IPextreme, and chairman of the Global Semiconductor Association’s IP Interest Group.   Warren’s company, IPextreme, commercializes and licenses intellectual property (IP).  They’re looking at how they can support the fabless community with IP building blocks, and what are the pricing models that are required for early stage companies to help with operational efficiency.   

The GSA’s stated mission for the IP Interest Group is: “To address IP industry challenges preventing consumers from success with IP. The IP includes: silicon, embedded software, verification and system level IP.”   During lunch we talked about some of the questions that the group is focusing on.  One of these is how to increase the number of semiconductor start-ups and improve the return on investment.  Another is, what is the ideal investor profile?  Another is, how do we lower the costs for start-ups?  And, finally, how can we best providing resources and efficiencies for fabless start-ups, putting everything together to create these companies faster, better and stronger? 

For more information about the IP Interest Group, go to http://www.gsaglobal.org/ip/index.aspx. 

 This topic is another great question from a Proformative reader or webcast attendee.  As a Proformative Topic Expert, I was asked to weigh in on this on that website already, but thought I'd also provide a slightly edited version here.

This is still a newer area in revenue recognition treatment, but it's a scenario that we're seeing more frequently.  E&Y has provided some good guidance in a paper called "Revenue recognition on the sale of virtual goods" - I'd recommend that as a good resource for starters. 

Essentially, there are three revenue recognition models tha may apply:

1. Game-based model (Average life of game) – Rev rec amortized over the anticipated game’s run. This is a bit tricky as it may be challenging to know how long the game will be popular among gamers if it is a new and untested title. Slowest form of revenue recognition as most companies are anticipating 5 year run rates or longer based on the investments made.
2. User-based model (Average user life) – Rev rec amortized over the average player’s gaming activity. The tricky part here is anticipating lulls when users have no activity but may come back months alter to start paying again.
3. Item-based model (Consumption model of virtual goods) – Most difficult rev rec method, but offers the quickest time to start recognizing revenue. Items need to be classified as either:

(a) "Consumable" - This meets the delivery test you mention in the post. But if the virtual item has a lasting effect on the user’s character even after physical consumption and the delivery occurred, the item may still need to be classified as durable.
(b) "Durable" – This is where the item enhances the user’s character over n extended period of time and may require amortization over the user's life (assuming the effects of the virtual item become part of the character’s attributes).

From a systems and general compliance perspective, the issue is how delivery is defined.  Is delivery giving the customer the virtual cash to spend, or is delivery the customer actually purchasing the virtual goods?  The latter has the feel for final delivery, but may necessitate very high volume percent complete / milestone delivery type revenue tracking for relatively small amounts of money.

If there is no physical effort required after the initial purchase transaction - and no additional cost incurred - you may be able to justify a revenue method based on the initial purchase of virtual cash. Options could include amortization of revenue straight line over the usual customer consumption period (sort of an inventory turns model), or on purchase, or two months after purchase. It would be helpful to find a simplifying assumption to help with the detailed revenue transaction management.

The following excerpt from the Zynga 10K (using the Item-based model) may be of interest:

“The proceeds from the sale of virtual goods are initially recorded in deferred revenue. We categorize our virtual goods as either consumable or durable. Consumable virtual goods represent goods that can be consumed by a specific player action. For the sale of consumable virtual goods, we recognize revenue as the goods are consumed, which approximates one month. Durable virtual goods represent virtual goods that are accessible to the player over an extended period of time. We recognize revenue from the sale of durable virtual goods ratably over the estimated average playing period of paying players for the applicable game, which represents our best estimate of the estimated average life of durable virtual goods. If we do not have the ability to differentiate revenue attributable to durable virtual goods from consumable virtual goods for a specific game we recognize revenue on the sale of durable and consumable virtual goods for that game ratably over the estimated average period that paying players typically play that game.”

Going forward, it will be interesting to see how social gaming companies deal with the issue of virtual sales in real life.  I expect that this is evolving.

 This question was posed by an anonymous Controller yesterday on Proformative: "Is there a revenue recognition software that is ideal for SMB's?"   As one of their Topic Experts, I provided a brief answer there, and wanted to expand on that further here.

While there are a number of industries with complex revenue recognition requirements, I think it’s safe to say that, in general, technology and software companies are the largest affected segment, as well as the most affected.  For these companies, the ability to scale quickly is often a critical business need.  Given that, a better way to state the question might be: “Is there a revenue recognition solution that will scale with our business, supporting the pricing and performance our company needs now and as our organization grows?”

One challenge for people in technology-related companies is that their expected capabilities are often set by expectations of upper mid-market or enterprise sized businesses in their industry.  These expectations can be a serious mismatch when the company’s current budget and/or transaction volumes fit what you would expect in the SMB market.  One of the main reasons to consider a revenue management solution is to meet the increased challenges and expectations that result from growth.  In this environment, what was easy to manage in a spreadsheet yesterday may quickly become unstable and unscalable.

My company has been offering revenue recognition applications for nearly five years.  Our customers span businesses from “early ramp” to large midsized organizations ($500M+). To the question’s point – yes, solutions are readily available which may be ideal for SMB’s.

 I had the opportunity to weigh in on another great question on Proformative this week, this one from a finance executive who's interviewing with a SaaS company and wanted a quick update.  His question was: "With all of the pronouncements coming out on software recognition, has there been any substantial changes to the basics, i.e. we would have a monthly subscription fee revenue (take full revenue in month they were charged and used the product) and any support and maintenance would be amortized over the contract period?"

Here's the brief answer that I provided there:

"Yes - most definitely.

EITF 08-1 impacts SaaS companies because it changes the prior guidance of EITF 00-21 from the Residual Method to the Relative Selling Price Method. The criteria for separating contracts into separate elements is also different under 08-1.

SaaS companies may find there are more elements to account for in transactions and they are required to have values for all elements, not just the undelivered elements. Because 08-1 is a recent accounting change, best practices are still evolving.

Companies may find that their current accounting system may not adequately address issues under the new guidance and may need to consider manual workarounds or changes to their accounting system and polices.

Good luck with your interview!"

While discussions related to IFRS (International Reporting Standards) unification with US GAAP continue to drag on, the joint FASB/IASB revised revenue recognition proposal is moving forward.  This specific effort will unify revenue recognition internationally and is slated to go into effect in 2015. 

2015 may seem comfortably far away for many companies.  However, public companies (or companies planning to go public) are required to maintain three years of historical records on the same accounting basis.  These companies will need to start almost immediately if they wish to track revenue by both sets of standards for the required three years. 

In addition, private companies in certain industries – including the technology and software industries – would be wise to review the impact of the FASB/IASB project now, and start planning.  For them, the old revenue standards of SOP 97.2 and EITF 08-01 will be going away, moving everyone closer to the 08-01 relative value allocation model for any Multi-Element Arrangement. 

One question that everyone should be asking is: Can my current accounting or ERP system handle complex revenue recognition requirements?

In general, ERP systems are built for broad markets and often lack specific vertical industry functionality such as complex revenue, billing and contract management.  This is why large ERP vendors nurture relationships with third party vendors who provide the complementary products that meet these vertical industry challenges.  And that’s exactly where Tensoft Revenue Cycle Management (RCM) fits into the picture. 

Tensoft RCM currently supports all of the technology industry related revenue standards, and will support the final new GAAP standards when they are finalized next year.   To help keep current with this changing environment, anyone can register on Tensoft’s Resource Center, where we provide access to white papers, articles and recorded webcasts such as "The FASB IASB Exposure Draft on Revenue from Contracts with Customers." We also regularly offer CPE-eligible online training and educational webcasts from industry thought leaders, and will notify you about these upcoming events if you’re interested. 

 Myth number three in our series on myths about ERP selection and implementation is:  

“Customizing/configuring an integrated ERP system is preferable to adding best of breed solutions, because you’ll still have an out-of-the-box solution after customization, which is much easier to implement and maintain.”   

This myth seems to have been promulgated in recent years as ERP vendors have added more tools to enable configurability.   While this is a trend that we can all be happy about, a great deal of confusion has risen over where configuration stops and customization begins. 

The short answer to this question is that customization involves writing code.  However, vendors may sometimes use the term “configuration” in a less than accurate manner, leading customers and prospective customers to believe that an entire module can be "configured."  Creating something where nothing existed before generally involves writing code.  Even if it's done with the tool set that is part of the product in question, someone will be writing new code with that tool set to create the heretofore missing functionality.  

This can complicate and substantially raise the cost of implementations and maintenance, and make upgrades a great deal more difficult and expensive.  And, these changes run the significant risk of relegating your company and solution to a “community of one.”  For more about the dangers of going solo in the areas of software development and software ownership, you may also be interested in reading “The Dangers of Customized Solutions – Part I” and “The Dangers of Customized Solutions – Part 2.”

As an alternative to customization, I’d suggest that you look at available best of breed solutions to fill gaps in your out-of-the-box ERP solution.   Service oriented architecture (SOA) has opened some doors for integration improvements that simply weren’t there when the “integrated systems vs. best of breed” argument first began.   

"Out-of-the-box" and "customized" are mutually exclusive.  The benefits that you're looking for in an out-of-the-box solution are often met with best of breed solutions.