Why Zuora : Zuora Provides a BluePrint to Succeed inthe Subscription Economy!

Measuring the Performance of Your Subscription Business:The Three Metrics that Matter

Measuring profitability of this business is easy

…this one isn’t as clear

The Problem of Assessing Subscription Companies

High growth subscription companies are often “unprofitable”

Yet the markets value subscription revenue at twice product revenue

Fast Growing, Money Losing, Highly Valued SaaS Vendors

4

-25% 0% 25% 50% 75% 100%

-80.0%

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

FireEye

Workday

Tableau

NetSuite

Marketo

Salesforce

0.0x

Intuit

Microsoft

Oracle

SAP

Splunk

Adobe

Revenue Growth

% N

et In

com

e

Companies moving to SaaS have high valuations even with negative

growth.Legends:Size of Bubble = Valuation/Revenue

SaaS

Mixed

Software

Only 30% of public SaaS companies make a profit!

Financial Differences

Sale Subscription Annuity

Revenue Acquisition Costs

Prior to Purchase Prior to Contract

Profit from Sale At Delivery Over Life of Customer

Revenue and Profit

Predictability

Large Profits, then nothing until next sale

Greater Profits, but over the Life of the

Customer

Comparing financial results requires a different analysis

Revenue comes later with Subscription Companies;Much later with High Growth Subscription Companies

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8$K

$20K$40K$60K$80K

$100K$120K$140K$160K$180K$200K

Purchase versus Subscription Annual Revenue – No Growth

Purchase

Subscription

Ann

ual R

even

ue

100 New Deals/Year$3K Purchase versus$1K Annual Subscription10% Annual Churn

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8$K

$100K

$200K

$300K

$400K

$500K

$600K

$700K

Purchase versus Subscription Annual Revenue – 30% Growth

Purchase

Subscription

Ann

ual R

even

ue

100 New Deals/Year$3K Purchase or$1K Annual Subscrip-tion10% Annual Churn

We need financial analysis methods to value long term profitability of the growing Subscription Annuity stream, not just short term profit.

The Limitations of GAAP Financials

GAAP is backward looking not showing the value of the recurring revenue stream

GAAP Income Statements do not give insights into the health of a rapidly growing subscription business

Subscription Financials Analysis Requirements

Build on GAAP standards

Recognize the future value of the Subscription Recurring Revenue stream

Measure the Revenue Acquisition Costs against the Recurring Revenue stream

Segregate the costs of Running the Business from Acquiring New Business

*at a sustainable cost

Subscription Businesses are all about Efficiently Building the Recurring Revenue Stream*

3 Metrics Measure Subscription Business Efficiency

Churn

The revenue that is lost and must be replaced

Growth Efficiency

= Revenue Acquisition Costs/ New Annual Recurring Revenue

The cost to obtain a dollar of new subscription revenue

Recurring Profit Margin

= Subscription Revenue – (Cost of Subscription Services

+ R&D Expense +

Administrative Expense + Acquisition Cost of Replacing Churn)Profit excluding Costs of Incremental Revenue

Key Metric: Churn

Churn destroys the value of the subscription revenue stream

Churn must be replaced raising the total cost of Customer Acquisition

Churn should decline over time

Ch

urn

Ra

te

Time as Customer

Churn Targets

More Customer Commitment Lower Churn

Customer Engagement (Use) predicts churn

0%

5%

10%

15%

20%

25%

Churn

Target Churn<10%<20% <25%

B2B EnterpriseB2C SMBB2C

Key Metric: Growth Efficiency Index (GEI)

The company’s ability to grow is constrained by the cost of growth

The acceptable GEI is a function of churn

The GEI should decline with company maturity

Salesfo

rce

Workd

ay

NetSuite

Box*

Zendesk*

0%

50%

100%

150%

200%

250%

300%

35%

104%

31%

111%88%

152%

75%

154%

262%

111%

Growth Efficiency of Public Companies

% Growth Growth Efficiency* Pre IPO

Growth Efficiency Index Targets

GEI will be high during the early company life

New Customer Acquisition is Expensive

Customer Expansion is much less expensive

Later Stage subscription companies have lower GEI

Target GEI

~.5~1.0~1.5+~2.0

B2C, High ChurnB2B, Later StageB2B, Growth StageB2B, Launch Stage

Key Metric: Recurring Profit Margin

Recurring Profit Margin is the estimated profit with no growth

Additional Sales & Marketing expenses will fund growth

0% 10% 20% 30% 40%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

26%16%

6%-4%

-14%

COGS Sales & MarketingR&D G&AProfit

Growth Rate

Exp

en

ses

Recurring Profit Margin with no growth

Sales Efficiency 1.0x

Subscription Businesses trade-off Profitability and Growth

Recurring Profit Margin Targets

Recurring Profit Margins should reach 30%+ with company scale NetSuite Workday SalesForce Box

-150%

-125%

-100%

-75%

-50%

-25%

0%

25%

50%

75%

-15%

-33%

-6%

-128%

55%

28%

57%

20%

% Operating Margin % Recurring Profit Margin

Subscription Businesses are all about Efficiently Growing the Recurring

Revenue Stream

3 Direct Measures of Growth

• Increase in ARR– Value of all Subscriptions contracts at a point in

time

• Increase in Revenue– Includes all revenue from the business

• Increase in Cash Flow– Focuses on the cash generated from operations– Should exceed the income from operations

The median growth of public and private SaaS companies is 30%

Customer Lifetime Value Predicts the Value of Subscriptions

• Customer Lifetime Value (CLV) is the Predictive Measure of the Net Present Value of the future Subscriptions Gross Profits

• Customer Equity is the sum of Customer Lifetime Values

When Customer Equity is growing rapidly, loses are defensible

Customer Equity

Annual Recurring Revenue

Cost of ServiceChurn

Cost of Capital

Customer Equity = Total Recurring Revenue – Cost of

Service %Revenue Churn

+ %WACC

Target Revenue Acquisition Cost from CLV

• Revenue Acquisition Cost < 25% CLV– Comparable to Product Sales

• Growth Efficiency Index < 25% CLV/ARR – Equivalent measure based on GEI

Tying it all together in the Subscription Financials

Contrasting Public Software & Subscription ProfitsSubscripti

on Companies

Software Companies

Revenue 100% 100% Cost of Service* (30%) (33%)Gross Profit 70% 67%

Operating Expenses S&M (39%) (23%) G&A (17%) (10%) R&D (18%) (15%)Total Op Ex (73%) (49%)EBITDA (.3%) 19%* Includes low margin professional servicesMedian Growth

26.0% 9.9%

Economic Value/Revenue 8.0x 3.2x

Source: SEC Software Equity Group, Q1 2014 Software Industry Financial Report

Public Subscription companies have over twice the valuation ratios of Public Software companies

Alternative Income Statement Presentation

Revenue 100% Cost of Service -20%Gross Profit 80%

Operating Expenses S&M -40% G&A -15% R&D -20%

Total Operating Expenses -75%

EBITDA 5%

Revenue 100%Cost of Ongoing Operations Cost of Service -20% S&M - Churn Replacement -10% G&A -15% R&D -20%Cost of Ongoing Operations -65%Recurring Profit Margin 35%S&M - Incremental Revenue -30%EBITDA 5%

Traditional Income Statement

Subscription Income Statement

Yearly Metrics: Prior Current GrowthRevenue 100 130 30%Ending ARR 115 150 30%Revenue Churn 10% 10% 0%Cost of Capital 10% 10% 0%Customer Equity 576 749 30%

Growth Efficiency 1:1 1:1 0%

Yearly Metrics:Prior Current GrowthRevenue 100 130 30%

Summary

GAAP financials show the historical company results.

Growth in Customer Equity and Recurring Revenue measure the company’s growth and future revenue.

Recurring Profit Margin of existing subscriptions should be separated from the costs of new revenue.

Subscription Metrics of Growth Efficiency and Churn are the Key Performance Indicators of cost effective growth.

The growth in the company’s Customer Equity measures the increase in company value.

Contacts

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Iain Hassall, VP Finance & Corporate Controller, Zuora

Twitter: @iainhassallEmail: iain.hassall@zuora.comPhone: +1 650-241-0658

Dave Key, Managing Director, CloudStrategies.biz

Twitter: @DaveKey0Email: dave@cloudstrategies.bizPhone: +1 949/887-4401

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