Your traditional business model is obsolete. So assume this -- everything you think you know about staying competitive is no longer relevant. Tyler Sloat, CFO, Zuora
As a core member of the C-suite, the chief financial officer (CFO) has always played a key role in business. But since the economic downturn in 2008, CFOs have found their responsibilities expanding greatly to respond to market changes, a challenging regulatory environment and quickly evolving technologies. The Modern CFO is responsible for more than just a business finances; he is expected to have a much bigger stake in business ownership, responsible for critical business decisions and ultimately being the primary driver of the business model.
A recent survey of Fortune 1000 CFOs found that the vast majority — 81% — believed they worked at companies that viewed their finance role as a “strategic business partner,” involving the CFO in top-level decision-making as never before. And CFOs predict their role will continue to change as they shift what they spend their time on and for how long.
But why is this happening? What is going on in the market to force this transformation of the finance function? Read on to learn more about the Modern CFO, how your business can respond to global shifts in a way that makes sense and sets you up for success.
To figure out why this shift is occurring, it’s helpful to take a step back from the CFO function and look at business holistically. We find that businesses are changing in every vertical and in both small and large companies around the world. And the changes are driven not from the top down, but from the bottom up: by consumers.
That’s because today, consumers expectations have radically shifted. They have access to more information and therefore demand more from the brands they choose to give their business to. They expect their experience with your brand and service to be personal and that you will provide on-going value in real time.
Nowhere is this shift more in evidence than in subscription-based businesses. In subscription businesses, the consumer—not the product—is at the center of everything. No longer is the transaction the holy grail; subscription businesses are built on and fueled by relationships. Netflix, one of the subscription economy superstars, had built a perfectly fine business by offering consumers easy ways to view their favorite movies and TV shows. But the way to protect its business from upstart competitors offering the same service for less (or some other game-changing move), Netflix hit upon a way to create a deeper relationship with its customers: creating original content that was available only on their service. You don’t have to be an industry insider to know how expensive it is to write and produce shows like House of Cards or Orange is the New Black, so the fact that they invested so much in their award-winning programming shows just how valuable that customer-brand relationship really is.
In today’s subscription businesses, every aspect of the company is involved in deepening that customer relationship: sales, marketing, customer service, IT, finance and more. Here’s a quick rundown of how successful subscription companies do business:
But today, the person owning this new business model is the Modern CFO. It is this role, and this role only that has the quantitative knowledge to be able to understand how certain business levers affect the business.
As business models shift, so too do the ways success is measured. That’s why today there are several unique finance-related metrics every subscription CFO should be held accountable for.
In a subscription business, your retention rate is arguably the most important metric. You’re going to spend a lot of money acquiring customers and you’re also going to spend a lot of money to keep them. If you don’t have visibility into how many customers you’re retaining versus losing, you won’t know how much to spend and whether you’re spending it in the right place.
Think of retention rate as the inverse of churn. Simply put, churn are the raw dollars leaving the system. If you think about Annual Recurring Revenue (ARR), the highest level metric for your business, the increment to ARR is Annual Contract Value (ACV). The decrement to ARR is churn.
Most subscription businesses run on ARR, and it’s the obvious metric you’re trying to maximize. But it’s just as important to make sure you prevent churn by increasing your retention rate.
Growth Efficiency Index
Growth efficiency index (GEI) is a measurement to understand what you’re spending to acquire your customers. Simply put, it is the cost of sales and marketing over any new ACV. Depending on your business or your sales cycle, you may want to measure the sales and marketing expense in a prior period against new ACV of a current period
Recurring Profit Margin
Recurring profit margin is where subscription businesses start to really stand out as a different model. How do you know when you’re running a profitable business? When you know your acquisition cost along with the efficiency of that acquisition. This recurring profit margin is the indicator of where you stand as a profitable business or the cost to support your existing install base. That existing install base is reflective of your entering ARR.
Even though you’re a subscription business, one-time charges should not be dismissed, and if you’re not careful this metric can sink a business. For example, several SaaS companies have a professional-services component to their model that charges per instance, not on an ongoing basis. Or if you’re a hardware company attaching services to a device and the hardware becomes a loss leader for the business, your hardware would be your one-time charge.
Understanding the margin on your one-time charge and making sure that it is not something that is going to be a burn on the business is incredibly important. Of course, you can choose to lose money on your one-time charge, but you really need it to be predictable. If it’s unpredictable, the more you sell the more you potentially lose and your business will be sunk.
The Modern CFO should consider institutionalizing these metrics into their business and evaluating them every quarter to make sure the business is on sound footing.
Once you’ve learned how much of the new subscription business model the Modern CFO is responsible for, the next challenge is to make sure everyone else in the C-suite gets how important these shifts are to the viability of your business.
As CFO, you need to be able to communicate those measurements specific to a subscription business and educate the executive staff on how you make business decisions based on those measurements. The best way to do this is to have a tool in place that becomes the “bible” of your measurements and the platform for communication. In fact, this document is critical.
Once you educate everybody it becomes very simple for executives to understand and get on board to the decision you’re making. For example, when you communicate these new objectives, the executives in charge of non-growth (engineering, product, tech ops and G&A) will understand that they don’t get to grow until ARR grows, and the faster you can get our ARR to grow, the more you’ll get to invest in the future.
With growth functions like head of sales marketing, you can let them know that you’re holding them accountable to a specific GEI because the model is set up so that if you give them dollars, they need to be very productive with those dollars.
If everybody is aligned on the model because you’ve expressed this through clear measurement and communication the business should experience deep acceleration.
How do you put that measurement and place in that company?
I can’t tell you how to run this for your business but I can tell you how we do it at Zuora and how it leads to making decisions and iterating.
What we do is not novel. We didn’t invent it. But I haven’t talked to a lot of companies that put it into the detail that we do.
We have a system called PADRE which stands for pipeline, acquire, deploy, run, expand and then we add PPM to the bottom for product, people and money.
The PADRE team is an expansion of our executive staff, but owned by our CFO. Every Monday this team meets to dive deep on every single element you see in our PADRE framework.
We start at the beginning of the funnel to report on the number of hits to our website, how they convert to leads, to opportunities and finally to new deals. And we actually look at these through multiple dimensions. For instance, how does that pipeline cover our territories? Where do we have health and where we don’t — both in terms of opportunity value, as well as Sales Rep coverage.
Then we move to acquire to look at how those Sales Reps are performing. And are we getting efficient in the way we’re investing in the entire growth side of the business?
Deploy is basically the professional services side of the business. In an on-demand world, it’s vital to get your customer live on your product as fast as possible. Not to mention, a critical stage in your relationship with your customer. This is where you deliver on everything you committed to as a brand prior to acquiring them as a customer.
On the run side, what are the support tickets looking like? How are we thinking through account management? How are we thinking about adoption and training?
Once all that’s been addressed we can talk about our expansion strategies. How do we iterate on our model for growth optimization? How do we nurture our customers with upsells and cross-sells.
Now, on top of PADRE there’s all this other stuff (PPM) that affects every part of PADRE. For instance, the road map. How do we plan to continue to deliver greater value to our existing customers in the future, as well as new customers we haven’t acquired yet? Should we be thinking through new verticals and geographies?
And how do we build out our people as they align to the PADRE framework that supports the objectives of our model? And how do we allocate our funds that support the model?
Regardless of whether you utilize PADRE or some other form of measurement, it’s critical that you have something in place that can act as the communication framework to make business decisions based on key metrics.
If you’re a CFO of a subscription business, no longer do you have to be responsible solely for the pure finance functions of your business. Now you can use your talents, experience and insights to guide major operational and strategic decisions within your company, playing a role even as the external face of the organization.
And with the key metrics of business success shifting, too, your ability to measure and analyze these metrics in a way that other C-suite members can’t will be crucial to your company’s success. Because the customer is now the center of your entire business, you have the ability to shape your business model by how you acquire that customer and then keep that customer through an iterative process. If you lose your customers, you lose your business model.
The Modern CFO now owns that business model and the levers that control it. You need to be able to educate the rest of your company about what makes sense for your business and then keep the communication path and the measurement path in place so that smart decisions are made at all points along the way.
By dedicating yourself to this type of new CFO strategy—versus the traditional tasks—you’ll be able to empower your teams, solidify your company’s relationships with your customers, and be the prime catalyst for major growth in your business.
For a slightly more visually appealing version of this article, check out our infographic below.