One Impact of SaaS on Internal Controls: You Can’t Cook A Trendline

May 31, 2006 by Matt Ammerman

   There are many internal control implications derived from the new software as a service delivery paradigm – and most are just now being discovered as companies explore SaaS and the effects that it has on core internal business operations.  In the accounting realm, software as a service directs changes on both ends of the SaaS delivery pipeline – the provider and the subscriber.  Subscribers looking to outsource key enterprise applications must do so in a way that does not undermine their internal controls strategy with weakened monitoring of company data.  After all, outsourcing applications and data to application providers does not mean less accountability on the part of the subscriber.  Perhaps I will delve further into subscriber-side internal controls issues (customization, etc.) in a future article.  Today I’m writing to illustrate one particular internal control related benefit that the SaaS business model affords the SaaS provider (ISV, Application Enabler, Infrastructure Host).  The somewhat understated benefit is that SaaS revenue modeling rolls financial accountability into the actual process of moving cash and revenue streams through the financial system.  Internal controls procedures don’t have to be retro-fitted umbrella policies or hammers brought down upon traditional accounting practices; instead they are actually built into the accounting model that SaaS creates.

   An important thing to remember about software as a service is that it rewrites the provider revenue model almost entirely.  An SaaS provider’s primary revenue stream becomes exactly that – a flow of money (in the truest sense) over time, driven by term-based usage fees paid by subscribers (customers).  Please note that for the sake of this article I’ll be politely ignoring other money-making offerings such as Professional Services and Consulting, and I’ll focus on the major benefit of actual SaaS application provisioning and delivery.

   A popular pro-SaaS talking point is the benefit that a recurring revenue model has on financial projection.  Because revenue from subscriptions is a volume number, and is not tied to the binary yes/no of landing one time deals for $unknown, revenue and cash flow projections are closely coupled to the subscriber (customer) base growth rate trendline:

Subscribers x Growth Rate x Access Fees ($)

Rather than the less predictable statistics of the traditional formula:

Leads x Conversion Ratio x Average Sale Size ($)

   While I whole-heartedly agree with the statement that this change in revenue forecasting is beneficial, I don’t believe that the statement is fully mature without a relation to accounting process controls. Software as a service revenue models align, by nature, with best practices for financially sound internal controls because recurring revenue models spell out future revenue and cash flow expectations much more clearly than the often subjective estimates provided by traditional financial systems.  Such ‘estimates’ have proven to be the catalyst for high-profile legal issues rooted in financial integrity concerns, i.e. ‘cooking the books’ a la Enron.  So, while I agree that accounting practice benefits from a recurring revenue model, I believe that accountability practice is the true beneficiary.  

   Simply put, the recurring revenue models provided by subscription-based SaaS delivery roll accounting and accountability into the same control.  Order to cash flow and order to revenue streams are tracked by placing money in definite timeslots (monthly, quarterly, yearly) whose terms are the very foundation of the recurrence model, rather than the somewhat arbitrary practice of predicting sales based on a subjective, and difficult to moderate, account of lead conversion potential.

   And, of course, there’s Sarbanes-Oxley, with one of its primary goals being to institute a corporate revenue reporting compliance standard.  SarbOx exists to ensure that companies are accurately reporting revenue numbers.  To do this, SarbOx layers controls on top of accounting practices that track and verify numbers through the entire order to revenue process.  SaaS recurring revenue models, as explained above, have that built in since the order to revenue process and revenue projection models are essentially the same numbers.  Furthermore, the revenue numbers are so closely tied to subscriber base growth rates that past performance becomes a much larger (and undeniable) player in the formulation of revenue estimates.  In traditional models, previous performance effects on projections can be mitigated by tactfully inflating/deflating anticipated sales numbers, since $unknown can effectively be fabricated entirely, and is quite difficult to argue against.  In the recurring models of SaaS, the proof is in the pudding of time and subscribership.

   Given the increasing adoption of internal control procedures (an August 2005 IDC report showed 55% of public companies have made augmentations to their internal controls procedures as a result of SarbOx), software as a service stands as a key business catalyst on multiple fronts.  While it does introduce business challenges, it is surely a multi-faceted problem solver.  And, just like many paradigm shifts of the past, it does so by building refined approaches out of seemingly disjointed processes – concatenating hurdles and jumping them all at once.

Further reading: The Impact of Sarbanes-Oxley on Revenue Recognition Practices by Robert O’Connor, Softrax

 

 

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A Bucket of Parts is Not a Solution: Part 1 – The Source

May 16, 2006 by Matt Ammerman

There’s a well-known debate amongst corporate leaders out there that goes like this:

Leader A:  “Our company focuses on the customer, because our customer is our most important asset.”

Leader B: “Our company strives for a productive and enjoyable working environment, because our employees are our most important asset.”

Both sides are able to offer convincing arguments and many a related discussion results in stalemate, sending both participants back to their respective companies free to run them how they best see fit while agreeing to disagree.  Perhaps there is no right answer on this one, but this article serves to illustrate my take on it.

First, let me address those that fall into the same school as Leader A above.  Sure, your customers and clients are quite important to your business, after all, money has to leave someone’s pockets to fall into yours (How’s that for a bottom-line statement?).  It’s true though, that, when your customers are spending your business is succeeding.  In good times, your customer service initiatives are paying off and customers are spreading the word about their experiences with your product and support channels.  Happy customers lead to growth, it’s true, good customer relations is pure fuel for business growth and that is critically important at times.  But let me ask you:  What happens during severe economic downswing?  Times when growth is not your priority, but survival is?  All the brand-loyalty in the world isn’t going to make customers spend money they don’t have.  And there’s the Achilles heel of the ‘customers are our most important asset’ argument… when customers aren’t spending – or worse, can’t spend – money, they have the ability to betray you in a way that can destroy your business if you put too much weight on customer relations.  I’m not saying customer relationships and loyalty are not important… but most important?  If a company’s long term strategy involves only growth and makes no provision for a solid base during times of survival… well, sure, I can see customer relations being the most important catalyst for business.  I can also see that company going out of business.

Now, here’s my approach to the ‘our employees are our most important assets’ philosophy.  I tend to agree, actually.  But to me, the key is in the phrasing.  I emphasize the plurality of the term ‘employees’ in my argument.  The true power of your business, the power that won’t fade assuming you provide a consistently solid and enjoyable working environment, lies with your employees.  But just what is it about your employees that serves your business the most? 

Is it their looks?  Ha.  Their social ability?  It helps at times.  Their educational background?  Closer.  Their training?  Getting warmer.

Ok, I’ll tell you.  The single most important asset to your company is in the heads of your employees as they walk the halls, type away at their computers, and converse in the kitchen.  It’s their knowledge.  Without the collective knowlege of the people you hire, your business loses definition, let alone productivity and ultimately success.  From the knowledge to perform daily tasks to the knowledge of complex business operations…simply put, your employees’ knowledge is the fabric of your business.  It remains so during times of growth, success, downturn, and yes, even failure.

This is where my philosophy differs slightly from that of Leader B above.  We’re in agreement that employees are the most important support structure to a business – but I’ve extracted out a quality from the employees that is not included in Leader B’s argument.  Leader B would say “Keep them happy and they’ll be productive”.  It’s a sound argument if quantifiable output is your only business metric.  Companies go about this in different ways, from environmental stimuli (think Pixar) to wildly over-indulgent employee benefits (think Google).  The way I see it, these tactics build solid employees.  But I say, don’t stop there!  Build solid, confident, happy employees and then harness the power that comes from that.  Transfer the power of your employees to the strength of your company.  It’s the difference between ‘our employees are important to our business’ and ‘our employees are our business’.  If you aim for the latter, then as long as you have employees, you have business, resilient through outside influences and attacks. 

The way to build a solid, unified, company is to build solid employees and then equate their power with the power of the company as a whole; and the way to harness their power is by capturing and showcasing their knowledge.

It may seem obvious to some.  However, in Part 2, I’ll outline why I think many companies miss the boat when it comes to the true value of their employees and why building an unsinkable ship, one that can weather the storms of economic downturn, is almost possible with the power of properly managed knowledge.  And, I’ll explain what many leaders can learn from an 80′s television series.

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