From Booking a Deal to Converting it into Annual Recurring Revenue (ARR)
You book $900K deal for a 3-year period on July 1st, 2020
- Under a license model, you’d book $900K of revenue on July 1st
- Under a license model, you’d book $900K of revenue on July 1st: $900K/ 3yrs = $300K/2 = $150K 6-months of recognized rev. You may also choose to recognize revenue daily.
When you recognize the $900K deal under a subscription model, you ‘depress’ revenue optically speaking; it’ll somewhat normalize for this negative effect after you shift to an ARR model
- The $900K contract will be signed July 1st, again though you’d post an annual recurring revenue increase of $300K on July 1st. The remaining $600K makes it to your backlog (this also depends on how you calculate the backlog).
Even though your ARR increases by $300K, you recognize revenue ratably through the year
- You recognize $75K in the third quarter and another $75K in forth, for a complete of $150K in 2020/Yr1.
Before going into more detail, I feel it’ll help to look at some of the basics behind the benefit of having or transitioning to a subscription model.
Growth Rates are often Sustained Longer
A subscription model gives you higher growth rates for an extended period of your time. Subscriptions are recurring and represent a foundational ground for your revenue in future years. For a $100K revenue in 2020, under a license/maintenance model you should sign, give or take, $88K of new business in 2021 to grow your total revenue by 10% (assuming $22K in maintenance rev). If you’ve got a subscription model, you have the $100K signed in 2020 and simply have to sign $10K of new business to keep the pace; the remaining in subscription revenue comes from the recurring revenue stream. Of course, I assume here 100% renewal rates for both the license/maintenance model and also the subscription model. So if you’ve got a…