Zuora FY2020 - playing a long game on subscription economy growth

The onward march of the subscription economy is gathering pace, and it's time to get ready for the next phase. That's been the message from Zuora CEO Tien Tzuo for the past year, which he reiterated following the company's Q4 earnings release on Thursday night. But the turbulent stock market proved less sanguine about the company's outlook and its stock price fell more than 20% at one point during Friday trading, before closing 10% down.

This was not a day to be talking about playing a long game, but that's the perspective Tzuo is taking, as he outlined in a call with us early Friday. The past year has been all about getting Zuora into shape for a surge in large enterprise adoption of subscription solutions. That won't happen overnight, but Zuora is ready for when it comes, he says:

When we look at it from a 3-, 5-, 10-year arc standpoint, it's really important for us to be a subscription platform for these businesses. Because then, when the revenue mix shifts, which it inevitably will, it flows through our system — our volume-based pricing model means we have an uplift in our business.

We're building growth vectors into the business, where we're seeding the business on things that we will get to harvest downstream as the subscription economy continues to evolve.

The trend towards subscription could even accelerate if the current stock market correction heralds a recession, he added — let's come back to that thought after a quick review of the earnings release.

Zuora FY2020 results - by the numbers

Total revenue for the quarter ended January 31st was up 11% to $70.4 million, bringing revenue for the fiscal year to $276.1 million, up 17%. Operating loss for FY2020 was $85.7 million on a GAAP basis ($40.3m non-GAAP). The guidance for FY2021 is for revenue to top $300 million while non-GAAP losses narrow to around $30 million.

The market had a negative reaction because the headline numbers were slightly below analyst expectations, and there was also the unexpected news that longstanding CFO Tyler Sloat is leaving to take up a new role elsewhere next month. But the company pointed to several highlights within the underlying numbers:

• Annual subscription revenue grew 25%.
• Professional services revenue grew more slowly because Zuora is succeeding in getting global systems integrators (GSIs) to take on this work, with the number of GSI-led projects tripling during the year.
• The number of customers with annual contract value (ACV) greater than $100,000 grew by 38 in the quarter, the largest-ever quarterly increase for this segment, and was up 19% for the year, to 624 in total. These customers make up 90% of annual recurring revenue.
• Despite some churn, due in part to M&A and business failures in the customer base, dollar-based retention was 104%.
• More than half of the 46 go-lives this quarter were outside of North America, up from less than a third historically.
• Three quarters of the new logos signed in Q4 were outside of the high-tech vertical, ranging across investment banking, vehicle and aerospace manufacturing, utilities, chemicals and pharma, and news media.

We've tracked Zuora's journey over the past year, including the appointment of a new Chief Revenue Officer and other actions to improve its performance in closing large enterprise deals. Those efforts are finally starting to pay off, as Q4 "saw better win rates and improved sales productivity" says Tzuo, and set a new record for bookings. But given Zuora's typical sales cycles, the full impact won't be seen until over halfway through the current year, he said on the earnings call:

I expect much of the business momentum to happen in the back half of this upcoming year, and setting us up for subscription revenue growth rates improving to the mid-20s by sometime next fiscal year.

Navigating the year ahead

Of course there's the small matter of the impact of the coronavirus pandemic between now and then, an unknowable that isn't factored into the guidance. Zuora is committed to doing its part to help keep employees safe and those around them while it takes its course. But based on the experience of previous market corrections such as the dot-com crash in 2001 and the banking crisis of 2008, Tzuo told me he believes there's every chance that once the worst of the crisis is over, then adoption of the subscription model will accelerate once more:

If you look at what happened in business, in 2001 and 2008, both times there was an acceleration of a shift — a shift to the cloud, a shift to SaaS. Why is that? Because people are realizing that having flexible subscription expenses is better than one-time cost. People are realizing that these digital services that provide better convenience, better customization and better outcomes, you see more companies willing to try some of these new services in these times.

It's hard to know what's going to happen. But I think it doesn't change any of the long term trends we've talked about, it doesn't change a shift to subscriptions, it doesn't change our market position, it doesn't change the strength of our technology.

In the meantime, the company has a clear path to cashflow break-even and plenty of cash reserves to see it through, he says. That roadmap is supported by the steps taken over the past year to reshape the business to serve larger enterprise customers such as Caterpillar, Ford, engine maker Briggs & Stratton, or French national railroad company SNCF. As well as building a strategic sales team and deeper partnerships with the GSIs, Zuora has been refining its suite of products and creating an extensible platform that allows for customization to specific industry or customer needs.

How car makers are using the Zuora platform

One example of how businesses are using the Zuora platform comes from automotive, where car makers want to offer connected services to drivers. Customers are using the platform to co-ordinate the delivery of those services to the car, whether that's a music streaming service, personalized directions, or ordering ahead for a drivethru takeaway, Tzuo explains:

We're a monetization engine. More and more we're being used to orchestrate entitlements, provisioning, e-commerce, and things like that. We're the orchestration engine that kicks off to make sure that accounts are set up, credit cards are validated, the billing system is set up, revenue is recognized — all delivered through a strong customer experience.

The platform allows for customization, such as building out the ability to use the Vehicle Identification Number (VIN) to match the vehicle to suitable services, and then connecting out to other capabilities such as Twilio's messaging platform for alerts and notifications.

People are building that all on the platform with our custom objects, custom workflow and custom notification. [It] allows the orchestration of all these different services to deliver a great customer experience.

All of this means that Zuora is uniquely positioned to capture the emerging demand from large enterprises for a mature subscription economy platform, says Tzuo, and now is the time for companies to make the move:

It's become an imperative. Their customers are more and more asking for this. They're saying, 'Why would I want to do a big capital expenditure? Why would I want to buy your big, million-dollar devices. Is there a way to make this more outcome based?'

It also opens up the potential to add new revenue streams alongside the subscription to the original product — which is especially attractive if sales of the physical item are in decline, he adds:

When you have a business that's based on usage, your business grows — we talk about the bigger trend of the end of ownership. In industry after industry, you're looking at unit sales continuing to decline — car sales, video console units, physical newspapers — but usage and consumption goes up. Miles driven goes up. We're all consuming more news than we ever did before. We're all listening to more music than we ever did before.

As software became SaaS, now everything goes XaaS

These other industries are starting to learn the same lesson that software companies learned in the early days of software-as-a-service (SaaS), says Tzuo, echoing a philosophy that diginomica calls the XaaS Effect, where XaaS stands for Everything-as-a-Service. The lesson learned by the early SaaS vendors is that being connected to customers while they're using the product brings enormous additional benefits, he explains:

You push your software out and then you realize you can actually see how your customers are using your product. For a bunch of folks that used to ship software and now know what happened to it, it was a truly amazing thing.

Now you imagine every car company, every washing machine manufacturer, every exercise machine maker, TV maker, desk and coffee machine maker — the engineers who design these things are going through the same experience. 'We know how our customers are using the product and we can deliver a much better outcome and experience for the customer than ever before. But it requires us to be agile, iterative, nimble.'

They're going through the same journey. The way you code software versus SaaS, that evolution now is happening with all physical products — not only products but professional services.

This is exactly the same vision that has been driving Zuora from the start, which is why Tzuo remains confident of the long-term outlook:

This is why we started the company. We took that mental leap, what if what's happening now in software happens to all companies? That's why the subscription economy changes the future. We're not after simple short term growth, we have to make sure we're poised to capture that long-term opportunity.

My take

The message certainly hasn't changed from those early days. This is what Tzuo told me back in 2008 when the company announced its Series A funding:

It's not just software that's moving to [a subscription-service model], it's entire industries. Within 5, 10 or 15 years, you're going to find yourself buying less and less stuff, you're going to be subscribing to things.

We really believe the Internet is just going to accelerate the shift from manufacturing to services, and that lends itself to a subscription-based services model.

Since then, that prescient view has become a commonplace observation, one that we've formalized in our definition of the XaaS Effect, within which the pay-as-you-go subscription relationship plays an important part. Zuora has established itself as the thought leader for the Subscription Economy and has proven itself in high-volume, complex subscription offerings across many different industries.

As we've noted in coverage of previous quarterly earnings reports during the year, that success has led to growing pains. Tzuo has been commendably frank about the headwinds Zuora has faced and the actions needed to correct its course. The company has been moving upmarket to serve larger customers and deliver much bigger projects — these have needed a different sales approach and the involvement of GSIs as partners, both of which take time to ramp up.

This adjustment has taken the shine off Zuora's topline numbers, although subscription revenue is still rising at a respectable clip. The challenge over the coming year will be to maintain that momentum in the face of new headwinds from the wider economic landscape. The good news is that our analysis of the trend to XaaS in a connected world concurs with Tzuo's view of the trend to the subscription economy. The more demand for conventional products stalls, the more businesses will look for new ways of generating revenue, which provides new opportunities for Zuora to shine.