The latest half-yearly edition of the Zuora Subscription Economy Index came out last month, providing valuable insights into how various industries are adopting pay-as-you-go digital services. There's a different story around each of the three sectors most affected by this shift — software, media and manufacturing — and what the statistics tell us about their journey to date and the potential to spread into other sectors.
We take a particular interest in this topic at diginomica because we see digital subscription services as one part of the overall trend towards what we call XaaS, which stands for Everything-as-a-Service, or simply X-as-a-Service. Digital services represent a fundamental change in how enterprises do business, because of the continuous digital connection between the vendor and its customers' use of the product or service. The pay-as-you-go subscription is just one element in the whole XaaS business relationship, but it's an important one and a useful bellwether of overall adoption.
In conversation earlier last month with Tien Tzuo, CEO of Zuora, he emphasized the ongoing momentum the company is seeing as consumer choice and technology advances continue to drive adoption. He said:
That's a fundamental shift as customers. We're not going back to buying products when we know services are better. Technology is enabling this. AI is going to mean more things are going to be in the cloud, more things are going to be services.
So what do the Zuora's findings, which are based on data sourced from its own customer's subscription billings throughout 2022, tell us about each sector's journey and their future direction? And what about industries that don't yet feature in the Zuora findings? Here are some thoughts.
The software industry wasn't the first to turn to digital subscriptions, but in the past two decades this has rapidly become its default business model in the form of Software-as-a-Service. SaaS is also the sector where Zuora started out — Tzuo founded the company after being one of Salesforce's earliest employees, where he witnessed its challenges in managing subscriptions. Unsurprisingly, therefore, the Subscription Economy Index (SEI) finds that SaaS is its fastest-growing sector, with participants posting 12.3% revenue growth on average in 2022. The report also notes that SaaS vendors have now reached a significant level of maturity in how they operate the subscription model. It says:
They are now focused on optimizing the subscription model via leading-edge practices in customer success, using advanced techniques to acquire and retain customers, deliver measurable value, and create opportunities for expanding their relationships.
It's likely that some of these developments are a consequence of SaaS being primarily a B2B sale, where sophisticated customer success functions have evolved to help ensure customers realize the expected value of a complex sale. It's perhaps also a reflection of Zuora's focus on high-volume and complex subscription management, in a competitive market where SaaS vendors with less demanding subscription requirements have many other options available to fulfil their needs.
While the software industry can boast two decades of selling its wares on subscription, publishing can point to more than two centuries of subscriptions. Remember that Charles Dickens rose to fame and fortune in Victorian England by writing his novels in monthly installments. That's not to say that the transition to digital subscription services hasn't been disruptive, but it's been a different journey than the one undertaken by the software industry.
As well as publishing, the media sector of the SEI also includes many other content providers such as streaming media companies, broadcasters, search engines and more. Overall, average revenue growth in 2022 was 4.6%. The report attributes this slower growth to the sector having become highly competitive, with many new entrants and a strong skew to the consumer market, where subscriber retention can be challenging.
Zuora found early success in the media sector, but again it has many competitors, including vendors that have a history as legacy providers of subscriptions in the pre-digital days, as well as newer startups. Last year, it expanded its footprint in this space with the acquisition of Zephr, which focuses on the subscription experience — in other words, tracking and nurturing subscriber engagement to maximize retention and upsells. Zephr is on a rapid growth path and Zuora expects to be able to sell its capabilities to other sectors beyond media. Tzuo told me:
Those acquisitions just make a lot of sense. We know that there's demand for what they do in our customer base. And we know that we've got the heft where we can bring that technology and immediately have a revenue impact.
Consumption-based relationships have a 60-year pedigree in the manufacturing industry, dating back to the introduction by engine maker Rolls-Royce of its 'Power-by-the-Hour' engine maintenance programs in 1962, in which airlines paid for jet engines based on a fixed hourly rate of flight time. This facilitated one of the core benefits of the XaaS model — an alignment of interests between the manufacturer and their customer on a single outcome, in this case minimizing downtime for breakdowns and maintenance. The service became digital in 2002 when the company added continuous data monitoring of its engines in flight.
Today, virtually every manufacturer is thinking about how to digitally connect its products and whether to invest in new digital services for customers, even if they're cutting back elsewhere in their operations. Tzuo comments:
They're really excited about these new digital services that are possible, now that all their products are connected. Now's not the time for them to hold back on this investment. Plus, when you look at these companies, [they] are $30, $40, $50 billion companies. The digital services division is a small division. If they are going to cut, this isn't making sense to cut here ... They continue to invest in digital services.
Having said that, there's more trial and error in this sector as businesses try out different models and service offerings. According to the SEI, manufacturing saw a sharp drop in subscription revenue in the first quarter of 2022, but has since recovered to post 3.1% average revenue growth for the year. Automakers were particularly active in introducing new subscription services during the year.
While there are some pay-by-results propositions — paying for tires by the mile, for example — many of these offerings are more focused on adding digital services around the core product rather than bundling the product itself into the subscription. Tzuo says:
We're seeing digital services. Can we sell the product the same way, but now there's all these new revenue streams from value-add that we can offer through digital services.
Services and beyond
One sector I'd be interested to see broken out is professional services, although I recognize that's not going to be a big sector in Zuora's own customer base at the moment. However this is an industry that has a history of offering its services on a retainer basis — diginomica for example pays a monthly fee for its accountancy services, and also for legal services — and if you look at subsectors such as technology services there's a definite move towards packaging up services into more of a fixed-price subscription proposition. Meanwhile in manufacturing, ongoing maintenance is often packaged up as a monthly or annual contract, and some businesses have developed quite sophisticated pay-by-results propositions.
Given the upsurge in interest in the automotive industry, there may be an argument for breaking out transportation as a sector rather than keeping it within the broader manufacturing sector. I was intrigued to discover a few years ago that the mass transit industry has adopted the concept of Mobility-as-a-Service. While the notion that autonomous vehicles will soon transform our cities seems to be receding into the distant future, the growth in rideshare and other on-demand mobility services, added to the initiatives being explored in the traditional auto industry, means this is a significant sector overall.
The other sector I'd be interested to see tracked is retail and consumer goods. With Amazon Prime one of the world's largest subscription services and other players such as Dollar Shave Club making waves, the notion of consumer goods on subscription certainly has some momentum.
The move to subscription and broader XaaS models is already much bigger than most people realize, I think. Digital technology has enabled a richer connection to the customer and much more granular measurement of various metrics to be able to provide new ways of metering and charging for usage. Zuora's SEI is a useful barometer of rising adoption, but in many ways is only measuring the tip of a huge iceberg of broader momentum.
However for many businesses, subscription is just another revenue stream and the ability to add digital services is seen as a way to increase revenue, rather than forge a deeper relationship with the customer that's focused on value. In my view it's only if enterprises look at the entire customer journey and understand what customers are getting out of the relationship that they will succeed long-term with these new models.