/// Wall Street Loves Workday, But Doesn’t Understand Subscription Businesses
Workday had a monster IPO last month, pricing well above the top of its range and closing its first day with a pop of nearly 75 percent, and Wall Street seemed to respond well to the company’s first quarterly earnings report on Wednesday. Founders Dave Duffield and Aneel Bhusri have been around long enough to know that this is simply a beginning, and they also know that as much as investors love subscription businesses, Wall Street has a fundamental misunderstanding of how to accurately value them. In the last few years, a new business model has taken hold — it’s happening in music (Spotify), transportation (Zipcar), consumer goods (Shoedazzle), and of course, in the software industry with the dominance of the cloud as the preferred model for consuming applications. But even while the Subscription Economy has taken hold across multiple, multi-billion dollar industries, investors, analysts and investor media continue to miss the fundamental differences between product and subscription companies that make their financial measurements just as different: Subscription business are about building and monetizing recurring customer relationships, not about building and shipping units for discrete one-time transactions. Subscription businesses are forward-looking, not backward-looking. The health of the business is in what it is likely to make this year, the next year and the next, not what it has shipped, earned and spent in the past period. Subscription companies operate on recurring revenue and recurring expenses and therefore care about recurring profit, not operating profit. Just think about it. We all know that if Bob is willing to give you $100, while John is willing to give you $100 a year for the next eight years, John’s offer is much more valuable. In the same sense, subscription businesses should be a more attractive investment than traditional one-time sales models. With a subscription revenue model, each year you start off with a known revenue level, versus having to chase every dollar of revenue, each year, from ground zero. Whereas in the traditional model, you invest in R&D, cost of goods, and sales & marketing with the hope of generating future revenue, in the subscription model, revenue from customers you have already acquired can be used to fuel future growth.
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Wall Street Loves Workday, But Doesn’t Understand Subscription Businesses