Enough with the Windows 10 updates.
Barron's Cover story, December 7:
How Subscriptions Are Remaking Corporate America
While Apple investors fret over the latest iPhone sales, the market has rewarded Microsoft for locking in a regular stream of revenue tied to the cloud and its Office 365 franchise. Those old Windows software boxes? They’ve been replaced by shiny mobile apps tied to monthly payments.
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Sure enough, Microsoft (ticker: MSFT) shares rose 3.8% in November, even as Apple (AAPL) tumbled. Despite Apple’s user base of one-billion-plus iPhones, the company’s shareholders still worry every year about the next device. It’s an exhausting cycle for consumers, investors, and, surely, Apple itself.
Subscriptions offer a way off the product hamster wheel. Recurring payments have changed the way that Americans consume software, music, movies, television, fitness, clothing, and food. Even tractor maker Deere (DE) is trying to sell subscriptions to farmers. And the trend goes beyond Corporate America. Don Ward, who has shined shoes for 18 years just outside Barron’s offices in midtown Manhattan, began offering a subscription service in 2010. For $100 a year, customers get unlimited shines. For $500—the “platinum” service—customers get shoeshines for life.
“It helps me because I reward my most loyal customers,” Ward says. Plus, “who doesn’t want to get paid in advance?”
Consumers and businesses have found an unlikely alignment through subscriptions. Merchants can see revenue months down the road, while customers get convenience, customization, and the promise of ongoing service upgrades for one, all-you-can-eat price.
“The entire $80 trillion economy is up for grabs,” Tien Tzuo, CEO of subscription-billing platform Zuora (ZUO), writes in his new book, Subscribed. Zuora’s stock is up 30% since it went public in April. Its revenue is expected to grow 39% this fiscal year, to $234 million.
Investors, somewhat belatedly, have discovered the subscription payoff. The market now values Microsoft at $23 for every dollar of profit it generates, while Apple’s price/earnings ratio is mired at a hardware-like 13 times.
The valuation math illustrates how important subscriptions can be. Getting the model right can generate billions of dollars for shareholders. Take the rise of Netflix (NFLX), which trades at a sky-high 67 times projected earnings for next year. Wall Street has become more and more bullish with every passing quarter. And, as long as customers pay their monthly bill, no one is worried about the commercial success of its latest show.
While Netflix has taught the world how to build a subscription business from scratch, Adobe (ADBE) has demonstrated that old companies can remake themselves with subscriptions.
In 2013, Adobe stopped selling boxed versions of its Photoshop and other design software, which cost as much as $2,500. Instead, users are now pushed to pay from $10 to $50 a month for access to the products.
Customers complained loudly at first. They didn’t like the idea of a never-ending rental charge for Photoshop, when previously they could pay a one-time fee.
But the lower upfront cost attracted new customers, and Adobe earned customer satisfaction by layering new value into the subscription at the same price. Adobe’s Creative Cloud now includes photo storage in the cloud and mobile apps that sync across multiple devices.
In 2012—the last full year it sold boxed software—Adobe earned $2.35 a share. This year, the company is projected to earn $6.82, going to $7.98 next year.
It’s a stunning jump for a 36-year-old outfit. The stock’s gain has outpaced earnings growth because investors are paying more for every dollar of profit. The stock has risen 793% since Adobe outlined its subscription strategy in 2011. Adobe trades at 31 times next year’s earnings projections. In 2012, the multiple was 12.
“On earnings that are three times larger, the multiple has tripled,” says Barry Gill, head of active equities at UBS. “All of a sudden, the universe of buyers and the frequency of repurchases have expanded. Because of that, investors are prepared to pay a higher multiple.”
Some 90% of Adobe’s revenue is now classified as recurring, up from 5% before the transition, Adobe CEO Shantanu Narayen says....MUCH MORE, a major piece.
