It’s a common trend in the software world today: service-based consulting companies transitioning to subscription-based SaaS product companies. Sometimes founders realize that they’re essentially solving the same problem over and over again for their customers and decide to capitalize on that demand by creating a product solution. Other times, founders have a SaaS product in mind from the start, but decide to fund the building and scaling of the product by generating a steady stream of substantial income from consulting.
In the long run, if you’re successful, a subscription-based SaaS business could be far more lucrative than a consulting company could ever be. But even in the best of circumstances, success is not guaranteed. If you’re thinking of making the leap from the bread-and-butter business of consulting company to a SaaS company, it’s good to understand the pros and cons. If you are already committed to the switch, and in the middle of this transition, you may want to read this post on how to transition from a service to product company successfully.
Upsides of moving to SaaS
Ability to scale
Once your product is built out, you can add a lot of users without a significant increase in cost. Not only can this lead to substantial profits, it also makes it possible for you to secure investment capital as you grow.
Cash up front
The longer your subscriptions are for, the more usable cash you’ll have to redeploy towards further growing your business. This is the exact opposite of consulting, where you need to do the work first, and then get paid 30, 60, or 90 days out.
With a subscription model, you can easily get a handle on recurring revenue, baseline growth, and customer churn. Combining those key data points will enable you to make a reasonable prediction about your company’s future revenue. This is in sharp contrast to consulting companies, where customers come back only as needed, and on whatever timeframe meets their needs.
More predictable future revenues will make it easier to market your company to providers of outside capital.
And now the downsides of SaaS
Unlike a consulting company, which is profitable almost immediately, SaaS companies take significant time to get in the black. Unless your consulting business is generating significant excess cash flow, getting your product off the ground might require outside capital. And debt capital can be hard to get if you are just starting out.
Even if your SaaS product is built out and profitable, you’ll need to be sure that you reserve some subscription revenue to provide ongoing service and updates for your customers during their billing period. If you don’t budget adequately, you could find yourself in a position where you can’t afford to deliver on something that your customers have already paid for.
Lower income per customer
The upside of offering a consulting service is that you can generally charge a higher amount per customer than you could if you were offering a monthly subscription. This means you’ll need a lot more customers for your SaaS business than you did for your consulting business. During the transition period, you may find that your gross income is actually lower than before, because your lucrative consulting clients have moved to a less expensive subscription while you don’t yet have enough new customers to make up for the loss. Even if your gross income goes up, without a significant customer base for your product, you may not be earning enough during the transition to make up for the cost of effectively running two business—a product business and a service business.
Differences in accounting
Before you make the transition from a service to a product company, you should understand how to properly recognize the accounting differences between the two, and ensure that you’re financially prepared to make the transition. So let’s review the differences in accounting for both types of revenue under accrual accounting.
Your consulting revenue consists of the stand-alone purchases of services. Your clients will likely be paying after completion for a smaller project, and then they may or may not choose to renew for another contract. In this instance, you would recognize revenue and an associated cost of service at the time of purchase. If you offered delayed payment terms, you would recognize an account receivable as a result of this transaction, but generally your clients will be billed at completion for cash. Additionally, if it were a longer term consulting contract, you would probably charge progress billings, which essentially divide a large contract into smaller pieces. With progress billings, you would usually collect payment at certain milestones determined by your contract. The associated accounting would recognize an asset called unbilled revenue which operates similarly to accounts receivable.
When you move to SaaS subscription revenue, your clients will be paying a recurring fee for access to your offering. In turn, you agree to keep your software up to date, and provide ongoing support to your subscribers. As a matter of payment you would provide access to your software to a client and immediately charge them for that access upfront for the entire billing period. This will result in unearned revenue, which is a liability under accrual accounting that recognizes the fact that someone has paid you for something that you haven’t fully delivered, which is a certain time frame of access to your service. Read more about how to record deferred revenue.
A good move for some businesses
In the long term, there can be a huge payoff to transitioning from a service business to a product business. But the going can be rough, especially if your consulting clients are transitioning to your service before you have enough new SaaS customers to make up for the lost income. That’s why this transition works best for companies that think they can either (a) get their clients to adopt the new SaaS product quickly, enabling them to ditch the consulting side of their business entirely; or (b) entice enough new clients to the SaaS product that they can afford to run both businesses at once.
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