One advantage held by companies selling subscription services is a tidy, predictable recurring revenue stream and a significant competitive advantage from switching costs.
It can be just too much hassle, time and money to switch to a competitor’s product. But that advantage exists only if the product is good and switching to competing options isn’t easy.
Take the case of the customer service, HR and financial compliance services offered by Workiva (NYSE: WK). They are not only hard to replace but are making clients happy enough that the company boasted a more than 23% second-quarter increase in annual subscription revenue.
When switching is easy, subscription revenue can take a big hit. That’s what happened in one segment of the media industry, with the loss of more than 1.6 million cable and streaming service subscriptions in the first quarter. The services upped their prices, removed content subscribers liked, and added content they didn’t like. With one or two clicks, subscriptions were canceled, and viewers switched to another, better service.
High switching costs keep customers in place
But if switching costs are significant, subscribers find it easier to stay put than leave. If disappointed Windows users balk at the cost of replacing expensive software and peripherals with Apple products, they’ll stick with Microsoft. And, when subscribers are happy with the product, a cheaper competitor will find it hard to woo subscribers away for something, even if it’s just as good.
That looks to be the case with Workiva. The SaaS platform increase its second-quarter subscription and support revenue by more than 23% year over year. And it reported a 35% increase in contracts worth more than $500,000.
The result was a share price jump of more than 15% on Aug. 1, after the earnings announcement, leaving shares now trading in the $77 to $79 range. That’s still well below Workiva’s 52-week high of $116.83. But it had dropped into the mid-$60s during June and July on concerns that its long-term growth rate was slower than expected for software companies.
The significance of GAAP, remaining performance obligations
The recent gains come amid projections that full-year earnings per share will be nearly 300% better than they were in 2024. So why hasn’t the stock rocketed back to its former highs?
The big reason is that those EPS numbers are adjusted, non-GAAP (generally accepted accounting principles) estimates. In GAAP terms, Workiva registered a loss of 35 cents per share in the second quarter, widening from a loss of 32 cents a year earlier.
One reason investors are overlooking the losses is found in another number – remaining performance obligations. That measures how much the company will collect from its existing software contracts. This number has been steadily increasing for Workiva and now stands at $1.2 billion. About $668 million of that is expected to be recognized in the next 12 months, with the balance coming in the following 24 months.
That’s enough for most analysts to rate Workiva as “buy” or “strong buy”, with price targets ranging $94.10 to $105. Revenue estimates average $871.64 million for this year and more than $1 billion for next year. Clearly, not many experts expect Workiva subscribers to make a switch anytime soon.
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