What Really Matters in Subscription

In consulting, clients commonly seek insights on the challenges and concerns of their peer group. While firsthand experience working across comparable companies is irreplaceable, it helps to take an unbiased look at the data. Fortunately, companies share these talking points in public through quarterly earnings calls. Thanks to digitization, we can now rapidly aggregate transcripts of these events and key in only on the topics that companies themselves consider to be top of mind. We refer to this practice as transcript analysis.

Rich data from earnings calls can bring insights by pulling keywords, measuring sentiment, and charting patterns that illustrate the state of any company or industry. While imprecise, this tool offers company leaders the opportunity to respond to market trends and define strategies that achieve business success and reward shareholders. By using data to study the good and the bad of a specific industry, executives can understand what matters to investors and how to manage the same headwinds and tailwinds that affect competitors, suppliers, and customers.

At Capgemini’s Subscription Revenue practice, we used this technology to track the pulse of the industry and derive insights from a retrospective of Q2’22 earnings calls for over 150 companies. In a year with no shortage of headlines, we dive deep into the data to find out what really matters in subscription.

Our top keywords

A typical earnings call involves executives discussing a company’s performance, followed by a Q&A session with analysts. Common topics include revenue growth, marketing, cash flows, competitors, and clients’ activities, and forward-looking statements on risks and uncertainties. The Capgemini Subscription Index (CSI), a grouping of over 150 public subscription companies, also emphasizes subscription-related topics like customer acquisition, customer retention, recurring revenues, and transitions to the cloud.?

Top subscription keywords of Q2’22

Net sentiment?

Every comment in a call is rated for positivity or negativity based on Natural Language Processing (NLP) methods. The accumulation of commentary is then scored in aggregate, from -100 to an optimum 100. In Q2’22, we calculated an industry-wide average of 17, which we associate with cautious optimism. However, with the Q1’22 score of 26, the trend is bearish in line with the larger economy.

While this represents a full-scale drop of only 4 percent, we consider that to be significant when the practical scale of historical scores is likely significantly narrower. To put this in context, the consumer confidence index?fell from 59 to 50over this same timeline. A historical comparison highlights the relative severity of this decline: the market drawdown of Q1’22 experienced a sentiment drop from 28 to 3 against a backdrop of a 20 percent loss in the S&P 500.

Market returns vs. sentiment score

Current trends

While CSI companies have a wide variety of products, services, business models, and customer bases, the unifying theme of executive discussions was the cloud. Although each of these companies largely transacts in subscription revenue, the actual mention of subscriptions ranks at 16 in the top keywords, with company leadership preferring to brand their cash flows as “SaaS” or “recurring revenue.” Additional emphasis on the stability of the customer base was shown in the data, which logically follows from the historically high valuation premiums afforded to these companies.

Other keywords on the list provide a view on the most important trends to senior leadership.

Top keywords and momentum in Q2’22

The macroeconomy is an ongoing concern

Mentions of “macro” and “economy” increased by 34 percent in Q2’22, which intuitively follows given the slowdowns and disruptions of the year. Inflation is a major headwind, especially to e-commerce companies.

The reduction in consumer demand was outlined by Shopify on?its recent earnings call:

While the macro environment exited tough COVID year-over-year comps in mid-Q2, consumer spend on services and in-person shopping remained high and persistent inflation at 40-year highs dampened online sales globally. In the face of rapidly escalating prices for essential goods and energy, consumers have been favoring discount retailers and reducing their spend on other goods categories. (Amy Shapero, Shopify CFO)

Downward trends in demand forced company leaders to innovate new business models. A noteworthy example is the pivot to ad sales?by Netflix:

[If] you zoom out a bit and look at past economic cycles, at least in the U.S., most forms of entertainment have been fairly resilient to downturns … if you look at the Pay TV business over economic cycle, it tends to be a bit more resilient as well, just because the value of in-home entertainment increases as folks perhaps don't go out as much. (Spencer Wang, Netflix VP Investor Relations)

“Cloud,” our top keyword for the quarter, was seen as a cornerstone to revenue durability. Enterprise migrations to the cloud enabled?companies like Datadog?to demonstrate resiliency.

Our efficiency and financial strength affords us options in times of macro uncertainty that other market participants will not have, and we intend to make the best of this opportunity to drive our long-term growth… In conclusion, while we recognize there is greater uncertainty in the macro environment right now, we see no change in the importance of cloud migration and digital transformation, which are critical to our customers' competitive advantage. (David Obstler, Datadog CFO)

Cash is king

In the face of a global slowdown, executives emphasized concerns about cash, with mentions up by 73 percent over the quarter. Businesses like Zoom looked to enact major cost reductions and stabilize cash flows and holdings, as its CFO, Kelly Steckelberg, indicated in a?second quarter earnings call: “Our products are designed to drive efficiency and cost savings within organizations… In addition, we have strong margins and cash flows, as well as a large cash balance.”

Companies which had not achieved break-even cash flows struggled to convince analysts that all measures were being taken to address the issue. One example is?Peloton, which planned to reach cash flow positivity by liquidating hardware inventories and cutting costs:

Now that being said, from a cash flow perspective, we do have this north star goal that we are working to achieve, to achieve free cash flow breakeven by the end of the year, and we will be maintaining a cash balance of at least $1 billion. And what we have to do in order to do that is make sure that we continue to work hard to rightsize our cost... (Liz Coddington, Peloton CFO)

Slower growth in Europe is driving risk

Europe stands at 14th??in our list of most mentioned keywords, far above other geographies like APAC (137) and Latin America (327.)

At a time when CSI companies are expanding rapidly to overseas markets, Europe is acutely affected by risks such as energy market volatility and currency depreciation. Clearwater provides an inside-out view of this headwind, with CEO Sandeep Sahai?commenting that the company?“did definitely [see] elongated sales cycles in the first half of the year.” For Bentley Systems, growth in Southern and Central Europe has accelerated, while ARR growth in Northern Europe declined. CEO Greg Bentley?elaborated: “We mentioned, for instance, Northern Europe, new business declined during the quarter, but there's still was new business. It just slowed down.”

Q2’22 keyword momentum rankings

Foreign Exchange (FX) is a common challenge

Mentions of FX in earnings calls increased 82 percent in a time when the US dollar has seen double-digit percentage gains against the world’s major currencies. A strong dollar has set pressure on companies with international exposure, with many executives using “constant currency” or “FX-neutral” to qualify revenue and growth.?

Many companies suffered from FX losses, such as Salesforce ($600 million), Netflix ($150 million), and ServiceNow ($220 million.) Match Group mentioned FX headwinds the most frequently in both Q1’22 and Q2’22. Currency devaluation caused losses of $195 million in 2022, with growth dropping by 6 percent. Match Group leadership elaborated on a?second quarter earnings call:?

For the full year, we're now estimating $195 million of year-over-year FX impacts, which is $72 million more than at our last earnings call and $163 million more than when we first gave our thoughts about 2022 back in November of '21. We estimate FX is causing a 6-point reduction in year-over-year revenue growth for full year 2022, 2 points worse than at the time of our last earnings call. (Gary Swidler, Match Group CFO & COO)

While FX-related losses were more severe than in expectations from the prior quarter, only a handful of companies mentioned a program for hedging currency risk. One example is Workday, where CFO Barbara Larson?provided additional detail?on the situation: “In terms of FX, we actively hedge our balance sheet subscription revenue as well as certain expenses. In Q1, there was some impact due to FX, but it wasn't material given our hedging program.”

Others, such as Salesforce,?discussed?natural currency hedging by denominating costs in foreign currencies to offset risk:?

With respect to FX, because our regional revenue and expenses are generally in the same currencies, there tends to be a natural hedge in our operating margin. As such, although we've seen FX headwinds to revenue, we don't currently anticipate a material impact to our operating margin for the full fiscal year. (Amy Weaver, Salesforce CFO)

Expenditures are (even more of) a focus

Consistent with stocking cash, companies are also cautious about spending. Many chose to downsize. For example, Blend Labs saw a 25 percent reduction, decreasing labor costs by $60 million, sourcing talent from offshore, as?recently explained?by the company’s founder:

Our first and most immediate lever is ou cost of labor. Since April, we have eliminated over 400 positions or 25 percent of our workforce… We should see the full impact of these actions by Q1 2023. In aggregate, both actions are expected to reduce our annualized expenses by approximately $60 million… Our second lever is offshoring. (Nima Ghamsari, Blend Head)

Companies with physical goods tried to control raw material costs, like?Blue Apron:

Given the current macroeconomic environment, I’d like to take a moment to discuss how we’ve positioned Blue Apron to control costs while we continue to offer great value to customers. As Linda said, we believe we are partially insulated from rising food costs due to the unique nature of our supply chain, with approximately 80 percent of our ingredients sourced directly from the producer. (Randy Greben, Blue Apron CFO)

Looking inward and ahead

If a rising tide raises all boats, a lowering tide must do the reverse. As bearish sentiment sets in on an uncertain economy, demand destruction will put continued pressure on subscription companies to innovate and remain lean. The interconnected trends of inflation, reductions in the money supply, and commodity surges continue to compel company leaders to demonstrate business resilience against omnipresent disruption.?

The subscription industry, due to its differentiated operations and sales models, will find unique challenges and opportunities that may run counter to those of conventional businesses. Stabilizing revenue and maintaining a healthy runway in an industry where companies deliberately run at a loss can be acutely difficult in an unpredictable future. Fortunately, as we tell our clients, no company is facing this alone.

For more insights, please visit our?Subscription Revenue?practice.?