Over the past year or so, we have noticed a number of companies shifting their strategic focus. While a mild shift in strategy could be a catalyst for improved performance and stock price appreciation, what are the potential pitfalls of a major shift in strategy? How can investors protect themselves from such risk, and how can they educate themselves about what might go wrong in such strategic changes? In this three part series, we will outline three examples of companies undergoing strategic shifts, what ultimately happened to their performance, and what investors can learn from these experiences.

Shifting Distribution Model

For nearly a quarter century, Rosetta Stone Inc. (Tii:RST) had been a market leader in language and literacy education serving schools, businesses and consumers. In March 2017, the company made a strategic shift in their consumer language business that fundamentally changed the nature of that business segment. Prior to this shift, Rosetta Stone’s consumer business was primarily based on the sale of language learning software that enabled consumers to learn a new language. The company’s CDs were sold in retail locations and through ubiquitous advertising in business and travel publications, but now the company was going to shift its business from the sale of language learning software to the sale of SaaS based subscriptions for consumers.

Rosetta Stone’s shift in distribution model was in some ways forced on the company, as the previous software model was quickly being overshadowed by more dynamic mobile applications and web based learning with greater levels of customization and live updates. With the evolution of the business toward a more dynamic business, company management made the shift toward a subscription based model that drove greater value to consumers with more dynamic language learning options while providing a better model to monetize these efforts. As with any shift in a distribution model, the shift to a SaaS based subscription model was not without challenges to the company and its investors.

In switching their business model, Rosetta Stone faced two separate but related challenges, first the shift involved a change in how the business operated, resulting in changes in revenue recognition and financial reporting. The second challenge involved effectively communicating with investors through each step in the transformation and thus effectively setting investor expectations appropriately. During the transition period, revenues from the foreign language consumer segment would likely be under pressure, while the subscription revenue grew to replace the former sales revenue. During that transition period, patient investors likely found some attractive investment opportunities as Rosetta Stone’s common shares languished below $10, but as the business evolved and investors began to appreciate the potential for the SaaS subscription model, the stock steadily rose through 2018 and 2019, eventually reaching a high of $26.12.