Look around and you’ll see that we live in a new economy today. A subscription economy.
Subscriptions are taking over the world!
The fastest growing companies — from media (Netflix, Spotify) to e-commerce (Amazon, Birchbox) to SaaS (Salesforce, Slack, Dropbox) are using subscription models. Recurring revenue business models are the new norm.
Massive companies like Amazon, Fortune magazine, and Apple have started building their subscribers database years ago and have leveraged their unique reach to build an unfair advantage. (In just 6 months, Apple Music got 10 million subscribers while Spotify took 10 years to get 20 million).
Think about Apple launching a bank — they already own the biggest set of credit cards compared to any existing bank. As for Youtube, they’ve started adopting the subscription business model by offering ad-free subscriptions that play music for a flat monthly fee. Starbucks just announced plans for a subscription service called Starbucks Reserve Roastery Subscription program, giving online customers access to its line of super-premium, small-lot coffees.
“80% of companies are seeing a change in how their customers want to access and pay for goods and services and 50% of these same companies are changing their pricing models as a result.” – The Economist
Should you move your business to a subscription model? It’s not too late to build recurring revenue.
Here are 7 reasons why you should consider subscriptions over the traditional business model (adopted from John Warrillow’s latest book — The Automatic Customer: Creating a Subscription Business In Any Industry):
1. Stability and predictability
Traditional customers are defined by single purchases at different parts of their life cycle. In contrast, subscribers provide built in regularity — smoothing out demand by renewing their contract at the same time every month for the duration of the subscriber’s agreement.
As a positive consequence, this dramatically reduces uncertainty and business risk in terms of revenue by guaranteeing advanced payments.
The ability to forecast your future revenue, within a few percentage points, is a big advantage over traditional business. It allows you to plan your business effectively and optimize your labor and supplies which leads to lowering your costs and investing more into growth.
Let’s look at a real example of a typical flower shop. Like many traditional businesses, it has to start each month with no revenue. Of course, it can make some plans and predictions based on past sales, but it doesn’t have a contractually obligated revenue stream.
Compare that model to the online flower delivery service — HBloom. HBloom is an e-commerce company that provides subscription-based luxury flower arrangements at affordable prices to direct consumers and corporations. In 2014, the company reported annual revenue of $7.2 million. Let’s say that 80% of its revenue comes from subscriptions — that means that company can expect $5.8 million each year. That figure is stable and predictable.
2. Higher customer lifetime value
By transitioning to a subscription model, you are much more likely to increase Customer Lifetime Value (the total Net Profit that a company makes from a given customer).
In a subscription business model, you build a long-term relationship with your customer. Let’s look at the example of Netflix vs traditional movie rental stores. Traditional movie rental stores sell or rent a one-shot DVD to a customer they may never see again. Whereas at Netflix, you can sign up for a monthly subscription of $8.99 and have access to thousands of movies. On average, a customer is able to stick with Netflix for about 20 months (it’s monthly Churn Rate, the percentage of customers who stop subscribing to a service, is around 4-5%). That gives us a customer lifetime value of $179.8 ($8.99*20).
3. Higher business valuation
Subscribers drive up the value of your company. Recurring revenue in the form of subscribers adds stability, security, and predictability to your business, which is something normal customers can’t provide.
As a business owner, your largest asset is your business and how it is valued by potential investors or buyers. To investors, the primary appeal of subscription business model is the value of predictable recurring revenue. On average, businesses with recurring revenue model are valued up to eight times higher when compared to a similar business using a traditional business model.
Remember the example of the subscription flower delivery service, HBloom, which is generating $5.8 million each year from its subscribers. That figure is stable and predictable, therefore, investors can plan and invest accordingly. That’s why HBloom has raised $26.9 million in venture funding from Battery Ventures and Shasta Ventures.
“When you have a recurring revenue business model, you rarely miss your monthly or quarterly numbers by more than 10-20%. Your forecasting process is much more accurate. At the beginning of the quarter, you start with a base to grow from rather than begin at zero. In a SaaS or subscription software business, you can predict your churn rate and new business closings to determine your growth rate. The management team and the investors are thus rarely surprised by major fluctuations in your results.” – Venture Capitalist Jeff Bussgang
4. Free market research
While traditional businesses might pay thousands of dollars to conduct market research (telephone surveys, focus groups, etc), companies with recurring revenue get that for absolutely free. Subscription business model gets you closer to your customers — giving you the ability to track your customer preferences in real time and simply ask them what’s on their mind.
It’s why Walmart launched Goodies Co., a monthly service that will send you a package of sweets and snacks for $7. The twist on this particular offering is that subscribers who are active enough in rating, reviewing, and touting the products can get Goodies boxes for free. Why give away free stuff, you ask? Walmart didn’t care much about the $7; what they wanted was the market research to help inform their buying decisions at the store.
Companies like Netflix, Conscious Box, and Microsoft are leveraging the subscription business model to discover what their customers want next.
5. Lower marketing costs
The subscription model helps you drastically cut marketing costs. Instead of spending money on multiple channels, you acquire the subscriber only once. You no longer have to do the work to get them back like in traditional business. It helps you lock in buyers who want your product again and again.
From a marketing perspective, the subscription allows you to learn your customers better and understand what’s on their mind. This helps you to optimize your sales channels, create personalized marketing for each audience and eventually reduce customer acquisition costs.
6. Subscribers spend more
A subscription business model allows you to talk to your customers on a regular basis and upsell them on products and services beyond their basic subscription.
Let’s look at the master of cross-selling and subscription business models — Amazon. When Amazon launched Amazon Prime, it provided unlimited free two-day delivery, on-demand video streaming, and free access to the Kindle library, all for an annual fee of $99. Later, Jeff Bezos, CEO of Amazon, reported that ongoing analysis of customer behavior before and after joining Prime shows that they increase their purchase with the company after joining, which means these customer relationships are deeper and their customer LTV is greater.
An oft-quoted 2014 study from RBC Capital shows that Prime customers spend more than double what non-Prime members do. “Similar to Amazon Prime members, Amazon Kindle owners are better customers,” says Mike Levin, partner and co-founder of CIRP (Consumer Intelligence Research Partners). “They also shop more frequently, and also buy more expensive items on average.”
That’s important because the longer customers stick with Amazon Prime, the more they spend. RBC’s survey indicates that 49% of first-year Prime members and 68% of year-four subscribers spend at least $800 on Amazon each year.
7. Subscriptions make customers sticky
When it comes to subscription-based businesses, subscribers knowingly enter into an agreement in which the convenience of uninterrupted automatic service is exchanged for their future loyalty. Rather than buying once and then deciding again in the future who to buy from, subscribers hopefully stick around for years.
For traditional businesses, earning customer loyalty can be very hard. When done well, they can keep customers coming back for repeat purchases, potentially turning this customer into a loyal brand advocate. When done wrong, they can be a huge waste of time and resources.
Should your business make the switch to a subscription model?
The answer is complicated. Consumer behavior, especially among the new generation, is changing. And the need to own things — from music to cars to houses — is dying out. You should consider a subscription model no matter the size of your business or the industry you’re in. But transitioning isn’t easy, and each company needs to evaluate the needs of its customer base — and how subscriptions could potentially open the door to new users.
And you don’t need to go all in on recurring revenue – you can experiment with various markets and product lines in your business. Many established companies are developing a hybrid approach to recurring revenue. You can always test new models out on specific audiences.
That’s part of the magic of recurring revenue.
The Automatic Customer: Creating a Subscription Business in Any Industry, by John Warrilow