E-commerce has experienced an exponential growth curve over the last decade. Consumers are now more than ever comfortable with buying commodities and making payments online. As a response, companies have been actively looking for ways to pivot their business models to align with the new normal. As a result, subscription-based businesses have grew by 300% between 2012 and 2018. According to Business Wire, the growth translates to 5x the revenues of the S&P 500 companies within the same timeline. The Subscription Economy IndexTM (SEI) reports that the Average Revenue per User (ARPU) grew by 8% when compared to 11.3% in 2017. In addition, Gartner estimates that by the year 2023, 75% of organizations that are selling directly to consumers shall be offering a form of subscription service.
What is a subscription business?
In a subscription-based business model, consumers make periodic payments (usually automated unless intentionally cancelled) for a product or service. Both the consumers and the business benefit from the symbiotic relationship between the two parties. While the consumers extract value, convenience and personalized offerings, the business enjoys stability in recurring revenues and a predictable growth path.
Origins of the subscription economy
Unbeknownst to many, the subscription business model has existed for hundreds of years. Think about the physical newspaper and book subscriptions that existed in the 1900s. However, the dawn of the digital and cloud technology era brought about the new opportunities we have today. Noticeably, Spotify changed the way the masses consumed music in 2006. Instead of buying a whole album to listen to one of your favorite tracks, Spotify enabled consumers to access a vast library of music and podcasts while making small monthly payments. That was revolutionary!
One of the pioneers of the subscription business in B2B was Salesforce in 2000. Armed with the motto “the end of software”, the company was the first to provide Software-as-a-Service (SaaS) offering through the cloud. Instead of a business incurring a huge lifetime license to the software, Salesforce allowed customers to access a standard solution at a lower cost of entry.
The three types of subscription business models
Subscription businesses can be classified into three major categories: replenishment, curation and access. Replenishment subscription businesses allow their customers to automatically make purchases for certain products. A good example is Unilever’s Dollar Shave Club. This company enables its customers to buy razors and have them delivered at a predetermined period of time. Curation subscriptions enable the customer to enjoy highly personalized products or services. For example, Blue Apron provides curated ingredients alongside chef-designed recipes for its subscribers. On the other hand, a subscription for access gives its members privileged perks such as lower prices or other perks meant for members only. For example, JustFab provides unique discounts for its VIP clientele.
Companies winning in the subscription-based economy
The subscription-based offering is not an exclusive club meant for companies that started off with the business model since inception. There are notable enterprises that have pivoted into subscriptions successfully. Microsoft changed their business model from a one-time license of $139.99 to an annual subscription fee of $99.99; as a response to competition such as from Google in 2013. What’s more, Adobe also shifted to a subscription model as an action to improve customer lifetime value. This helped reduce the barrier of entry in their software suite for many customers worldwide.
Making the subscription model work
The greatest challenge with subscription-based businesses is customer churn. Businesses need customers to stay long enough in their systems to gather deep insights and learn their behavior. This translates to the business providing greater value to the customer by customizing their offerings to them. However, consumers are inherently hesitant to make long-term financial commitments. As a result, customer acquisition costs (CACs) are normally high. Excessively high churn rates make it unfeasible for businesses to both recoup their CACs and grow their revenues. Ideally, the customer lifetime value (CLTV) to customer acquisition cost should be at least 3:1. Therefore, having a proper strategy to mitigate churn is imperative.
Countering churn in a subscription-based business boils down to two fundamentals: price and value. The right combination of the two will ensure that customer retention is maximized. Even though the customers are hesitant to sign up for a subscription, once they extract value from it, they are sticky. Businesses need to demonstrate value to their new customers beyond a reasonable doubt.
Author: Dickson Ndoro