By Daneesh Shahar
This popular revenue model may not be for everyone
Subscriptions have become synonymous with how we consume products and engage with services. Nowadays, it seems almost impossible to listen to music, watch movies, or shop online without being attached to a monthly subscription plan.
The perpetual exchange of value and the ability to cancel anytime helps us avoid the stinging feeling of dropping large sums of money for things like software licenses. Endless libraries (think Netflix and Spotify), 24/7 customer support, constant software updates, and algorithmic curation all feed into the appeal of subscriptions.
For companies, this business model presents an opportunity to strengthen their profitability forecasts, cultivate deeper relationships with their consumers, and collect data to uncover said consumers’ engagement habits.
According to an October 2019 report published by subscription software provider Zuora, subscription business revenues grew around five times faster than S&P 500 companies in the first half of the year (18.2% vs 3.6%). Given the tremendous revenue potential, it comes as no surprise that many companies have recently initiated plans to transition all or part of their revenue streams to the subscription model. For instance, industry rumors suggest that Apple may introduce an iPhone subscription plan, bundled with services like Apple Music and Apple TV+.
However, many companies attempting this transition fail to recognize the key steps to creating a successful subscription-based business–including assessing product-market fit, and deploying effective change management. In such instances, the pivot alienates their consumer base and ultimately threatens their existence.
The perks of subscription
The subscription model took the form of gym memberships, grocery chain loyalty programs, and DVD-by-mail services before developing into software-as-a-service (SaaS) and subscription ecommerce boxes.
Customer relationship management software company, Salesforce, pioneered the SaaS model through its founding in 1999. Riding on the rise of broadband Internet and mobile technology in its early years, Salesforce has now cemented itself as the industry leader. But unlike companies that transition to a subscription model later, Salesforce began as a SaaS company, avoiding the negative effects of a pivot.
By nature, subscriptions provide a degree of certainty in a company’s projected profit and loss statement. They provide upfront boosts in cash flow at the start of every renewal period, which typically translate into a stable financial position for the rest of the month or quarter.
The model not only has a robust effect on a company’s financials, but is also monetarily beneficial for consumers. Subscriptions help financially constrained businesses avoid the substantial upfront costs of software licenses and IT hardware, such as servers.
Adobe is the poster child for how to successfully transition to the subscription model. The company released a monthly subscription plan for its creative software suite in 2012. Surprisingly, a year later, overwhelmingly positive reception of the new pricing model prompted Adobe to cease selling licences for the entire suite. Enterprise and individual users overwhelmingly preferred to pay in smaller monthly installments of $50, rather than an upfront $2,500 to purchase the license to Adobe’s master collection.
Consumers also benefited from regular software updates, which gave them the perception that they could regularly gain new value from the software–this, in turn, encouraged retention by preventing the product from feeling stale. Additionally, a subscription also allowed the company to more strategically leverage its engineering talent, who previously had to wait to launch products that they had been developing for extended periods of time as part of the company’s year-long release cycle.
On the data-side, continual updates via the subscription model unlock an entirely new channel for its collection and analysis. Ecommerce companies looking to transition to subscriptions can analyze actions like return rates, cancellations, and plan upgrades or downgrades. The analysis of consumer data can then inform price adjustments, return policies, and other changes in a gradual bid to constantly improve the subscription experience.
Jumping on the subscription bandwagon without examining your product-market fit can be damaging to your business. According to a 2018 McKinsey report on consumer goods subscription services, a consumer will not hesitate to cancel their subscription if they feel that it doesn’t deliver a satisfactory experience. The deciding factor can vary between the level of convenience, personalization, or value, depending on the type of consumer good.
A clothing subscription service that delivers new clothes every month on time, but does not provide the service of personalized curation, would have a high churn rate if their target audience values personalization over convenience.
Failed attempts to transition to subscription-based models can largely be attributed to poor change management. A subscription business requires finance, sales, and product teams to reassess priorities and redefine milestones.
For example, salespeople now have to understand that the first transaction with a new customer is the beginning of a potentially long relationship, rather than the end of a sales process. The benefits of the subscription model–robust cash flows, increased profitability, higher customer retention–can only be achieved if employees and management are equipped with the right mindset to create supporting systems and procedures.
Besides these factors, there are external considerations that need to be assessed before transitioning and maintaining a subscription model. For instance, Zuora’s Subscription Economy Index estimated that media and publishing have the highest churn rates of 37.1% and 28.2%, respectively, over a seven-year period. When it comes to streaming services, it is likely that a combination of intense competition between the major players (Netflix, Amazon Prime Video, HBO) and new entrants to the industry (Disney+, ApplyTV+) will keep the churn rate high.
The meteoric rise and fall of subscription meal-kit service Blue Apron can be attributed to a myriad of reasons, including logistical challenges, poor product-market fit, and major players disrupting the grocery space (e.g., Amazon’s acquisition of Whole Foods). The company’s inflated marketing costs and high churn rate (72% of users cancelled their Blue Apron subscriptions within the first six months) signalled they were never able to fully convince new customers of the value of their service. Blue Apron has plummeted from its peak valuation of $2 billion to its current market cap of $36 million (as of March 2020).
Despite these challenges, the subscription ecommerce industry ballooned from US$57 million in 2011 to $2.6 billion in 2016. The entrance of major players like Walmart Beauty Box and Unilever’s $1 billion acquisition of Dollar Shave Club (razor subscription), helped legitimize subscriptions boxes as a viable business.
Nike’s Adventure Club, a service that ships children’s shoes on a monthly, bi-monthly, or quarterly basis, is a recent addition to the slew of brands experimenting with ecommerce subscriptions. The service addresses the problem of having to constantly buy new shoes for children because of how fast they grow out of them.
Here, the power of the subscription model lies in its ability to capitalize on recurring behavior. Nike’s Adventure Club eliminates the friction of having to repeatedly buy new kids’ shoes, and also works to instill loyalty in their youngest users. The launch of the service may hint at a future Nike plan to introduce subscriptions for other users with recurring purchase behaviors, such as marathon runners.
Will subscriptions take over everything?
For many of us, it’s difficult to imagine our media consumption or goods delivery taking any other form than a subscription. Discretionary monthly spending has become so ubiquitous that we’ve now opted into delivery services that regularly supply us with toothbrushes, makeup, and cooking ingredients. But is the subscription model practical for all service industries, and does it make sense for more companies to transition?
Zuora CEO Tien Tzuo certainly thinks so. In a Stanford Graduate School of Business interview, when asked about what other industries he expects to embrace the subscription model next, he answered: “There are already subscription-based companies in real estate, education, finance, and pet care. The reality is, ownership is dead; now it’s really about access as the new imperative.”
His strong opinions coincide with the rising prominence of the sharing economy and the trend of access over ownership, though there is skepticism about whether sharing behavior will translate well in industries where strong ownership incentives exist. Only time will tell whether the subscription model will take over more of our lives–in all likelihood, we have set ourselves on the path to using everything available, and owning nothing at all.
Daneesh is Jumpstart’s Journalist in Residence.
This story was originally published in Jumpstart Issue 29: Back to Basics as Transitioning to the Subscription Model.