Episode #217: The Subscription Business Model

We used to know the people we bought from: the butcher, baker, blacksmith, barber, farmer, etc. All that knowledge got lost when the Industrial Revolution ushered in the product era. That knowledge is coming back in a big way!

The idea is turn customers into subscribers—the Subscription Economy, according to Tien Tzuo in his book, Subscribed: Why the Subscription Model Will Be Your Company’s Future—and What to Do About It.

World is moving from products and services to subscriptions, favoring access and outcomes (Transformations) over ownership and deliverables. Customization, not standardization, constant improvement, not planned obsolescence. Lock-in and Switching Costs effects.

According to McKinsey, the subscription ecommerce market has grown by more than 100% a year for past five years. Subscription-based companies are growing eight times faster than the S&P 500 (17.6% vs. 2.2%), and five times than US retail sales market (17.6% vs. 3.6%). Companies running on subscription models grow their revenue more than nine times faster than the S&P 500.

Tzuo argues this model is industry agnostic:

Health Care, Concierge, Direct Primary Care, Amazon Prime and Rx, Education (it fires their customers after four years); Insurance; Pet Care; Utilities; Real Estate; Finance; Automobiles; Newspapers, etc.

Subscriptions are a forward-looking revenue model, as seamless as buying a book on Amazon. It changes the question from “How many services can we sell?” to “What does our customer want, and how can we deliver that as an intuitive service?”

Competitors can steal your service features, but they can’t steal your insights you gain from an active, loyal subscriber base.

Salesforce and Amazon don’t have customer segments, they have individual subscribers (Prime has 90 million subscribers who spend an average of $117 billion per year). Other businesses that have subscription models, either in total or in part:

  • Apple: Earnings call Feb 1, 2018: service revenue $31.15 billion in 2017, growing at 27% a year, more than half of Apple’s growth

  • Spotify: 50 million subscribers > 20% global music industry revenues

  • Netflix: Spends $8 billion a year on original content, providing new and innovative services to its subscribers

  • Gillette: Market share decreased to 54% (2016) from 70% (2010), because of Harry’s and Dollar Shave Club

  • Warby Parker: Averaging $3,000/sq. ft. retail space (slightly less than Tiffany’s), because 85% of foot traffic has done extensive browsing online

  • Uber/Lfyt: 60 million riders (testing flat-rate subscriptions, no surge)

  • Starbucks: More than 13 million Starbucks rewards program

Old business model: Products/Services > Channels > Customers

New business model: Services > Subscriber > Experiences > Channels

From linear transactional channels to a circular, dynamic relationship with your subscriber.

Fender guitars, 90% new users quit within one year, so Fender launched subscription-based online video teaching, Fender Play. By simply reducing the abandonment rate by 10%, it could double the size of its market (applying a service-oriented mindset to a static product).

Instead of margins and unit sales, thinking about subscriber bases and engagement rates.

Other industries where subscription business model is happening:

Automobiles

Hyundai’s new hybrid, Ioniq, you can subscribe to for $275/month. Makes owning a car as easy as a mobile device.

Porsche’s Passport, half dozen models, covers maintenance, insurance, and vehicle tax and registration, starting at $2,000 per month.

Cadillac, $1800/month, switch out vehicles as frequently as 18 times per year.

Volvo: XC40, $600/month.

One out of five autos are expected to be subscription by 2023. Here’s the differences between subscribing to a car and leasing one: 

  • Not bound to specific vehicle

  • Signing up with the company, not the car

  • R&M, etc., go away

  • Can’t buy the car at the end (company’s interest to keep car in good condition, not yours)

Data and services associated with vehicle > vehicle itself (Spotify, Sirius, OnStar). From car manufacturers, but transportation solutions (Ford: make that “bed to bed” journey as simple as possible). 

Airlines

SurfAir: Uber of the skies: limitless flights for a flat monthly fee, western USA and Europe (more than 200 million frequent fliers up for grabs!).

Newspapers

169 million US adults read newspapers online, 70% of the adult population.

  • Financial Times metrics: Recency (last visit), Frequency (how often do they visit), and Volume (how many articles read)

  • The Economist: Charges for digital and print, increased revenue 25%

  • New York Times: 60% revenue comes directly from readers, more than $1 billion, digital-only subscription revenue exceeded print advertising revenue in the second quarter of 2017.

Software

Gartner predicts by 2020, 80%+ software providers will have shifted to subscription-based models (no growth left in on-premises software).

Swallowing the fish: as the revenue curve temporarily dips below the operating expense curve before climbing back upward again.

Adobe launched Creative Suite, a perpetual license in 2012. The new metrics (not GAAP): AAR = Annual Recurring Revenue (ARR); ACV (Annual Contract Value).

Digital subscriptions in May 2013 (Adobe Creative Cloud), let customers know, no longer updating Creative Suite: from 0 to 100% subscriptions in three years, inspired Microsoft, Autodesk, Intuit, and PTC. Today, over 70% Adobe’s revenue is recurring

Microsoft, Office 365, IBM, Symantec, Sage, HP Enterprise, Qlik: IT buyers prefer opex to capex.

Creates deferred revenue, so quarterly GAAP metrics can take short-term hit.

Hardware companies, too: Cisco is swallowing the fish.

IOT and Manufacturing

What can’t your subscribe to? A refrigerator? Roof? Tease out the service-level agreement that sits behind the product! 

  •  Refrigerator: fresh, cold food

  •  Roof: solar energy

Selling the milk, not the cow.

Komatsu uses drones to survey a site in 30 minutes, which changes the question from: How many trucks can I sell you? To How much dirt do you need moved?

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Advantages

  • Predictable revenue

  • Customer lock-in and Switching costs

  • Not selling services, but creating annuities with a lifetime value that far exceeds whatever you paid to acquire them

  • Collective knowledge of our customers is a competitive advantage can’t be duplicated

  • 1:1 Marketing: Changes the 4 Ps of marketing (pricing is most important). We’re not pricing a service, we’re pricing an outcome and insurance (peace of mind)

  • Monitor usage, solve problems, pursue opportunities, and provide Transformations 1:1

  • Shift to a long-term relationship focus rather than delivering tasks

  • Allows for faster growth, as will attract new customers (rather than just selling more to current customers)

  • We can plan capacity more effectively

  • Moving beyond efficiencies and into possibilities (don’t solve problems, pursue opportunities, Drucker, otherwise starve your successes and feed your failures)

  • Breaks down silos, mold organization around needs of customer

  • Actuarial approach to risk pricing, work planning, etc. (20/80 rule)

  • Tears down silos: Portfolio approach to analyzing profit, rather than silo DCM and Realization Rates,

  • Truly “one-firm” model (this doesn’t just talk about one-firm, it achieves it!)

  • New metrics (not GAAP): AAR = Annual Recurring Revenue (ARR); ACV (Annual Contract Value)

  • Recency (last visit), Frequency (how often do they visit), and Volume (how many articles read); to keep customers renewing and re-engaging, have to provide real value

  • Dynamic cycle of action: renew, suspend, upgrade, downgrade, etc.

  • Experiment with different value metrics: tied to: seats, boxes, events, gigabytes, locations, texts, family members, you name it

  • Companies that employ a small amount of usage-based pricing in their revenue mix (less than 10%) grew more than twice as fast on average, with lower churn rates.

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Ed Kless

Ed Kless joined Sage in July of 2003 and is currently the senior director of partner development and strategy. He develops and delivers curriculum for Sage business partners on the art and practice of small business consulting. Courses include: Sage Consulting Academy, Business Strategy and Customer Experience Workshops. Ed is the author of The Soul of Enterprise: Dialogues on Business in the Knowledge Economy, a compendium of a few of the episodes of his VoiceAmerica talk-show The Soul of Enterprise: Business in the Knowledge Economy with Ron Baker, founder of the VeraSage Institute where Ed is also a senior fellow.