Subscription-based businesses are here to stay. The subscription business model is prevalent for modern software, and it’s hard to find an industry that hasn’t witnessed at least one success story related to subscription models over the last decade.
That is precisely why this method is so enticing. When used properly, it is a highly effective growth technique.
You can lay the groundwork for success by learning how this company model operates and what it takes to nail your pricing strategy.
A subscription pricing strategy can involve tiered pricing based on functionality, discounts for bulk purchases, usage tracking, or rewards.
They can be altered according to the time of day the service is utilized (a popular option among telcos), adjusted to incentivize activity from specific geographic locations, updated on a term basis to lock in long-term commitments, or adjusted in conjunction with partner promotions.
There are overage charges, free trials, virtual coupons, early-bird specials, and freemium to premium conversions… the list continues on and on.
We recommend beginning with two or three basic unexpected pricing tiers and gradually increasing them as you learn about your clients.
If you have an ideal pricing point in mind, be sure to add another to make it more appealing.
Let’s face it: the year is 2021, and nearly everyone we know is a subscriber to some form of service.
Whether it’s Netflix or Spotify, subscriptions have largely supplanted the traditional model of product consumption.
In the article, we discuss subscription-based business models–their advantages, disadvantages, and how to measure their effectiveness.
Table of Contents
- What is Subscription Business Model?
- How Does a Subscription Business Model Work?
- Subscription Business Model Benefits
- Types of Subscription Business Model
- Advantages of Subscription Business Model
- Disadvantages of Subscription Business Model
- How To Measure Subscription Business KPI?
- Final Words On Subscription Business Model
What is Subscription Business Model?
The subscription-based business model is when clients pay a recurring price — often monthly or yearly — in exchange for access to a product or service.
Subscription business models are founded on the concept of offering a product or service in exchange for recurring subscription revenue on a monthly or annual basis. They place a higher premium on customer retention than on customer acquisition.
The concept of a subscription business model is to generate revenue by requiring a consumer to pay several of them for extended access to an item or service rather than making a large upfront payment.
Subscriptions are now replacing ownership of automobiles, software, entertainment, and shopping. The LTV (lifetime value) of the customer increases as a result.
A subscription model is used when a business charges a regular fee for its services and products. You can choose to pay annual or monthly recurring charges.
The concept of subscriptions is not new. Today, subscription businesses have made their influence felt in our everyday lives, from coffee subscriptions to library memberships to Kindle Unlimited.
However, what is the subscription business model that makes it so appealing to both customers and businesses?
For customers, it’s about convenience and personalization; for businesses, it’s about predictability and sustainability.
Subscription business models need customers to pay a recurring cost consistently to gain access to a product or service.
Subscription business models prioritize client retention while constantly growing their customer base. The customer’s subscription period is thus maximized to maximize revenue.
And subscription-based business models are unquestionably here to stay. McKinsey & Company found that 46% of customers now pay for at least one subscription service.
This assertion is borne out by the 300 percent increase in subscriptions in the last seven years alone!
How Does a Subscription Business Model Work?
A subscription business model was pioneered by newspaper and book publishers in the 1600s.
The advent of technology and software as a service (SaaS) offerings has led many businesses to adapt to a subscription-based revenue model that rewards customers for regular access to a good or service.
Subscriptions are typically automatically renewed and enabled using a pre-authorized payment card or bank account.
The advantage of subscription business models is that they generate recurrence revenue, which helps to build strong client relationships.
Customers are billed regularly for a subscription-based product or service in a subscription model.
A majority of memberships allow you to extend or cancel your membership whenever you want easily.
If you are in the business of offering subscriptions, consider yourself bound by the agreement between you and the customer.
A customer agrees to pay for a product or service over time, and the business honors that agreement as long as they make their periodic payments on time.
Customers have the option of renewing or canceling their subscriptions when their contract expires.
Subscription Business Model Benefits
1. Subscriptions Offer Customers Convenience.
There is a shortage of time. When consumers are given the option of receiving a product (that they enjoy) when they need it with little effort on their part, they tend to sign up.
Subscriptions eliminate the need for customers to conduct product research and shop in-store, resulting in a more seamless customer experience.
2. Companies can accurately predict revenue.
Subscription models make forecasting your company’s monthly revenue much easier. Your consumers pay you regularly, so you know what and when they will pay.
A realistic view of your company’s resources is possible when you incorporate budgeting into your business strategy.
3. Customers are exposed to new products.
Customers can also test out new products they might not have tried otherwise since they don’t have to travel to the store.
You can buy snacks in boxes from across the globe, including some from Snack Crate. You may discover a new favorite snack you weren’t aware existed with this membership.
4. Subscriptions can increase customer loyalty.
Consumers may find that some products or services are prohibitively expensive. You can set a lower price and help consumers budget for it in their monthly expenses by charging weekly, monthly, or annual.
You might want to consider purchasing a car. When you buy it in part, you will be placed on a payment plan that will allow you to play incrementally over time. You can afford the vehicle even if you don’t have the entire amount immediately.
5. Customers are better able to deal with businesses.
You can also create stronger relationships with customers by continuing to work with them over time.
When your service team consistently provides outstanding customer support, customers develop a sense of trust in your personnel and grow acclimated to dealing with your brand. Customers need to know this when deciding whether to renew their subscription.
Types of Subscription Business Model
Subscription business models can be used by a wide range of businesses and industries.
Many industries like cable television, websites, gyms, satellite radio, lawn care, and storage facilities.
Some companies are a little younger, such as subscription boxes, that have subscription models. The subscription box business model includes services like meal delivery and meal delivery kits.
A subscription-based business model for online document and photo storage is also available, such as Apple’s iCloud.
You can also order some products directly to your home, including personal care products. Birchbox and Dollar Shave Club are examples of companies that operate in this field.
You can access a vehicle via car subscription services if you pay a monthly fee. The subscription price typically includes registration, maintenance, roadside assistance, and liability insurance.
Car service does not require a long-term commitment like a lease. You can subscribe for a shorter time and exchange your car each month.
A few examples come to mind when we think of subscription businesses or our bank accounts, for that matter. Spotify and Netflix are often cited as the poster children for this economic strategy.
Subscription businesses are frequently successful in this manner. Their differences are either in the type of service or in the frequency of subscription payments.
Let’s take a look at a few of them.
1. Software As a Service (SaaS)
SaaS is a methodology for delivering software in which applications are centrally hosted in the cloud and licensed on a subscription basis.
SaaS clients prefer cloud infrastructure for many reasons, including the ability to self-serve and eliminating the need for on-site maintenance.
Several software companies operate using subscription models as their products are updated and improved frequently.
The subscription model makes it possible for customers to change the product without affecting the user experience rather than repurchase it every time it is updated.
Subscription software (Software as a Service or SaaS) is another trend in the subscription arena.
It has traditionally been the practice for corporations such as Adobe (developer of Photoshop, among others) to charge a one-time fee for access to the software. The software often stopped being developed and supported, resulting in angry clients.
Subscription-based businesses such as Grammarly or Slack have built their entire business model around them.
2. Physical Subscription
Subscription models based on actual products have grown in popularity over the last number of years.
Customers pay a recurring price in exchange for a consistent supply of a physical commodity.
The Dollar Shave Club and Quip toothbrushes were both founded on this premise.
Dollar Shave Club offers clients the option of establishing a wish list of grooming supplies they need. You will then receive a new set vier times a year or according to the schedule you choose.
Clients of subscription services are entitled to free deliveries and a money-back guarantee at any time.
3. Traditional Subscriptions
The subscription model has grown in popularity over the last few years, but it is far from revolutionary.
Subscriptions have been part of our lives for decades, whether for electricity or a gym membership.
A key difference is an ease with which these may be terminated and the ability to reach an exponentially greater number of people via the internet.
Subscriptions to content are not new. The trend of consumers subscribing to material with a cable TV subscription or news magazines dates back decades.
The launch of Apple TV+ and Disney+ are recent examples of Apple and Disney’s push into subscription streaming services.
5. Integrated with hardware
We are witnessing a trend where existing gear is coupled with a subscription-based component. One of the startups pursuing this strategy is Peloton, which recently went public.
The peloton makes exercise equipment such as treadmills and stationary bikes. They offer live online exercises for a monthly fee of $39. This makes their business model unique.
Their instructors lead these workouts, and they draw participants from all over. They can then evaluate their performance against others and try to improve it as they go along.
6. Streaming Service Subscription Model
Streaming services provide access to content, such as movies, television shows, and music, for a monthly fee.
Consumers gain from this approach since they can access their entertainment content whenever and wherever they like.
7. Food Service Subscription Model
Subscribing to a food service may be just the thing you need to change up your usual mealtime routine. You can order food from these companies and receive recipes along with it.
We provide both supplies and instructions so that even if you’ve never prepared a meal, you can do it the right way.
Advantages of Subscription Business Model
It is easy to see how lucrative this business model can be for a firm as large as Apple who transitions from selling hardware to subscription-based business models. Subscription business models offer some significant advantages.
Relationships With Customers
Subscribers generally make frequent use of their subscriptions and are devoted to them. Businesses can strengthen their client relationships in this way.
People are increasingly willing to provide information, making it easier to gather feedback from consumers.
When you buy a product from a company, you get to know them better than if you bought it from a business that sold it to you once and then abandoned you.
Spotify remains loyal to consumers and continues to flourish, with nearly 95% of users using the service. It is most certainly not an anomaly in this area.
The subscription business model has the advantage of ensuring that customers will continue to support a service. It simplifies revenue forecasting and enables long-term planning.
Creating an Ecosystem
Amazon Prime provides customers with free delivery and gives them access to Prime Video and Music, discounts at Whole Foods Market, and early access to Prime promotions.
Amazon has created an ecosystem around its prime membership due to its close interactions and frequent input from consumers.
Clients are extremely unlikely to cancel the service due to its abundance of benefits and ease of use.
Price Raising Capacity
You may be able to increase your prices if your clients are inextricably linked to your product. Buyers will not consume an excessive amount of those, though! A price increase by Netflix caused its subscribers to leave.
Subscribing to a certain product or service is often convenient for consumers. Subscription businesses may have easier gaining clients because of a short setup process and no hidden costs during setup.
Disadvantages of Subscription Business Model
Subscription business models certainly have their pros, but their flaws are also present.
Easy to cancel
You can cancel your subscription with the same ease as signing up. It is one of the benefits of subscribing to a service to cancel it at any time without drowning in monthly charges.
Initial investment is high.
Imagine Netflix only offering ten films: would you subscribe? Most likely not. Developing the content and technology necessary to attract consumers cost an arm and a leg.
Customers may feel hesitant to sign longer-term contracts (such as gym memberships).
You’re committing to making payments to your customers for a while. The customer may not feel like they are making a substantial commitment as a result.
Whenever you notice your subscription is becoming degraded, you can easily cancel it (see the previous point). Subscription businesses are therefore constantly updating their products.
A severe interruption, such as server downtime or delivery delay, cannot be tolerated as well. You will quickly lose those clients to your competitors if you don’t take action.
How To Measure Subscription Business KPI?
The development of a subscription business often requires a substantial upfront investment.
Sometimes, it takes years before a business breaks even financially. Thus, it is crucial to monitor these four Key Performance Indicators (KPIs).
1. Customer Acquisition Cost
The term “customer acquisition cost” refers to the money spent on acquiring a new customer.
Customers can be obtained through a variety of methods, including internet advertisements on billboards, television, podcasts, and social media, as well as traditional face-to-face sales.
The customer acquisition cost is estimated by summing all sales and marketing expenses (during a certain time) and dividing by the number of customers acquired.
CAC = (Sales and marketing) costs ÷ new customers
For instance, if you spend $100 on Instagram advertising and get ten new consumers, your CAC will be $10.
A high CAC is not troublesome in and of itself, as long as the customer gained generates enough revenue to cover the acquisition cost.
The issue is a result of a high CAC and a high rate of client churn. You then incur a loss on each new customer acquired.
You need to reduce your CAC and improve your customer churn rate and overall lifetime value (LTV).
2. Churn Rates
The churn rate (also known as customer churn) is one of the most significant metrics for subscription-based organizations. It represents the rate at which you lose customers over a specified time (monthly, quarterly, or annually).
You determine the churn rate by subtracting the total number of users at the start of a period from the total number of users at the end. The result is then divided by the number of users at the start of the specified period.
Churn Rate = (Users At Beginning Of Period – Users At End Of Period) ÷ Users At Beginning Of Period.
It is one of the best customer satisfaction indicators to look at turnover over time, even when it can fluctuate significantly.
You must have a lower churn rate than the rate at which you grow your business. If your monthly user count is 1000 at the beginning and 900 at the end, your churn rate is (1000 – 900) 1000 = 10%.
It is common to use the terms retention and churn interchangeably. Your client loyalty is the total number of customers who continue to use your service. So a client churn rate of 20% would equal 80% retention.
3. Customer Lifetime Value
Customer lifetime value refers to the overall revenue generated by a customer over the term of their membership.
CLV is difficult to forecast early on, but understanding it helps you forecast each customer’s potential revenue.
There are numerous methods for calculating CLV, and so the results may vary significantly. The most straightforward technique of determining your CLV is as follows:
CLV = ARPA ÷ Churn rate
ARPA denotes your average revenue per account over a specific time (e.g., monthly). For example, monthly ARPA is computed by dividing the month’s income by the month’s client count.
Let us look at an example of CLV with this in mind. When your customers churn at a rate of 5%, and you make $10 per month from them, this is your CLV for monthly customers:
CLV = 10 ÷ 0.05 = 200$
The lifetime value is critical when determining how much you should pay to acquire that customer. The more money a customer is expected to spend, the more money you can spend on their acquisition.
Recurring Monthly and/or Annual Revenue
MRR or ARR indicates the amount of revenue you may anticipate earning in a given month or year.
You can use these two indicators to determine how much money you have to spend and how long it will last.
You can determine the financial benefit of adjusting a marketing campaign or adding your MRR or ARR new features.
The monthly (or annual) revenue per customer and annual revenue per customer are calculated by multiplying your monthly (or annual) income per customer by the number of customers who pay.
MRR = Monthly revenue x Total customers
Thus, if you have 1,000 consumers paying $5 a month, your monthly revenue is 5,000 dollars.
When investing in subscription-based businesses, startup investors frequently look at MRR and ARR as significant KPIs.
These measurements (in conjunction with your turnover rate) can indicate how long a business can survive without going bankrupt (often referred to as the run rate).
What makes the subscription model sustainable?
Traditional corporate models flow revenue linearly – from marketing to sales and finance. Subscription businesses, however, have cyclical revenue streams.
All operations have similar objectives. However, revenue implications are magnified since customers must be ‘acquired’ not only once but also repeatedly.
The subscription model allows businesses to lock in customers for an extended time. It ensures a steady stream of recurring revenue.
Businesses can develop alongside their customers and improve their products and services by building long-term relationships with them.
Final Words On Subscription Business Model
This concludes our discussion! Subscription business models offer limitless opportunities for traditional and modern firms due to their obvious benefits and durability.
You are well-positioned to capitalize on these opportunities if you have the correct product-market fit, a strong pricing strategy, outstanding service, and a killer tech stack.