The subscription economy is certainly a hot topic. But, what does the subscription economy really mean? What are its advantages and disadvantages, how do you win in this economy, and what does the future hold for this business model?
First let’s look back, the subscription business model itself has been around since the 17th century. As the world evolved and technology advanced, so did the appeal of anything-as-a-service (XaaS). Over the last few years, organizations have seen explosive growth for subscription-based services. This has prompted companies to make the transition from traditional business models to ones that are subscription-based. In fact, according to Statista, the subscription market will continue to grow at 18.4% CAGR to reach $1.5 trillion by 2025.
What is the Subscription Economy?
The term, subscription economy, describes the trend of companies and consumers shifting from traditional pay-per-product/service to a subscription-based business model. With this model, billing is based on a variety of pricing strategies. These include fixed, usage, tiered, per user/unit, and value-based – or a combination of two (or more for a hybrid billing approach).
Fixed Pricing
Also referred to as flat-rate pricing, this billing model provides a set price for access to a product or service that offers limited capabilities or features. While it’s the simplest of the pricing strategies and is easy to sell, it’s not always the most effective as it limits the customer pool to those that require only minimal functionality. For this reason, it’s most appropriate for companies that offer uncomplicated products.
Usage-Based Pricing
Also known as pay-as-you-go, this pricing model charges customers based on their usage of a particular product or service. While customers consider this pricing model the fairest, it has drawbacks for the company – difficult to scale, disproportionate pricing between small companies and larger enterprises, and poses challenges in forecasting future revenue. From a customer perspective, pricing fluctuates each billing cycle, making budgeting a bit more difficult.
This pricing model is primarily used by IT, utility companies, and communications providers, as well as organizations that sell software products that entail frequent API calls and data usage.
Tiered Pricing
One of the most used pricing models, it provides customers with options based on features, functionality, and services, as well as usage volume, and even the perceived value of the offerings. To avoid customer confusion, the number of tiers are typically limited to 3 or 4 such as basic, standard, and premium or free, basic, advanced, and enterprise.
This pricing model offers customers choices, as well as the ability to upgrade or downgrade based on their changing requirements. From the business side, it enables organizations to reach a larger target market, increase up-sell opportunities and maximize customer lifetime value (CLV). This pricing model is popular among software-as-a-service (SaaS) companies.
Per User/Unit Pricing
While more complex for organizations to set up than some of the other pricing models, it provides customers with more flexibility since they only pay for the number of users (or number of units consumed). The more users/units the more revenue the company receives.
Although often used by SaaS companies or as a supplemental pricing strategy alongside others, this pricing model comes with some disadvantages such as low volume of users/units and the sharing of login information.
Value-Based Pricing
Not based on typical metrics such as the cost to produce the product, this pricing model focuses on the customers’ opinion or appreciation of the product which is reflected in how much they are willing to pay. Primarily used by companies that provide high-end offerings and serve niche markets, it enables these organizations to maximize profitability.
Regardless of the billing strategy, subscription-based business models enable companies to receive a recurring revenue stream, while providing customers with the ability to access the business’s products or services – without high upfront costs.
“Spoiler” Alert: Customer Happiness Drives Success
When you dig deeper into the subscription economy, it’s more about delivering an experience, rather than selling a product or service. Putting the customer at the center of the business ensures the experiences they receive encourages them to become loyal brand advocates.
This business model shifts the focus from products or service, and places it on the value customers receive from your offerings. For many organizations, this is different from how they currently do business – and for some companies counterintuitive. Touching nearly all internal departments such as product development, marketing, sales, and accounting, it’s a different paradigm that requires organizational changes.
Today the subscription-based business model has become the standard for many companies and industries – even those that (not too long ago) didn’t think it would benefit them or their target market. From larger organizations like HelloFresh, Dollar Shave Club, Amazon, Disney+, Spotify, and Porsche, to lesser-known companies such as Spiffy Socks, Tokyo Treat, Wickbox, Wine of the Month, and Fruit for Thought; virtually everything can be offered on a subscription basis – even high-end items like vehicles, travel services, and apartments.
Given that this business model is expected to dominate throughout the foreseeable future, let’s look at its pros and cons.
The Subscription-Based Business Model: Benefits and Shortcomings
From a business and customer perspective the subscription economy offers an abundance of advantages, as well as a few disadvantages.
Business Benefits
- Provides a predictable revenue stream: A predictable cash flow makes it easier to accurately forecast future revenue, as well as keep the business viable in times of financial fluctuations.
- Expands target market: The low barrier to entry helps companies to quickly increase their customer base.
- Increases upsell/cross-sell opportunities: The longevity of customers and the data collected allows for more personalized marketing.
- Improves customer satisfaction ratings (CSAT): Since it takes virtually no effort by customers to continue using the products or services, the experiences they receive are enhanced, fostering customer and brand loyalty.
- Maximizes CLV: Given that the success of this business model relies on customer retention, companies can increase CLV.
- Improves customer retention: Since customers subscribe for a certain length of time, they are more committed to a long-term engagement and less likely to churn.
- Lowers customer acquisition costs: By building customer loyalty and hence CLV, organizations spend less on acquiring new customers to replace those that have churned. Additionally, subscription renewals may be activated automatically, turning a one-time sale into recurring revenue.
- Reduces failed payments: By using stored payment information for automatic payments and by preemptively identifying soon-to-expire credit/debit cards, organizations can proactively reach out to customers.
Customer Benefits
- Provides cost predictability: Since billing happens monthly, quarterly, or annually, customers can efficiently budget their finances.
- Creates peace of mind: Whether a subscription to software or a subscription box, availability/delivery is predictable.
- Allows for scalability: As needs and requirements change, customers can easily scale accordingly.
- Lowers barrier to entry: Customers can use products and services that may have been unaffordable without the subscription model.
- Delivers ongoing value: To keep customers over the long term, businesses need to continually improve their products/services, create new offerings, and add features and functionality.
Business Shortcomings
- Increasing competition: As this business model continues its upward trend and the playing field becomes increasingly crowded, companies will need to find a way to stand out such as delivering exceptional customer experiences, providing quality products/services, ensuring consistency in customer interactions and offerings, creating unique branding, etc.
- Subscriber churn: Whether from subscription fatigue, contract aversion, switching to a competitor, etc.; businesses need to proactively monitor customer satisfaction, put processes in place to reduce subscription cancellations, deliver exceptional products/services and experiences, and even make it easy for the customer to cancel their subscriptions.
- Contract avoidance: Commitment-phobia may have some customers wary of signing a contract. To lessen the impact of this disadvantage, companies should increase their marketing spend to put laser-focus on the value the products/services provide, as well as offer free, no-commitment trials.
- Providing ongoing new value: To stay relevant, it’s vital for businesses to constantly add value to their offerings by developing new products, services, features, and functionality, creating packages and bundles, offering discounts and promotions, etc.
Customer Shortcomings
- Increases vendor lock-in: In some cases, such as a particular business-critical software, the customer may have no choice but to remain with the company.
- Subscribe and neglect: More common with B2C subscriptions, customers sign up for a subscription then forget about the product/service purchased. In most cases it is when auto-renewal happens that the customer ‘remembers’ the purchase.
Win in the Subscription Economy
With the ever-growing number of companies transitioning to a subscription-based business model, the playing field is becoming extremely crowded, with new competitors joining the ranks every day. To win in the subscription economy, your company needs to stand out and to do that there are a few actions you should consider.
As previously discussed, the subscription economy is less about the product/service and more about the customer experience. It’s about creating convenience for your customers, providing an attractive price point, and delivering value. It’s also about ensuring subscribing to your offerings is a seamless transaction, and building an ecosystem that fosters customer and brand loyalty.
To be successful in the subscription economy you need to know what your target market wants. Doing this can take the form of surveys, analyzing data acquired from current customers, getting feedback from your sales team, or a combination of tactics. This information will enable you to improve your business model, enhance your offerings, and even (when needed) shift business strategies – to one that is more customer focused.
Measuring Success is Simple
At this point, you may be wondering – How do I know if my company is winning in the subscription economy? The answer to this question is metrics. While there are quite a few to choose from, here are the ones that provide the best insights.
Monthly Recurring Revenue (MRR): Refers to the predicted revenue a company expects to receive on a monthly basis in exchange for providing products or services. This metric includes invoiced recurring charges, credits, and refunds.
Annual Recurring Revenue (ARR): Used to determine how much revenue a company can expect each year, it refers to ongoing revenue for products or services delivered, projected over one year.
Average Revenue Per Customer (ARPC): Also referred to as average revenue per user (ARPU), it’s the amount of revenue a company can expect to receive over a period of time. This metric is typically measured and tracked monthly, quarterly, and annually.
Churn Rates: Refers to the rate at which customers end their relationship with a business.
MRR Churn: This is a measure of revenue lost from customers that have canceled or downgraded their subscriptions in a given month.
Trial Conversion Rate: Refers to the percentage of trial users that became paying customers at the conclusion of their free trial.
The Future of the Subscription Economy
While it’s virtually impossible to predict the future of the subscription economy with complete accuracy, one thing is certain – it will continue to grow and evolve. Just keeping up with the competition will no longer be enough. In this fast-paced environment, the winners in this economy will be the organizations that step outside their comfort zone to continually reinvent, optimize, and personalize their solutions to cater to evolving customer needs, solve specific problems, and deliver their products and services instantly and seamlessly.
McKinsey research revealed that 28% of subscribers view a personalized experience as essential to remaining engaged. Further, consumers are quick to cancel subscriptions that don’t deliver superior experiences, including poor product quality, assortment dissatisfaction, or lack of perceived value. What does this mean for the future of the subscription economy?
With personalization being key to sustained growth and profitability, we expect organizations to cater to the specific needs of their customers – both B2B and B2C. For example, companies may provide QR codes that subscribers can use to access personalized videos that detail product setup and usage. They may also use the data they’ve accumulated to further personalize their offerings or send personalized SMS messages that offer products/services that complement previous purchases or provide discounts, loyalty programs, awards, or customized bundles.
Looking into the future even further, companies may align their products with social and sustainability causes such using recycled materials for their products or packaging; reducing their carbon footprint with point-to-point shipments; and even form associations with communities where a percentage of the purchase price is redirected from the brand to specific social causes or community needs.
Don’t Just Join the Subscription Economy – Thrive!
The subscription economy is about shifting your business paradigm from one that is transaction-centric to one that is relationship-driven. Thriving in this environment requires a personalized and innovative approach. For companies to be successful in this dynamic environment they will need the tools that allow them to quickly pivot to meet changing market needs, make operational changes and strategy adjustments, modify or develop new pricing models, and send invoices that are timely and accurate.
The subscription economy has increased the need for greater business agility, which is driving organizations to demand more flexible operational support solutions. BillingPlatform delivers the flexibility and automation needed that can quickly and easily adapt to any billing need or business requirement. We provide a complete solution that supports all your business requirements – any product, any service, and any business model, enabling you to not only succeed but stand out and thrive in the subscription economy.
Are you ready to make your mark in the subscription economy? Contact our team of experts today and start pushing your business forward faster!
