There is no question that a subscription business which by definition has a recurring revenue string offers superior benefits than a more traditional pay as you go business model. Not only the fact that that revenue is in many cases on “auto” pilot but also the ability to scale and easily add more customers (in the case of technology companies) is extremely appealing to any entrepreneur. There are hundreds of subscription companies that tend to make the headlines all the time, such as Netflix, Adobe, SalesForce, etc.
In the case of Tech Subscription, such as Netflix, the company streams video content into your device, but is up to the consumer to consume the videos. Regardless if the customer watches a movie or not, Netflix gets its monthly fee. There is also the Box Subscription where the company send a box or products to the customer. There are hundreds of different products that fit this model, pool supplies, food, candy, shaving cream, groceries, etc. In this case, the consumer has the ability to change the quantity or type of products or pause the deliveries. As you can imagine, the more flexibility the company provides in terms of allowing the customer to pause or stop the box delivery the less predictability the revenues becomes.
Besides this intrinsic business model differences between one type of business or the other, there is at least one important aspect that also needs to be evaluated. Revenue or Customer Retention is in many cases the achilles heel of a subscription model. Many entrepreneurs just look at the top line and love to see the steady aspect of the revenue stream. And in the case of high growth companies, e.g. Zoom, they love to see how that revenue line is not only consistent, but is at a 75 degree angle. But this growth line may hide a significant problems with customer defections or churn.
Let’s compare two examples: a company that has a subscription business vs. a traditional e-commerce business without a subscription but that provides services to customers on a regular basis.
Same revenue and Gross Margin as the previous example, except that in this case the company only has a 10% churn. Let’s also assume that since is not a subscription business, the Opex is higher than the previous example. This company makes $8k.
Revenue: $166k
GM: $83k
Opex: $75k
Op. Income: $8k
Developing a product or service that can be delivered as part of a subscription model is a great idea. However, unless this business is well supported by an excellent customer experience model, this business can be a money pit. The company may have to spend a lot of money in marketing to replace the customers that they are loosing. On the other hand, you may have a business that provides services regularly but customers prefer to control their purchases. As noted above, this type of business can be more profitable than a subscription business depending on how well the company manages retention. Managing retention is not managing the customer credit card, is managing customer experience at every touch point.
Customer Retention measures the number of customers that the company retains during a given period. This is the typical retention metric for tech. companies because is easy to calculate and manage. On the other hand, it is only useful, if the revenue per customer is fixed or doesn’t fluctuate significantly. Alternatively, if the company offers 3 types of services (e.g. standard, premium and supreme) the company should probably measure retention by type of customer.
Revenue Retention measures the amount of revenue that customers generate month after month. This metric doesn’t really apply for the traditional fix monthly subscription such as Netflix because the revenue technically is the same every month. This metric is extremely valuable for any business that offers multiple products that customers purchase on a regular basis. For example, office supplies, manufacturing supplies, etc. In addition to churn, the company wants to measure if the revenue increases over time through up-selling and cross-selling efforts.
In summary, a subscription business model by itself is not a guarantee of success or necessarily superior to a non-subscription model. You must look beyond and evaluate the other pieces of the business model to really see which model is operating more effectively and efficiently. If you have a business that is currently not a subscription, don’t try to force customers into a subscription without ensuring that:
1. Customers will see value for the subscription and
2. The Company has the right process in place to ensure that the customer experience matches the fact that they are going to pay you x amount every month.
To evaluate other KPIs and understand why they are important take a look at this post.
