The Subscription Model: Tips & Warnings
We previously covered how subscription became a prominent business model and how SaaS businesses leveraged that model to become unicorns. The applications of the recurring revenue model are not limited to SaaS businesses, though. If you have an eye for innovation, you can adapt this model to many different industries. There are a few points to bear in mind, however.
Act to disrupt
The subscription model lends itself to creativity quite well. Most successful subscription-based businesses were not built on revolutionary ideas but rather a creative take on a conventional problem. Some of these businesses create value for you by spreading a lump sum payment over 12 months; others help you deal with perishable inventory in return for a fixed monthly amount. There are also subscription products whose value proposition is based on saving you from having to deal with a nuisance. Take buying razor blade cartridges, for example.
You don’t buy replacement cartridges frequently enough, so they are easy to forget during your supermarket trips. Availability is another concern with razor blade cartridges. When bought so seldom, new cartridges turn out to be of a different design, which is not compatible with handles purchased in the past. The price stability of replacement cartridges is the third problem. As commodity prices fluctuate, you can be forced to pay significantly higher prices in your future purchases.
Dollar Shave Club solves all three pain points with its subscription model. The brand’s subscribers receive razor blade refills (and other personal care products) without paying for delivery and according to a schedule of their choosing. Launched in 2012, the brand came with an initial offering that cost its customers just $1 a month for 60 blades a year, when Gillette sold a package of 10 cartridges for $19.99. Dollar Shave Club had 3.2 million subscribers in 2016 and was looking at a sales revenue of $200 million for the year when it was acquired by Unilever for a sum of $1 billion.
This model can be adapted to any business idea that offers a solution to some sort of a nuisance people have in the back of their minds. Whether it is regular purchases of flowers, mowing the lawn, or spraying the backyard to keep mosquitos away, there are many services or products people would like to subscribe to so that they cross tasks off their to-do lists.
Beware of the churn
Churn refers to the rate at which your customers quit their subscriptions. It can be expressed either in the percentage of customers leaving your brand or the revenue you lose due to that.
Some of the churn is involuntary and thus unavoidable. People die, their credit cards expire, or their needs change. The biggest reason for the avoidable portion of churn is your failure to onboard the customer. Without a smooth, well-designed onboarding process, the customer cannot engage with the product and quits without getting to appreciate the value your subscription offers.
Containing churn should be a startup’s primary goal. However, amidst all the troubles a startup has to wrestle with initially, the need to minimize churn will probably not be a priority. After all, churn can seem manageable at the early stages. If you have 20 paying customers and a monthly churn rate of 5 percent, that would mean one customer quitting his subscription and leaving every month. That’s easy to make up for. All you have to do is work a little harder and sell just one more subscription the next month. However, it all adds up in the long run as you bring in more customers.
Investor and product-led growth guru David Skok uses a model to demonstrate the long-run impact of churn. Skok starts with a hypothetical MRR of $10,000, $2,000 in additional subscriptions every month, and a monthly churn rate of 5 percent. His model generates $90,000 in lost monthly revenue at the end of the fifth year. That’s a lot of money to leave on the table.
The best move to reduce churn would be to redesign your onboarding, remove friction, and fast-track the customer’s journey to her “aha” moment. Another option could be to charge your customers upfront. After making a lump sum payment at the beginning of the subscription, your customer will be more motivated to use and engage with your product in order to get her money’s worth. This will increase her chance to derive value from the product.
Upsell & cross-sell
People reconsider their subscriptions from time to time as different payments pile up on their credit card bills. They conduct a triage every now and then and quit some of their subscriptions while they try out new ones. You don’t want yours to be among the ones getting axed.
Two methods can help entrepreneurs retain customers in a subscription model:
- Upselling: Selling existing customers upgrades or new products or services at higher price points.
- Cross-selling: Selling customers related or complementary products or services.
A financial consultant serving his customers on a subscription basis can take advantage of upselling opportunities to reduce customer and revenue churn. He can charge his customer a higher price for a premium option where they can reach him 24/7. Such a move not only creates additional revenue for him but also engenders customer loyalty.
For an example of a business leveraging cross-selling to expand its revenue and boost its revenue, we can turn to Dollar Shave Club again. Having started with selling only replacement razor blade cartridges, the company later set its sights on “owning the bathroom cabinet.” Today, the brand will sell you anything you need in the bathroom, from shaving butter to shower gel, skin care products, and even wet wipes.
Upselling and cross-selling bring in additional revenue that can neutralize the customer and revenue churn your startup is suffering from. These two techniques can help you achieve negative churn. This term refers to the amount by which your expansion revenue (revenue from new signups, upselling, and cross-selling efforts) exceeds the revenue you lose because of churn.
Net negative churn is how the subscription model works its magic. It reverses the compounding impact entrepreneurs suffer from when they have churn. Thanks to negative churn, you can grow your baseline revenue, increase customer lifetime value, and achieve a level of MRR you would not have believed was possible before starting off.
It is no surprise that the subscription model has become so common in the last few years, regardless of the industry. It provides a win-win situation between the customer and the company. Barring any radical changes in customer requirements or product quality, the subscription model sets the stage for a long-lasting relationship, which every startup should strive for.