Understanding the Subscription Business Model

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Subscriptions are an increasingly common business model, used by firms to generate recurring revenues while allowing access to the product or service without a high upfront cost for customers. Increasingly software, music, and other forms of entertainment are sold via monthly payments allowing continued to access the service. This article explores some of the tradeoffs associated with the approach. 

The advantages of subscription services: For companies and customers

Low initial outlay – encourages adoption that otherwise couldn’t be afforded

One of the most attractive parts of a subscription service from the perspective of the customer is the ability to gain access to the product or service without a high upfront expenditure. Historically, Adobe used to sell access to its suite of design products with a one-off purchase – over $1,000 for the full software suite. While it is possible for professional design firms to justify this cost as necessary, for more casual users, affording and justifying the initial expense is difficult. Now the full suite is available at $52.99 per month. While subscription will cover the initial expense within a few years, it is much easier to justify the smaller recurring payment. Not only do you not need access to the money upfront, but you can cancel the service if you are no longer using it.   

Of course, the ability to provide a product or service to customers without the initial outlay expense can provide a unique opportunity for new firms to compete. If it is standard within your setting for customers to purchase items outright, then there may be opportunities for selling to the segment of customers that don’t have the financial means to justify a large upfront cost (or would find the prospect of spreading that cost over a longer period attractive).

Greater flexibility – lower risk

Couple with the lower initial outlay, subscription services have a lower risk for users, allowing them to try services that they may benefit from, but are not sufficiently sure to justify a high one-off amount. Depending on the number of on-the-fence buyers – and whether you are able to convince them to continue to use the service beyond the initial few months – this could potentially be a large new customer base that you can tap into. By lowering the barriers to accessing the product or service, you can potentially expand the total market size to a new set of customers that previously would not have risked buying the product or service.

Constant revenue stream

One of the key reasons why subscription services can be attractive to companies is that they provide a constant source of revenue, extending well beyond the customer’s initial adoption of the product or service. While product sales can result in a sharp spike in revenues after a product is released, which quickly reduces, subscriptions provide a more consistent source of revenue for the firm.

The constant stream of revenue is particularly important where improvements are minimal over time. When software was in its infancy, there were substantial improvements with each annual release cycle – Word 2000 was substantially better than Word 1997, and likewise, the 2003 release added lots of new features encouraging customers to make the upgrade. Over time, however, the importance of the features added has declined – the upgrades are more incremental in nature, and it is now possible to use software that is ten years old or more, and still have access to the vast majority of features required. Shifting to a subscription model helps alleviate this problem – it is no longer necessary to perpetually have to convince customers to upgrade to the latest version, once they are subscribing, they must continue paying to maintain access to the current features.

Subscriptions may align with costs incurred

The final potential advantage of subscription services is that the revenue stream may align better with your cost structure – and particularly so in the long term. Having a subscription business model

For example, the move to ‘cloud’ services has been associated with a gradual move away from one-off purchases of software to subscriptions to the cloud equivalent. While some of this has been to allow firms to gain the benefits discussed above, part is to align the costs of providing cloud services with the revenue. The costs associated with hosting and processing files can mount up, and continue potentially indefinitely. Having a subscription service avoids the danger that over time, customers that bought in at a one-off price end up costing you, as the recurring costs of continuing to provide the service are still incurred many years after the initial purchase has been made.

The counter-example of the above is video games and particularly multi-player games. Video games historically, and still predominantly are, sold as one-off purchases. While there used to be no ongoing costs for developers in providing the game (which ran ‘local’ on the user’s game console), games are increasingly requiring servers to host the multiplayer components. The costs associated with continuing to provide the game continue well after the game has generated its sales – with game publishers expected to continue to provide their services, even if the game’s popularity declines and the ongoing costs exceed new sales.

Limitations of the subscription business model

Buyer preferences to resist recurring payments

While some users may prefer recurring payments – particularly for items where they cannot afford or justify a high one-off payment, the desire to convert one-off payments to recurring amounts is by no means universal. It is only a few years ago where music streaming services were resisted by those who preferred to ‘own’ their own music rather than just rent it.

Beyond an emotional desire to own rather than rent, there is also the economics – once you have bought an item you own it forever. With subscription services that payment is recurring, and the recurring amounts can quickly mount to being more than they are used to.

High churn in subscribing customers

Another key risk associated with the subscription business model is that customers will look to sign up short term, and then quickly cancel their subscription. High user churn is not uncommon with subscriptions, and in part is a natural result of reducing the difficulty for potential customers to try the service.

A key problem of high churn arises though if you end up making less because customers who previously would have been willing to purchase the product or service at a high price, are now

One of the key reasons that can result in high customer churn is that customers are able to derive all of the value they need from the product within a short period of time. Certain products are needed across time – music would be a good example for this – it is not possible to stack up all of your music listening within say a month period, and then no longer need to listen to music again. Other products may however have a more transitory need –

This is a challenge that Disney has faced with its Disney+ offering. If a video streaming service only has limited content, then you may be able to quickly watch the programs that you want to watch, and then cancel the subscription. While services like Netflix have a lot of back content of TV series, Disney primarily has movies – which can quickly be watched within a short time period.

This problem may be even more server if you can in some ways retain ownership of the product even after they have canceled the subscription. If for example, your service provides access to data, and allows customers to download the data for processing themselves, then you risk customers quickly downloading all they require and then terminating their service. While there may be ways of adjusting your business model to limit this occurring – potentially restrictions preventing bulk downloads, constant refreshments to what is provided, or terms that only allow users with a valid subscription – it is important to consider the risk of customers being able to maintain the product despite canceling the subscription, and the difficulty of enforcing terms of service designed to prevent this behavior.

High user-churn can have high onboarding costs

Beyond the danger that only limited money is made through users that cancel their service after a short period is that this user churn may substantially increase your support and related onboarding costs. Particularly for products that require an element of training to each user that signs up for the service (for example a meeting to explain how to use), there may be high initial costs associated with onboarding each customer – which may exceed the revenue associated with the firm few months of service.

Further thoughts: Examples of subscriptions services

For further details of why subscription services exist across industries, see our guide to exploring examples of subscription services across software, entertainment, deliveries, meal kit services, and subscription boxes.