Introduction

Subscription models are heavily used by businesses for designing their revenue models. It’s prevalent in almost every industry, i.e. hardware, e-commerce, finance, cloud services, etc. Many businesses are also making a move from one-time product sales to subscription models. Understanding this model can be quite useful for startups.

In subscription models, customers pay a modest fee to gain access to a product or service and then pay on a recurring basis for continued access. This model is founded on the notion of recurring sales, which are often made with a specific frequency, i.e. weekly, monthly, yearly, etc. This revenue model differs dramatically from the business models built on one-time sales since subscription services prioritize client retention and loyalty over the long term instead of one-time exchange.

A company that uses a subscription model earns the majority of its income from consumers who make multiple payments over time rather than paying a higher upfront price for a one-time purchase. Some services we encounter in our day-to-day lives are: Netflix for movies, Prime for deliveries and other services, Playstation for gaming, etc.  Such models rely upon a customer’s lifetime value rather than a one-time purchase for their business.

The following article delves into how the subscription business model works, its benefits, and relevant metrics to track the performance of the subscription business.

Working of Subscription Business Model

Subscriptions are not a novel idea. In reality, book and newspaper publishers were the first to use them in the 1600s. Customers nowadays generally sign up for subscription services online, supplying credit card or bank account information and authorising recurring charges. If the consumer does not cancel before the end of the subscription month, the subscription will automatically renew. The customer’s account will be charged, and he or she will have continuous access to the goods or services they purchased. A handful of today’s most popular subscription services are listed below:

1. Streaming – Netflix, Hulu, Amazon Prime Video, Apple TV, Spotify, Sirius XM, Disney+
2. Supplies – Dollar Shave Club, Ipsy, Butcher Box, Man Crate, Barkbox
3. Online gaming – Xbox Game Pass, PlayStation Now
4. Software as a Service – Google, Salesforce, Dropbox, Mailchimp
5. Workouts at Home – Peloton, Fitbit Premium, Mirror, Tonal
6. Fashion – Rent the Runway, Stitch Fix, Trunk Club

Advantages of subscription-based business models 

Let’s look through the main advantages of subscription business models and why they’ve gained popularity in recent years.

1. Predictable Revenue: With a subscription-based business model, customers make payments on a regular basis. Since the amount of recurring payments are decided at the time of initial sale, it allows the organization to predict revenue each month. This also ensures that owners of businesses aren’t ordering more supplies or stocking more inventory than needed.
   
2. More Customer Attraction: In general, charging customers $2 per month is more attractive to consumers than charging them $20 at once. There are exceptions but usually, the higher the transaction value, the fewer the number of purchases.
   
   Subscription models lower the barrier to entry for products and services and allow more potential customers to purchase products. While they may pay a larger amount over the long term, they can get immediate access to the product. They also enjoy the increased benefits as the business grows and the company improves products over time.

3. Gain Customers’ Loyalty: Customers subscribe to products or services because it saves them time and money on repeated purchases. Subscriptions can also grow with the consumer. They are not required to pay the total price for a product and then pay again for a newer or updated version. Instead, users may only pay for the extra value by upgrading or just selecting a higher plan. This path of development and adaptability with consumers fosters loyalty and long-term customer connections.
   
4. Forecasting Demand Effectively: Businesses can anticipate product demand by analysing the subscriber base’s purchasing history. This allows for more effective inventory management while also saving money on operations and shipping expenditures.

Pricing in subscription-based models

Pricing is the key factor in the success of a fantastic product or service. This also applies to the subscription business model. Let’s have a look at several subscription pricing structures.

1. Flat rate pricing: Flat rate pricing, as the name implies, is a one-size-fits-all strategy in which the product is given with fixed characteristics for a predetermined price. Although simple to predict, this strategy may not work for many consumers.
   
2. Tiered pricing model: It is a relatively frequent price mechanism that employs 2 to 5 levels. The tiers are divided into several groups of product characteristics with different price levels. Because consumers will require more features as they expand, this model is great for upselling.
   
3. Usage-based pricing model: The pay-as-you-go approach is another name for usage-based pricing. ‘Usage’ varies according to the product or service. For an internet subscription, it might be the amount of bandwidth consumed.
   
4. Per-user-based pricing: Per-user pricing enables a company to charge for a product depending on the number of people who use it. In this price model, as the product’s use grows, so does the revenue.
   
5. Per feature pricing: Cost per feature covers pricing dependent on the product’s features. This practically translates to the product’s worth. This allows the consumer to just pay for what they require. However, the challenge lies in determining the optimum clusters of feature lists that will benefit both customers and businesses.
   
6. Freemium pricing model: Freemium is a pricing strategy that allows users to access parts of a product for a limited time (also known as a free trial) and then be prompted to upgrade to the premium version later on.

Key metrics to track for the subscription business model

The subscription businesses’ distinct income model necessitates a distinct set of KPIs to monitor. However, that does not mean that the business should track everything that it can. Measuring what matters at the appropriate frequency will not only provide actionable insights but will also keep the dreaded analysis paralysis at bay.

Some of the key metrics are listed below:

1. Customer acquisition cost (CAC): CAC is the average amount of money spent on client acquisition. It takes into account all the sales and marketing expenses and provides insight into the entire efficacy of the business acquisition strategy.
   
2. Monthly recurring revenue (MRR): The total monthly recurring revenue earned from subscriptions is referred to as MRR. Subscription companies rely on recurring income, and MRR is a good indicator of how much money subscriptions will bring in on a consistent basis.
   
3. Average revenue per user (ARPU): ARPU is the average revenue earned by each paid subscription over a set period of time, usually a month or a year. It is vital to remember that free/freemium users should not be included in ARPU because they do not contribute to business income.
   
4. Gross MRR churn rate: The churn rate is the frequency with which consumers terminate their subscriptions. It is the proportion of subscribers who stop using their services and terminate their subscriptions. Because subscription businesses live on retention, a high churn rate is a cause for concern.
   
5. Customer lifetime value (CLTV): CLTV is a customer’s average revenue earned over the course of their involvement with the business. CLTV is a very useful metric for subscription businesses, which can drive profitability. CLTV can help in determining how much the company should spend to gain new customers, how long consumers stay on average, and when they stop using their services. It’s one of the most useful metrics for businesses.

There are many other metrics that are used to measure the effectiveness of subscription models. Only the prominent ones are listed above. Businesses should define the most appropriate ones for their goals and track them accordingly.

Note: Both SaaS and Subscription-based business models are similar in nature, due to which many metrics and pricing models may overlap with each other. To know more about SaaS-based business models, you can read the article shared here.

Conclusion

In this article, we have discussed some of the essential aspects of subscription-based business models, different pricing techniques, key metrics, and how these are useful for businesses. This model has been in the industry for a long time, and its usage will keep increasing in the future. Using this model provides more consistent revenues to the company, and establishes a long-term bond with customers. Startups should also re-evaluate their business models and tweak it to include subscription elements in their strategy.