By Megan O'Brien with Robbie Kellman Baxter
- Subscription business models are all the rage — here's what companies need to know about them.
- Subscription success requires a long-term mindset with an understanding that the model is an investment and not a quick fix for cash flow troubles.
- Companies will also need to consider their unit economics, technology use and the transition from "customer support" to "customer success."
As businesses look to grow, many have begun exploring the potential of the subscription business model to satiate consumer demand for flexible consumption. Case in point: In just the past few weeks, Tesla, Twitter and TripAdvisor (yup, all the Ts) announced forays into the subscription world.
Subscription models meet market demand, but companies shouldn’t adopt one thinking it’s a quick fix for all corporate ills. Like any business model, subscriptions come with benefits and place new requirements on the organization.
To discuss the realities of the subscription model — in all its glory and potential pitfalls — Brainyard consulted subscriptions guru Robbie Kellman Baxter. The founder of Peninsula Strategies, a management consulting firm, she is also the author of the bestselling book, “The Membership Economy.”
Brainyard: Are there any types of businesses that should not adopt the subscription model?
Robbie Kellman Baxter: Let’s say you have a fleet of fishing boats and you sell your fish in a single market for a single price. There’s only one customer type; there’s only one price; and there’s no marketing involved. That’s probably not a good business for the subscription model.
And if your core business is successful due to a geographic, regulatory or patent-related advantage, then you probably don’t have to worry about membership either, because people don’t have a choice. If you sell the medicine that I need to stay alive and I don’t have any other choices, then it doesn’t matter how you treat me as a customer, nor does it matter whether we have a relationship. I’m going to keep buying from you.
I also don’t recommend the subscription model to businesses unwilling to think of subscription holistically and for the long term.
Take for example an organization that says, "We know subscription revenue enjoys higher multiples when a business is sold, so we’re just gonna quickly turn everything into a subscription and then sell the business." First of all, whoever buys your business is buying garbage. The subscription isn’t going to add the value it’s supposed to. It’s like buying a golden goose that can’t lay eggs. So I don’t recommend this mentality, because I think it’s unethical.
Additionally, at the beginning of the pandemic, I had some very well-intentioned calls from people saying something like, "COVID-19 massively disrupted our business, and we need revenue quickly. How can we do a subscription that will get us lots of revenue right away?" But a subscription is actually like a golden goose: It’s not about getting piles of gold in one day; it’s about forever. Every morning, there’ll be a golden egg. It’s about commitment. Any business that can’t afford, or isn’t willing to invest in, the long term should not be doing subscription.
Don’t add a subscription offering if:
- You only have one type of customer.
- Your core business is successful due to a geographic, regulatory or patent-related advantage.
- You’re not committed to the subscription model long-term.
- You’re looking for a quick cash-flow fix.
BY: What are the qualities of businesses that you’ve seen do well with the subscription model?
RKB: I’ve noticed that some of my best clients own closely-held businesses — owned by a family vs. being public, or perhaps they have venture-backed shareholders. Those kinds of businesses are often, almost by nature, very long-term in mindset because [their leaders are] thinking about having something to give to their children or their children’s children. They’re thinking about building something sustainable.
Other companies’ leadership is sometimes more focused on building a business that will sell or hitting numbers to get a bonus. When you have leadership like the latter, a subscription isn’t ideal.
BY: What should companies consider prior to offering a subscription option?
RKB: Subscriptions often involve moving from being product-centric to being customer-centric. Let’s say I own a wedding dress store. I’m product-centric, because I sell wedding dresses. I know who my audience is: people who are having a wedding and need to buy a dress. But, looking through the lens of membership, that person is on a journey: a journey to get married or a journey to have a happy life with another person. How can I help them thrive on that journey? Look at it from a membership perspective: If you want brides to be “members” and invest in you long-term, then you have to do more than just give them a dress. So perhaps I’ll start offering marital counseling, financial education and parenting lessons — and my product becomes a membership for that journey.
Subscriptions involve a different way of thinking. So if you want to get into subscriptions, don’t just take the products you have lying around and suddenly charge people to subscribe. Take a step back and ask about the goal of the person buying your product today.
Questions to Ask About Your Customer
- What brought them to your company in the first place? In other words, what are they really hoping for?
- What more can you do for them, on an ongoing basis, to increase the likelihood that they achieve that goal? Can you do it in such a way that they’d pay you regularly?
- What is a fair price for your company delivering on that promise?
BY: How can businesses gauge what their customers want to create an attractive subscription?
RKB: It depends on how well you know your customers to start with and the depth of your relationship. In some cases, you might know exactly why your customer is doing business with you or what they want. I’ve also had clients who have never asked those questions.
A lot of clients do market research when making a transition to subscriptions. They might send out a survey or invite a few customers to a focus group. I advise them to start broad: Ask customers what’s important in their life in your broader category without leading the witness. Say, "So, what’s on your mind? Tell me how you’re feeling and what’s challenging right now." That can help you understand whether the customer is “looking for something” in the first place. Then, you can keep prompting them and narrow in on what you really want to ask. Eventually, you’ll see how largely your product looms in their goals.
Instead of doing this, however, a lot of organizations ask over and over about their product. They may miss the boat, because the big question is: Is our product or service something you’re even interested in, in the first place?
For example, let’s say I ask, "If you were looking for a fire extinguisher, what would be important to you?" You’ll give me your best answer. And let’s say I ask, "What might you pay for a fire extinguisher?" You’ll give me your best answer. Now, let’s say I ask, "What’s the likelihood you’re going to buy a fire extinguisher?" You might say, "You know, it wasn’t even on my mind. There’s one in my apartment building, so it’s not a priority for me." Now, I know the answer to my company’s big question: It doesn’t matter if it’s $400 or $500; a fire extinguisher is not something our customer thinks about. So, we have a bigger problem to deal with.
BY: If my company moves forward with a subscription model, which logistical changes do we need to make?
RKB: From an operational standpoint, several things need to change.
For example, let’s say you have a restaurant delivery subscription service. Every Sunday, you bring dinner to your members. As you’re starting out, you’re using a spreadsheet and your own car. But then it starts growing, and now you’re delivering from five restaurants on multiple days of the week. Now, you’ll need to invest in subscription technology and processes. You will probably need subscription billing systems and to understand the legal requirements around recognizing subscription revenue. (You can’t recognize revenue until you actually deliver the service, even if your customers paid for their subscriptions, say, at the beginning of the year.)
You’ll also need what I call "customer success” (vs. customer support). Customer success is a term mostly used in software-as-a-service companies, but I think the concept is applicable to any subscription business. Instead of waiting for your customer to have a problem and call you, it becomes your responsibility to make sure the customer is happy with the subscription — because if they’re not happy, they’ll stop paying.
Let’s say I buy a Lamborghini. I keep it in first gear, and I only drive it to the grocery store. And I think it’s a lousy car because it doesn’t go very fast. That’s my problem, not the Lamborghini dealership’s problem, because I already bought the car. But, if I’m subscribing to that Lamborghini and keep it in first gear and never figure out how to make it go fast, then I’ll think it’s lousy and cancel my subscription at the end of the first month. In this case, that dealer needs to make sure I know how to get the value I’m paying for.
Businesses have to make sure that I’m using the product in the right way — and that my use is a habit. That’s a very different role than customer support. It’s very proactive.
BY: How can my company ensure our customers are getting the full benefits of their subscription?
RKB: Almost anyone who uses the subscription model talks about customer retention and customer attrition (churn). They don’t want subscribers to cancel. But remember: Customer engagement is the leading metric for churn. You can tell whether somebody’s likely to cancel by how they’re using your product or service.
So track engagement, or how customers are using your offering, especially in the period right after customers subscribe.
Engagement Metrics for Subscription Offerings
- Recency (When was the last time the customer used my offering?)
- Frequency (How often do they use it?)
- Depth of usage (Which features do they use?)
- Breadth of usage (Do they use every feature they’re entitled to? For how long, and how often?)
If you’ve been offering a subscription for a while, then you probably have systems to track much of this activity. But let’s say you don’t or that you have a physical product whose use can’t be easily tracked in a system. For instance, I just interviewed a woman who runs a subscription box of children’s books. She doesn’t know how often her customers read the books: whether it’s the kids’ favorite book or least favorite book or if parents love reading it or not. She has to run surveys and make phone calls to find out. In contrast, if you have digital content or software products, you can easily see user behavior because it’s tracked in the technology itself.
Whatever your offering is low- or high-tech, make sure you understand how people are using your product — and the differences between customers who cancel their subscription and those who use your product well and subscribe for a long time.
BY: Are there any risks or pitfalls in transitioning to the subscription business model?
RKB: Let’s say you’re thinking about moving your whole business to a subscription model. And let’s say that in your restaurant, customers pay $20 per person for dinner, and you’re thinking about moving to a model in which you’ll deliver once a week for $15 per meal. Well, if the only people who subscribe are those who used to pay $20 a week, it’s going to actually hurt you to make the switch, because they’re now paying only $15 a week. The hope is that they’ll stay longer, eat with you more frequently and expand the relationship — and attract new customers. But the biggest risk when you’re switching is: What if you keep the same customers and start charging them less and nobody new joins?
There is another pitfall involving cash flow. Imagine that you sell cars and that now, instead of selling cars, you’re going to have people subscribe to access your vehicles. Image that in order for this model to work financially, a customer has to stay for three years. Over time, you might learn that your customers tend to stay for five years, making this an incredibly profitable model. But regardless, you’re losing money in those first three years.
A lot of businesses transitioning to subscription see what is called the “fish model,” in which your revenue goes down as your costs go up. Eventually, they meet; they swap places; and the business looks good again. But there’s a period in which you’re spending more than you’re making. So, you need to think about how long it’s realistically going to take before your subscription business becomes profitable. Even if it’s healthy and on the right path, you might need to invest for a while before you see results in your bank account.
BY: At what point does a lack of profitability become concerning?
RKB: When the unit economics don’t make sense, it becomes concerning. Consider a subscription box company, for example: If they're spending a lot to acquire a new customer and customers stay a good amount of time — but the majority churn before the business breaks even on that initial cost — then the unit economics are not good.
Now, on the other hand, if we go back to the car example — in which we tend to break even at three years — and most of the customers came in last year, then we’re currently losing money. We need to have some savings in order to stick it out. But we know our customers are likely to stay five years and it’s therefore a very good business. Our unit economics make sense. We invested a lot in acquisition, knowing it will take three years before our investment bears fruit.
BY: How can I know whether moving fully to the subscription model is right for my business?
RKB: Some businesses want to offer only subscriptions but don’t want to risk everything until they understand the economics. In that case, you might do experiments [to test the subscription model]. I encourage you to create a list of hypotheses — including what you’re worried about and what you hope will happen.
For example, you sell video games that cost $60 to buy. And you’re thinking about offering a subscription: lighter access to multiple games for $100 a year. It would be bad if the only customers who transitioned to the subscription were those that formerly bought two or more games a year. (You’d get only $100 per year vs. the minimum $160.) On the other hand, it’d be great if some new customers came in, or customers who formerly bought one game transitioned to the subscription, or customers continued to buy games in addition to subscribing.
When doing your experiments, set expectations and milestones at which you’ll measure success. In this example, we need to see some of these “other groups” participating in the subscription, and we need to see whether there’s improvement in the overall condition of subscribers (e.g., they buy more games after enjoying those in the subscription). You want to identify the risks — and any evidence that those risks are being borne out.
BY: Companies frequently adopt a hybrid model because they don’t want to be fully subscription-based. How can they integrate the new subscription offering into their business?
RKB: These businesses can think about where the subscription fits into their broader ecosystem. For instance, with the restaurant, I might say that I want to have the brick-and-mortar location and this subscription offering. That presents questions: Is the goal of the subscription to bring in new customers for the brick-and-mortar? Or is it to go deeper with folks who already love your food?
Define the role that the subscription will play in your bigger model — and after you integrate the subscription, make sure it’s in fact playing that role. If you hoped that your subscription would get new people into your restaurant who then would buy more from you later, then make sure that’s the case. If you hoped that your best customers would go deeper and subscribe, then make sure that’s the case.
About Our Expert
Robbie Kellman Baxter is a consultant, author and speaker. She is also the author of “The Membership Economy” and “The Forever Transaction” and hosts the podcast “Subscription Stories.” Robbie has more than 20 years of experience providing strategic business advice to major organizations including Netflix, Fitbit, Microsoft and Consumer Reports. She has been focused on subscription and growth strategies for the past decade. Baxter has been featured in the Wall Street Journal and on CNN. She earned her MBA from the Stanford GSB and graduated with honors from Harvard College.