How the Subscription Economy is Driving a New Kind of Business Model
Part 2 of 3
In the first article of this series, “The Subscription Economy: What It Is and How It’s Changing The Way People Buy,” Dave Frechette, Vice President of Worldwide Sales Strategy and Execution at Zuora, shared his thoughts on why many businesses are moving toward a subscription-based selling model.
This Subscription Economy, a phrase coined by Zuora, is fundamentally changing the way businesses operate. The shift to the Subscription Economy brings with it the need for a completely different approach to building your business.
In this post we’ll focus on four of the essential areas that foundationally and operationally change when companies transition their models to the new Subscription Economy:
- Customer Onboarding
- Internal Operations and Growth
- Financial Metrics
1. Pricing Model
It turns out that pricing in the Subscription Economy is far more complex than it seems.
First, a business must select its unit economics, calculating direct revenues and costs needed to be profitable on a per-unit basis.
Next, a business must choose its billing periods, determine the appropriate pricing model (i.e. capacity vs. usage) and create different packages for varying user segments or for light vs. heavy users.
With so many businesses trying to price on a subscription basis (and especially for startups with new technologies that don’t have pre-determined market value) it begs the question, “How do you price to be competitive?”
If a company has been traditionally selling in a B2B world, they’ve been using cashbox, invoices, checks or wire transfers. In the old world, billing was straightforward. You shipped $1500 worth of stuff, so you billed for it.
In the Subscription Economy:
- You have to bill for new customers.
- If they sign up in the middle of the month, you have to charge a prorated amount.
- You have to bill customers at the point of renewal or recurring billing cycles.
- You have to bill customers as the service is consumed (e.g. per GB, minute, etc.).
In the new Subscription Economy model, instead of fixed, SKU-based pricing models, your pricing is based on flexibility. Because pricing options and packaging strategies may seem almost infinite in the new Subscription Economy, operationally, you’ll need to prepare for the complexity.
2. Customer Onboarding
Once you’ve determined your pricing structure, you’re ready to sign up customers, right?
Actually, no. In the Subscription Economy, setting up accounts and billing for customers is both critical and complex. These new complexities require businesses to constantly generate accurate, well-designed and user-friendly bills for new and existing customers.
Businesses operating in the Subscription Economy should treat each bill as an opportunity to interact with customers. Your billing engine must take the inputs you have, calculate your bills, make sure they are accurate and format them in a way that is clear and promotes your brand and image.
Onboarding your customers requires forethought into payment gateways, billing systems, payment confirmation, customer notification, user accounting, and customer propagation into the company’s CRM system. With a recurring revenue model, billing can happen at point of sale, mid-month, or at various times throughout the year.
With 90% of customer-to-company interactions coming from changes to existing subscriptions, businesses are required to provide customers with intuitive and comprehensive tools to manage their accounts over the entire subscription lifecycle. The customer is in control and if customers aren’t given the control they want, a company will risk customer dissatisfaction and may lose them in churn to their competition.
As a subscription company’s customer base gets bigger, this becomes one of the most important keys in their entire framework.
3. Internal Operations and Growth
Accounting practices that accommodate the business complexities of a recurring revenue model require a difficult shift for companies. At a high level, you’re dealing with upgrades, add-ons, change orders, downgrades and suspensions.
Many difficult discussions and decisions will need to be made in order to navigate the internal operations for a successfully running subscription model.
- How should I compensate my sales team?
- How do I reduce the number of failed credit card transactions?
- How do I reduce churn or attrition with my customers?
One indicator of a customer’s churn risk can be based on a customer’s usage of the product or service. Businesses can start to take preemptive measures to make sure their customers don’t churn because of low usage.
In this way, a company’s internal operations shift from supporting the delivery of a one-time product or service to operating like a well-oiled machine, seamlessly reducing friction at the many complex touch points between customer and company.
The shift to a subscription-based model also brings with it the need for a completely different approach to growing your business.
A one-time buy goes away because, in this new growth model you're no longer selling units. Instead of growing by shipping more units, you're now monetizing long-term relationships and nurturing that relationship over time.
A perfect example of this is the “bundle of services” now offered by AT&T or Verizon. Relationships are being monetized through family plans where you sell a base level of service for usage or units of measurement in your package. From that base, you can grow revenue by selling customers “add-ons.”
4. Financial Metrics
The Internet of Things and a proliferation of smart devices has accelerated the shift in consumption we’re seeing from users. The next eighteen months will see a tectonic consumer shift towards connected devices, from automobiles to homes to wearables. Companies now have ways to strengthen their customer relationships over time because of the growing amount of customer face-time they have access to, as well as the vast amounts of new behavioral data being produced by these connected devices.
Not only do the devices themselves yield value for consumers and businesses, but they can also acquire valuable data on how and when the device is being used. All hard good OEMs (original equipment manufacturers) are starting to think less about units sold than services rendered, including data plan management, intelligent diagnostics, and perhaps most importantly, proactive customer success as opposed to reactive customer service.
The world of opportunities this opens up to businesses presents a major shift in how metrics are gathered to help support the business growth model.
Instead of financial metrics that are backwards-looking and focused on past performance, the new consumption model allows, if not requires, that businesses rely on forward-looking metrics that give insight into future recurring revenue.
The revenue focus is now shifting from what companies can quantify from past deliveries of a product or service to what they can expect and ratify from a customer relationship over 12 months, 18 months or 24 months.
But with this shift toward predicted income, companies now have to take into account a technical consideration - the shift from “cash” to credit cards.
In the old model, payment was accepted at the time of delivery - making it easy to verify that the payment was accepted or, in the case of credit cards, approved.
In the Subscription Economy, the billing relationship requires a monthly charge to a user’s credit card. Since a subscription-based business requires that payment is accepted each month in order to ensure good cash flow and accurate financial projections, companies have to consider the following:
- How do I verify a customer is in good standing with that credit card?
- How do I integrate “retry” logic into my system?
- Should I charge a set-up or an implementation fee?
- How do I account for multi-year contracts?
The technical and operational considerations, in shifting from a traditional business model toward a subscription model, are many. But once the shift is made, the potential for growth is exponentially scalable.