While recurring revenue markets have been around for decades, the trend towards a subscription economy has surged rapidly in the past few years.
Several businesses are looking to earn recurring revenue, going beyond B2C companies such as Dollar Shave Club and Netflix. B2B businesses are now also jumping in, even those products that are long-term. For instance, elevator manufacturer Otis offers Otis One, a subscription-based elevator solution with predictive maintenance insights.
About a decade ago, the perpetual license model was the only way people could purchase business software licenses. But today, subscription models are becoming more prevalent. According to IDC, 53% of all software revenue will come from a subscription by 2022. Even the car subscription area is set to rise 71% by 2022 (1).
Today, let’s talk about the benefits of the subscription-based business model that are driving the trend.
The Rise of Subscription Business Models
Over the past few years, industries everywhere have started to adopt subscription business models. Spotify has replaced CD shelves, and Netflix subscriptions have taken the place of DVD collections. Meanwhile, businesses such as Dollar Shave Club, Stitch Fix, and Blue April deliver everything from dresses to dinner straight to customers’ doorsteps on a ‘set and forget’ recurring schedule (2).
The subscription economy is growing fast. Revenue among subscription-based companies has surged about 5x faster than both the S&P 500 and retail sector from January 2012 to June 2019, as per Zuora.
Several factors are driving the surge, including the advancements in the tech infrastructure. Perhaps most essentially, the subscription model aligns incentives on both sides, offering convenience and affordability for customers and stability for businesses.
Even companies offering services have also started adopting subscription models, and the value offered is not ownership but access. For instance, car subscription services allow drivers to rent cars for occasional trips instead of purchasing one. Fitness brands have also started to turn customers’ living rooms into gym memberships.
Before the internet, people paid for service subscriptions such as milk delivery and newspapers. However, adopting and implementing new subscription-based business models has been difficult for companies. For decades, the most significant challenge for the subscription business model was collecting payments. Businesses didn’t have enough infrastructure to collect recurring payments from thousands or even millions of customers.
However, today, the rise of digital payment platforms like PayPal, Paytm, and Stripe have allowed us to start and carry out recurring payments without the massive workforce investment that was once needed.
Meanwhile, analytics companies such as Recurly, Zuora, and Profitwell have offered businesses better insight into consumer behavior, allowing companies to hone their subscription models over time.
If we look at physical products, advances in logistics, Amazon being the best example, have made it more cost-effective and efficient to ship products at scale more reliably.
While the infrastructural developments have increased the feasibility of subscription-based business models, it alone doesn’t account for the growing numbers of the subscription economy. It is essential to look at the appeal of the subscription model to both businesses and customers to understand it.
Appeal for Businesses
- Recurring Revenue
- Customer Insight
Once a business starts acquiring subscribers and has a solid outlook into churn rate and customer lifetime value, subscription business becomes easier to predict and track. Since subscription models are based on recurring payments, they also offer surer revenue sources that business trailblazers can rely on for strategic planning and investment.
It also offers deeper customer insights. When customer interaction is limited to one-off purchases, it isn’t easy to create a nuanced understanding of customer preferences and behavior.
However, when businesses have continuous relationships with customers, they can keep contact and gain deeper insights into how consumers interact with their offerings. Then, businesses can use those insights for a wide range of business decisions such as product alterations, marketing decisions, and new product launches.
Customers also tend to stay with a subscription service once they sign up.
“Subscription is a robust business model because it builds a space where retention is the default customer behavior as contradicted to one where the default behavior is churn.”
– Eric Stromberg, an angel investor (3).
There is a controversy that churn is a risk for subscriptions while retention is described as a benefit. However, subscription businesses that offer market-fit products can successfully ignite consumer obsession and count on subscribers to stay around for the long-term, which is a huge benefit.
Appeal for Customers
For customers, subscription-based business models promise simplicity and address practical requirements.
The first is cost. Today, consumers have more demands on their budgets, big-ticket expenses like housing, education, and healthcare continue to climb more rapidly than wage rise. For several products, a monthly subscription is more accessible and affordable compared to a higher one-time expense.
The second is convenience. As customers seek out to simplify their lives, the ‘set and forget nature of subscription services allows them to do so.
Moreover, they can also offer variety. Instead of watching the same movies frequently, Netflix users get a library of thousands of movies. Instead of choosing a car to buy, people with car-rental subscriptions can drive different types of vehicles. The model also offers consumers the feeling of owning multiple products without the responsibility, cost, and clutter of actually purchasing them.
Lastly, subscription-based business models offer greater customization. In the last few years, curation and personalization have surged as leading consumer trends. Subscription models allow consumers to select the service level that meets their personal requirements, no more, no less via tiered pricing structures and personalized recommendations.
While subscription-based businesses are enjoying unprecedented popularity, the model still has several pitfalls. High-profile struggles such as Blue Apron and Movie pass serve as reminders that plenty can go wrong with a subscription-based business model if there is a lack of alignment between positioning, pricing, product, and incentives.
Repetitive buying is among the key benefits of adopting a subscription-based business model. However, as the struggles of Blue Apron’s subscription meal kit service indicate, it is not always failsafe.
Blue Apron was a primitive success story of the subscription market. However, it started to stumble after its IPO in 2017 because of customer attrition. A Harvard Business Review article called it a ‘customer acquisition treadmill,’ churning through consumers in great volumes and constantly spending more to replace them (4).
As per Recurly data, churn rates vary from sector to sector within the subscription economy, ranging from 4.79% to 10.54%, according to the industry (5). However, month-to-month subscription plans are pretty easy to cancel; hence, it is a risk that businesses must address while considering the model.
According to a McKinsey report (6), consumers can quickly cancel subscriptions that don’t offer a superior experience. It can include poor product quality, lack of perceived value, and dissatisfaction with the assortment.
Another challenge that comes with the subscription economy is the sheer number of subscription options out there.
In the earliest days of video subscription, Netflix was a mostly unchallenged behemoth in the space, with Hulu in a comfortable distant second place. However, as major media brands and networks, including Disney, Amazon Prime, Apple, have thrown their hats into the online streaming ring, space is quickly getting more crowded. It leads to frustration for customers as they feel overwhelmed by options and intense competition among platforms battling to host the most in-demand content.
Several industry observers have also started to warn of subscription fatigue. They speculate that there may not be enough consumer money to go around. They will start to drop one service in favor of another.
The phenomenon is already underway as more Netflix subscribers are canceling their subscriptions following the launch of Disney+, Disney’s streaming service (7).
Balancing Accessibility and Profitability
Businesses adopting subscription models must strike the right balance between accessibility, appeal for customers, and profitability.
A marquee fiasco on this front is MoviePass, a movie ticket subscription service. The business grew its customer base to more than three million subscribers by offering unlimited movie tickets for a flat monthly charge. However, it struggled to deliver on promised profitability, finally closing down in September 2019 (8).
The struggles of MoviePass is a case study in what happens when the success of a subscription service is contingent on consumers not using it.
“The subscription economy works since it bets on people not using it that much. However, if there is a very high utilization, it will affect the margins.”
– Rafat Ali, Founder and CEO of Skift (9).
Surprising Industries Adopting to Subscription-Based Business Model
Potential challenges aside, a growing number of businesses are using subscription business modes, in several cases, in industries one may not expect.
In March 2019, Kara Swisher, a prominent tech journalist, published an op-ed in the New York Times (10) that ‘owning a car will soon be as quaint as owning a horse.’
And the evidence to support that claim is rising as private car ownership started declining for the first time in 2018 across the globe. And as the car companies faced the paradigm shift, they started offering all-in-subscriptions to people, including roadside assistance, insurance, maintenance, and the vehicle itself for a monthly fee.
One of the earliest firms to do it was Zipcar, founded in 2000. It allows subscribers to reserve vehicles on-demand for seven USD a month and an hourly rate for each drive. Legacy car-rental firms Hertz and Enterprise also rolled out subscription car services as a way to grow beyond their core use case of short travel rentals.
The shift toward subscription in the car industry highlights how a subscription-based business model can allow legacy businesses to adapt to their target market’s changing preferences and habits (11).
The automotive industry’s subscription also indicates the power of all-in-one pricing. Virtually all car companies pursuing subscription models provide all-inclusive subscriptions, bundling maintenance, insurance, roadside assistance, and access to the vehicle itself in a monthly payment, removing the requirement for customers to manage them individually via additional vendors.
Major commercial airlines and travel companies are turning to subscription models to offer a couple of different value propositions to boost loyalty and customer retention. Airlines like Delta, JetBlue, United, and Southwest offer subscriptions with perks like priority boarding, guaranteed overhead bin space, and drink vouchers (12).
The expansion of airline subscription services illustrates that the subscription models don’t have to offer cost savings to be attractive. Convenience and comfort, like more comfortable flying, saving time at the airport, can carry significance with subscribers if the overall gain to their experience is notable enough.
Subscriptions are not new to the fitness world, as gyms have run monthly or yearly membership plans for decades. However, in the digital era, subscription fitness programs that allow customers to sweat out in their homes have become popular.
Peloton is the most prominent in the emerging subscription fitness space, combining one-off product sales of its treadmills and bikes with a subscription fee for ongoing access to a library of workout-related content (13).
The explosion of subscription-based businesses in the fitness space indicates the importance of experience to a successful subscription brand. Companies like Mirror and Peloton have emphasized personalization as they recognize that it will keep customers engaged while combating churn.
As the internet and streaming tech has improved, millions of gamers have started playing via subscription services, monthly fee payment for access to several games rather than purchasing individual ones.
It offers players novelty and variety while still allowing publishers and platforms to maintain control of their products.
“Subscriptions offer platform owners a lot of power. It allows them to curate and gets control of distribution.”
– Dr. Daniel Joseph, an academic specializing in digital app stores economics (14).
Most of the major video game consoles like PlayStation and Xbox have launched subscription services in the past few years. Even tech companies not known for gaming are following the suit.
In 2019, Apple introduced its gaming subscription, Apple Arcade, playable only on Apple devices with a selection of almost exclusive games (15). At the same, Google had also introduced Google Play Pass, granting subscribers access to more than 350 games for 4.99 USD a month (16).
The subscription business model’s success in gaming indicates that the appeal of the ability to find and try various games without the burden of having to purchase them all individually allows the model to thrive.
Apart from these, even spaces like health and wellness, education and professional development, and home maintenance have also started adopting subscription-based business models, illustrating the value of convenience, the need for continuous service, personalized offers, and more.
Lessons from Subscription Economy
Businesses in the above industries have gained success with the model tapped into the subscription economy principles, which goes much deeper than the price.
They allow businesses to re-engage or reclaim customers and synergize with stakeholders.
As the implementation of subscription models in air travel, home repair, and video games illustrates, many times, the knowledge that the service is there is worth the price of membership. These businesses offer service and some higher-order psychological or practical benefit, whether removing the responsibility and effort, saving time, or offering greater selections.
What is Next in the Service Subscription Economy?
The subscription economy is surging, and the possibilities are not limited to subscription boxes and SaaS products. As the model’s logic of the model continues to expand into new industries, we will likely see even more unexpected verticals adopting subscription-based business models in the future.
Some likely candidates include eldercare, camping, skincare and nutrition, and fashion and apparel.
As the boomer generation ages, ensuring their care and comfort is a growing issue both personally and economically. Papa, a ‘grandkids on demand’ service, already connects older adults with college students for help with chores, transportation, and technology on an on-demand basis (17). At the same time, companies like Umbrella are focusing on home help. These companies could introduce subscription models to ensure consistent service and convenience to the older population.
The revenue from camping equipment sales is surging. However, in the spirit of access but not ownership, introducing a subscription model can help the industry grow its reach further to those who wish to enjoy the camping experience but are unable or unwilling to purchase their own equipment.
Camping is getting popular among millennials, who are already a prime subscription demographic (18). There are already several product-based subscription boxes in the camping space. Meanwhile, the property is also being modularized and commoditized for camping via services like Hipcamp. Hence, it is reasonable to imagine that subscription campsites may not be far behind.
Skincare and nutrition can also be the next logical steps for businesses looking to offer a wellness-focused subscription service. Atolla, a skincare company, expands its subscription beyond the typical replenishment model via offering subscribers personalized serum based on their skin measurements. Lumen pairs a hardware device in the nutrition space that checks the customer’s metabolic levels with personalized meal plans to meet subscribers’ unique requirements. Little Spoon offers custom baby food formulated to a baby’s nutritional requirements (19).
Rent the Runway was a pioneer in endorsing the idea that the access instead of ownership model can be applied to fashion with significantly less risk of obsolescence since there is no digital alternative to clothing.
The clothing rental service became a unicorn in 2019 and has rolled out several new services, including maternity and athleisure rental services. Le Tote follows a similar model, offering people the option to either return products or purchase them for up to 50% off the retail price (20).