5 Stages of The Subscription Business Model
For decades, industry has been focused on convincing buyers that they need to own more stuff. The traditional focus of a product supplier and its value chain is to transfer ownership of the product to the customer. But, today’s customers are looking for access to positive experiences, and ownership is not a prerequisite to access. Value is not equal to the product itself; instead customers find value through the experience of using the product. Business models are evolving to help enable the flexible monetization of experiences, and subscription has proven to be an excellent foundation for this approach.
For companies, subscription models help drive predictable, linear revenue and may help with competitive differentiation. However, getting subscription right is challenging. Instead of simply selling units, subscription success requires the monetization of relationships. Success is not only about signing new subscribers but also about reducing churn. For a subscription strategy to be effective, pricing and packaging need to be full featured, transparent, and aligned with customer experience.
Five Stages of the Subscription Business Model
Here are the five stages of the Subscription Business Model Management MaturityScape:
STAGE 1: AD HOC
Wild West: The focus is on signing up new subscribers above all else, not on retention. Metrics are backward looking and rooted in the traditional focus of shipping products. Where systems exist, they are disparate and support only a reactive management of the business. Pricing and packaging is haphazard and unfocused.
Business Impact: Customer experience is inconsistent and often painful. With no focus on retention, churn is excessively high even if prices are low. The average customer lifetime value is lower than the cost of customer acquisition. It is hard for businesses to rise out of this stage. On the one hand, there is nowhere to go but up. On the other, the company (or an investor) will have to commit resources and time to a business that is probably already losing money.
STAGE 2: OPPORTUNISTIC
Differentiated: Above all else, the company’s efforts are directed on honing the differentiating quality of the offering. To reduce the cost of customer acquisition, the company is making it easier for new subscribers to sign up in low-touch ways, such as via self-service portals, although the overall system lacks the scalability to handle spikes in demand. There is no thought to the customer life cycle; customers come in and they leave in a linear fashion.
Business Impact: Customer experience hinges entirely on the individual’s perception of how unique, cool, convenient, cost effective, or useful the offering is. Pricing focus is on promotion, not retention, and churn is still high and unpredictable. The cost of customer acquisition is improving because of efficiencies in sales and marketing, but customer lifetime value is still low and close to the cost of acquisition.
STAGE 3: REPEATABLE
Customer Loyalty: As the subscription business matures, attention is placed not only on signing new subscribers but also on keeping existing ones. Structures are put into place to help manage the renewal process, and the concept of a customer life cycle is starting to take shape. Systems are in place to ensure that the subscription can be turned off if the customer no longer pays and to make it easy for the customer to add more units or services or to downgrade. Social outlets are created or supported for customers that want to engage with one another to help build loyalty and reinforce customer value.
Business Impact: Customers express their loyalty via social avenues and with their pocketbooks by renewing agreements and purchasing additional services. Pricing and packaging are designed to help bring the “right” customers into the offering. Churn is slowing. If growth continues to be high, the cost of customer acquisition may still outpace customer lifetime value. Recurring revenue measurements and overall retention rates will be more instructive in determining business health.
STAGE 4: MANAGED
Time to Value Acceleration: The focus of the provider is on getting the customer to recognize value in a timely fashion. The subscription business is fully integrated within the company’s portfolio of offerings (if these exist), making it possible for customers to transition back and forth as well as mix and match other offerings with subscription and still have a unified customer experience. Systems and processes support continuous engagement by providing recommendations and demonstrating value through elements such as usage reporting. In addition, upsell and cross-sell opportunities are identified. At the same time, the customer is viewed as an individual, not a segment.
Business Impact: To achieve stickiness, business practices that enable customers to feel empowered, such as transparent pricing practices or the ability to easily cancel the service, become important. This may seem counterintuitive, but customers must trust the provider to be motivated to realize value and deepen the relationship. The company now has a more detailed view into key metrics and is focused on profit as well as revenue. Gross sales and marketing efficiency are important to look into at this point.
STAGE 5: OPTIMIZED
Customer Life-Cycle Optimization: Optimization of the customer life cycle is at the center of the subscription strategy. The provider understands the customers and their potential value even before they buy, and systems support the seamless movement of the customer from lead to cash. There is a clear and systemized cadence of customer contacts focused on building and deepening relationships. The customer can purchase from any channel and have the same experience. Cloud telephony enables the proactive triage of support contacts to enable a dialogue — not simply a transaction.
Business Impact: The provider has price agility; it can run pricing experiments supported by technology that allows the provider to see the results of price changes by customer segment in real time. A dashboard view is available across all key subscription metrics, including bookings, billings, recognized revenue, revenue backlog, and deferred revenue. With data on customer usage, the company can predict when a customer is ready to move to the next stage. Sales folks are actively engaged, monitoring customer usage data and incentivized to contact customers and get them into the right plan. The company realizes that sometimes putting customers in the “right plan” means putting them in the lower-cost plan. At the same time, customer lifetime value is three to four times the cost of customer acquisition.
WHERE DO I FIT IN?
Subscription is not a brand new phenomenon, and different companies are at different points of maturity. A large company with a history of traditional, up-front product sales may enter the model at “ad hoc,” while a company that has focused on subscription since day 1 may skip that phase entirely and start its journey between “opportunistic” and “repeatable.” A company may find stages that are “repeatable” in some ways but “managed” in others.
What can I do?
IDC offers the following guidance to those organizations looking to improve their subscription business model approaches:
In the next 6 months: Spend some time reflecting on why customers can’t live without your products or services. How does your offering make them feel? What can the customers experience with your offering that they could not experience any other way? What do the customers tell their friends and family about your company? Successful subscription companies know the answers to these questions and build business strategies that reinforce these. Also, recognize that not all subscription companies are going to execute on the business model in the exact same way. Subscription businesses are built on relationships, and these relationships are going to differ depending on who your customers are and what they are trying to achieve. In addition, any single-subscription company will need to have different channel, support, and pricing/packaging approaches for different demographics.
In the next 6–18 months: To successfully manage a relationship-based business like subscription, the operational systems that support the business have to be designed for subscription businesses. You need visibility, agility, and control in all aspects of your operations, whether these be internal- or external-facing systems. Most companies have a number of key technologies that must be subscription ready, including billing systems, telephony, financials, and customer sales and support. In addition, begin to look at the connection between your pricing/packaging and customer experiences. Does the model do a good job of measuring value? Is your pricing transparent and easy to understand? What level of price-to-value satisfaction do customers have? Many of your customers’ most formative experiences, as well as most of their ongoing interactions, are centered on contract terms and pricing.
In the next 18–36 months: Continue to look at the relationship between price and experience. Pricing is not the tool that companies should use to develop loyal customers — experience is. However, these need to be aligned. Customers that are paying premium prices should have differentiated, premium experiences. Loyal customers should also see benefits through elements such as value-added services, special discounts, or differentiated treatment. Customers that are coming in at entry level should see enough value out of the experience to continue subscribing, but they should also be tempted to consider upgrading. Companies should integrate people, process, and systems that support subscription pricing and customer relationships and experiences. In addition, as a subscription business matures, the assumption is that customer retention will be favored over customer growth. That is certainly one way to make profits improve. However, today’s subscription businesses are focused on both deepening relationships with existing customers and expanding the base of new subscribers.
Amy Konary is Research Vice President at IDC.