The way consumers buy goods and services is changing. Have a look at your bank statement over the last several months, and I’ll bet there are more than a few recurring charges for Netflix, Amazon Prime, Spotify or Zoom. Consumers used to buy one-off products or services but are now increasingly subscribing to receive them on a regular (often monthly) basis. Many consumers have realized they are tired of the high price that comes with outright ownership and prefer the flexibility and added value that a subscription-based service can offer. With this shift in consumer demand, a thriving “subscription economy” has emerged.
Benefits of a subscription-based business model
Subscription-based businesses can come in many forms, such as software-as-a-service (SaaS) companies like Salesforce, which offers software services through a recurring online subscription, subscription box companies, including the likes of Birchbox or Blue Apron, which physically ship you a product on a recurring basis, or streaming/access services, such as Netflix or Disney+.
For small businesses, there are a number of upsides to operating a subscription-based model, the most prominent being the ability to generate predictable revenue.
The ability to forecast future income ultimately enables your business to scale with confidence and can help you to raise further financing more quickly if needed. Another upside is that due to the long-term interaction with your customers, you are able to foster deeper relationships, which enables you to deliver more value to them and in turn inspires their loyalty.
Tips for starting a successful subscription-based business
So, while the benefits of starting a subscription-based business might be clear (who wouldn’t want to be the next Netflix?), the secrets of success might be less so. We’ve worked with over 400 recurring revenue businesses and evaluated their success and future earning potential and, in short, there are a number of key themes and traits that crop up among the most successful.
Keep it simple
As the old adage states, “When it comes to pricing, keep it simple, stupid!”
Simple pricing always wins. Offering complex pricing tiers simply adds complexity at the expense of velocity. Not only do various tiers add complexity at the front end of customer acquisition, but they are also complicated to manage — meaning you may be spinning your wheels as a business to manage your basic operations rather than investing that time in creating more value for your customer.
Pricing in the subscription world truly is an art form. For example, when you present two options to someone, their preferences among those first two options can be drastically affected with the introduction of a third option — something called the decoy effect. Small changes like this increase the complexity of decision-making. But once done right, subscription models can lead to a very healthy and predictable revenue stream.
The best subscription-based businesses create intrinsic value for their goods/services based on comparable companies existing in their market. They make assumptions on a reasonable price point that satisfies necessary margins without deterring potential future customers. Once that is in place, you test and define the ideal annual contract value (ACV) of a customer subscription, meaning roughly how much revenue you’ll generate per customer. Finally, tweak the ACV via different billing frequencies (i.e., annual, quarterly, monthly) and associated discounts.
According to the dictionary, a flywheel is defined as “a heavy revolving wheel in a machine that is used to increase the machine’s momentum.”
In Jim Collins’ respected business book, “Good to Great,” he defines what he calls as the “Flywheel Effect” by describing how great companies are not created by one singular defining moment or killer innovation, but rather by “relentlessly pushing a giant, heavy flywheel, turn upon turn, building momentum until a point of breakthrough and beyond.”
While it might not be that incredible of an origin story, most successful subscription-based business in my experience all adopt this philosophy. They work hard to uncover these “flywheels” across their organizations, thereby growing more efficiently and compounding on their investment of effort to get to “escape velocity” (the other quote from the flywheel book!)
For instance, at Capchase, when great customers grow fast, this leads to more volume being deployed, which in turn leads to lower cost of capital in the form of lower rates for our customers. This then allows us to be able to work with more top customers.
Experiment again and again
Another key trait of the most successful subscription-based businesses is that they religiously experiment and test things out. Through this process, they gain valuable data and insights that help them to refine (or sometimes completely nix) ideas before fully committing.
In the long run, this saves time and money and ensures you are only devoting resources to the most promising business opportunities.
Key takeaways on building a subscription-based business
There are many benefits to subscription-based businesses, the the most prominent being the ability to generate predictable and recurring revenue. Use the above tips to keep your subscription model simple, build up to your breakthrough moment and use your data to continually refine your idea.
Originally published June 29, 2021.