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DownloadHow can your company take advantage of the subscription-based model, the most dynamic growth sector of the economy? Subscribed describes how companies from software-as-a-service to auto manufacturers, music providers to construction equipment manufacturers, are turning customers into subscribers by teasing out the service-level agreement that sits behind the product.
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With consumers increasingly focused on access over ownership, the key is to start with the wants and needs of your particular customer base, then create a service that delivers ongoing value. This will require a new organizational structure; a shift in the focus of the sales, marketing, and finance teams; and, a new approach from IT. But, the initial drop in revenue and rise in expenses will be more than worth it.
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Whether for an established company like GE, a streaming service like Netflix, or a new service provider like Box, accessing customer data to create a subscription-based offering is the growth path of the future: companies running on subscription models grow their revenue more than nine times faster than the S&P 500.
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In today's digital world the focus is on the individual customer not on the product, and those customers prefer outcomes over ownership. Brick-and-mortar retail is transforming, focusing on customers' online experience and using the data gleaned there to inform the stocking of physical stores. The news industry is enjoying a renaissance thanks to online subscriptions; media is in a new golden age of on-demand streaming; and car subscriptions give access to a range of vehicles from the same company. Adobe led the way in cloud-based subscription software services, overcoming the initial drop in revenue and rise in expenses to reach a position of steady growth. With the Internet of Things even heavy equipment like construction supplies can move to a subscription model by teasing out the service-level agreement that sits behind the product. The subscription access model is being used in healthcare, government, utilities, and more. The customer-focused subscription company has to break down the old production silos and use customer data for perpetual innovation. It needs an IT system focused on the customer's entire subscription life-cycle. Pricing becomes the key metric and annual recurring revenue the cornerstone of the financial statement.
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We are at a pivotal moment in business history, one where the world is moving from a focus on products to a focus on services, and where consumers are increasingly favoring access over ownership. Subscription-based companies are transforming business across a range of different industries. To turn your customers into subscribers, start with the wants and needs of your particular customer base, then create a service that delivers ongoing value. This is the growth path of the future: companies running on subscription models grow their revenue more than nine times faster than the S&P 500.
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The digital transformation
GE was #4 on the Fortune 500 list in 1955; as of fall 2017 it was still on the list, at #13. During the 2017 Oscars GE ran commercials with the tagline, "The digital company that's also an industrial company." This transformation is what has allowed GE to remain so high on the Fortune 500 list. Companies like GE and IBM no longer talk about refrigerators and mainframes, they talk about "providing digital solutions." Most of the companies that have stayed on the list for 60+ years have similarly transformed.
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Alongside these transformed companies are the 'new establishment' companies like Amazon, Apple, and Netflix—companies that were focused on building direct digital relationships with their customers right from the start. And then there's the up-and-coming new disruptors, like Uber, Spotify, and Box, who have not only gone beyond selling products but have actually invented new markets, services, and technology platforms.
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These types of companies—GE, Amazon, and Uber—have all recognized that we now live in a digital world, where customers prefer outcomes over ownership and the one-size-fits-all approach just doesn't work anymore.
The new business model
For the past 120 years or so, the dominant business model was focused on products: inventory, shelving, and cost-plus pricing. Companies were organized into product divisions, something that was exacerbated by the emergence of enterprise resource planning (ERP). The margin and supply chain economics ruled, with the goal of matching supply and demand with the least inventory possible.
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Today, that model has transformed. Customers are more informed than ever, and they don't want the burdens of ownership. Forrester Research says this is the beginning of a new 20-year business cycle that it calls The Age of the Customer. People want the ride, not the car; the music, not the physical record; and they want it now.
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Today's successful companies don't start with the product, they start with the customer. This means that the more information they can learn about the customer, the better they will be able to serve the customer's needs. This shift to a customer-centric organizational mindset is a defining characteristic of the Subscription Economy. And it's happening right now because the advent of the digital age means that those subscriptions can now be delivered digitally. As a result, the subscription model is transforming every sector of the modern economy.
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The retail transformation
On the surface, the data says that brick-and-mortar retail is dying. About a quarter of the 1,000 or so enclosed malls in the United States are expected to close within five years, and Silicon Valley is convinced that Ecommerce is the future. However, over 85% of all US retail sales still happen in physical stores. Amazon now owns 460 Wholefoods stores and breaks out revenues from physical stores in its quarterly reports.
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It's not that brick-and-mortar retail is dying—it just needs to flip the script. For example, most Americans shopped at Walmart at some point in the past year, but unlike Amazon Walmart can't tell you what you last bought there. Once you pass the cash register, you fall out of Walmart's sight. The issue is not so much Ecommerce vs. traditional retail, it's that the likes of Amazon always put the customer first.
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Successful subscription companies—like Birchbox (cosmetics), Freshly (meals), and Fabletics (active wear)—have taken a customer-first approach to retail. They create fun, compelling experiences that get smarter over time. It's an approach that can work even with an expensive product.
Take the example of Fender, maker of amazing electric guitars for over 70 years. Sales of electric guitars are falling, and most new guitarists quit playing the instrument within a year. Fender needed to keep people playing, and to keep them as customers. So, the company came up with Fender Play, a subscription-based online video teaching service that encourages customers to keep playing.
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Studies show that most people research online first, then head to the stores to try out a product before buying. So, another key to today's retail brand experience is to prioritize the online experience. A smart company like Birchbox knows this and uses rankings and reviews from its website to inform the layout and stock in its New York store.
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The 329-year-old start-up
Husqvarna is a national institution in Sweden; founded in 1689, it manufactures equipment for forestry, lawn, and garden maintenance. And, it's embraced the subscription model with a service called the Husqvarna Battery Box. Subscribers in Stockholm pay a flat monthly fee to get access to all kinds of heavy-duty equipment, like hedge trimmers, chain saws, and leaf blowers, which are dispensed from a storage shed in a shopping center parking lot. When the subscriber is done, they just return the tool—freeing the customer from the hassles of storage and maintenance.
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Media's new golden age
The Golden Age of Hollywood ran from the late 1920s to the early 1960s, when the big five movie studios churned out dozens of films every week. The internet challenged this model of the entertainment industry—but some smart companies have made it easier to consume media through online subscription services. Netflix started streaming movies in 2007 and today has over 100 million subscribers. Spotify now has 50 million subscribers and is responsible for more than 20% of global music industry revenues. With algorithms and playlists, Spotify has added a whole new discovery layer of music.
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Roughly two-thirds of all Americans now subscribe to a streaming video service. Streaming video on demand (SVOD) subscriptions now generate more than $14 billion in annual revenue, compared with nothing ten years ago. Freed from the blockbuster movie mindset of the old studios, today's entertainment industry is enjoying a new golden age, where streaming services can take a chance on smarter and edgier projects, like Stranger Things or Orange is the New Black. Netflix invests $8 billion a year on new content that both attracts new subscribers and extends the lifetime of current subscribers, regardless of whether a particular show is successful or not. This short-term spending boosts the company's profitability in the long run.
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The one genre missing from the universe of SVOD is sports. The UK-based company DAZN ("Da Zone") is positioning itself to be the Netflix of sports. It is currently hosting over 8,000 sporting events a year for a monthly subscription of $20 and is starting to win sports-rights away from major cable networks like Sky Sports.
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Transportation
Vehicle subscription has arrived. This is not the same as leasing, which ties you to a particular vehicle. With a car subscription, you get access to a range of vehicles from the same company; plus, you don't have to deal with annoying things like registration, insurance, and maintenance. You can get a subscription to Hyundai's new hybrid car, Ioniq, for $275 a month; Porsche's new Passport service gives you access to half a dozen car models; and Cadillac, Ford, and Volvo are starting subscription services.
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Car companies are reacting not just to the sea change in customer preferences for services, but also to the challenge of Uber. In many ways Uber is already like a subscription service—it has your ID, payment information, and a history of your preferences—and in some cities it is testing a flat-rate monthly subscription service that includes bundles of reduced-rate trips with no surge pricing.
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America's big automakers have some definite advantages when it comes to the next stage of personal transportation, and they already understand that in the future they'll be doing less individual vehicle sales and more fleet management. They have the distribution, with vast dealer networks; they already have a huge scale of operations, which will be hard for anyone else to beat; and, they have massive financial resources.
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Similar changes are happening in the airline industry. Surf Air gives members access to limitless flights for a flat monthly fee of $2,000. The subscription model gives the company predictive revenue, something that no commercial airline enjoys.
This new competition in the transportation industry is not just vertical—airlines competing with airlines, car companies with car companies—it's increasingly horizontal—light rail competing with rideshares and with budget airlines. France's state-owned railway, SNCF, realized it needed to compete with all these other modes of transportation to stay viable, so it launched a subscription service targeted at young adults, giving them unlimited rides for a flat monthly fee and using new software services to make sign-up easy. The result was astonishing—the company hit its annual growth target within a couple of months.
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Spreading the news
In 2008 The New Yorker declared that "newspapers are dying." But, the news industry is not dying, it's transforming. More than 169 million US adults read newspapers every month, in either print, mobile, or phone-format—that's almost-70% of the adult population.
Readers and publishers are embracing the paid subscription model for news, rather than the old ad-based business model. People don't like advertising in general; digital ads don't make sense from a business point of view; and ads risk turning content providers into clickbait factories. With an increasing number of customers comfortable with the subscription model thanks to services like Netflix and Spotify, people are also more likely to pay for online news content.
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Take Motor Trend magazine, which first appeared in 1949. In 2016 the company launched a subscription streaming platform called Motor Trend on Demand, which gives access to hundreds of hours of exclusive content. Today, less than half of Motor Trend's revenues come from its print edition and the company anticipates that recurring subscription revenues will soon account for 20% of its overall revenue.
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The Financial Times newspaper knew they would see a surge of traffic the weekend after the Brexit referendum, so they dropped their paywall and made sure the flood of new readers saw plenty of subscription offers—resulting in a 600% surge in the number of subscription sales compared with an average weekend. Today, the FT has more than 900,000 subscribers and over 75% of their revenues comes from digital subscriptions. The company also uses a simple framework to gauge reader engagement, scoring every reader on the recency, frequency, and volume of their visits, allowing the promotions group to target churn risks with discount offers.
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Today, more than 60% of The New York Times's revenue comes directly from its readers. It has reached the crossover point where a dwindling proportion of its revenue comes from advertisers: in the second quarter of 2017, for the first time, digital-only subscription revenue exceeded print advertising revenue. And, it now has subscribers in 195 countries.
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Lessons from Adobe
In November 2011 Adobe CFO Mark Garrett announced that the company was going to stop selling its profitable Creative Suite software in boxes and would move to a subscription model. The company saw that its business was mostly growing thanks to price increases and not to a larger user base. Historically, Adobe had delivered product updates every 18-24 months, but it realized that users' content creation needs changed more frequently than that. By shifting to a cloud-based subscription service, Adobe could offer continuous innovation, digital services, lower monthly costs, and organically increase its user base.
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Today, subscription services have become the tech industry's dominant business model after initially facing a steep uphill climb. Author's Thomas Lah and J. B. Wood call the transition period into a subscription model "swallowing the fish." Initially, the revenue line drops downward and the expense line curves upward; eventually, expenses drop and revenues curve back up again.
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This was the challenge that Adobe faced in 2011. The company tackled it with a strong commitment to communication, starting with its employees. The finance and product divisions had to get comfortable with a different way of doing things. They had to get Wall Street analysts to look at the company a different way, throwing out the old unit sale approach in favor of one based on subscription revenue.
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In three years, Adobe Creative Cloud grew from nothing to a near-100% subscription model. Its transition inspired Microsoft, Intuit, and others. Even hardware companies are looking at subscriptions. Cisco sells the routers and switches that forward data packets between networks. A few years ago, it realized that, thanks to cloud computing, its clients didn't need as much of its hardware. So, Cisco decided to go all-in on services, focusing on the data inside all the hardware. Its latest hardware comes embedded with machine learning and an analytics software platform, offering ongoing value to clients. Today almost a third of its revenue is recurring.
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The Internet of Things
Thanks to IoT—the Internet of Things—even heavy equipment like buildings and construction supplies can move to a subscription model by teasing out the service-level agreement that sits behind the product. IoT lets you learn what your customers really want; and, that relationship with your customers becomes your real competitive advantage.
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Take construction: surveying a site is an inefficient process that can take weeks. Komatsu, one of the world's oldest construction and mining equipment manufacturers, can now survey a site in 30 minutes thanks to its Smart Construction service. A Komatsu team uses a fleet of drones to create a 3D-rendered topographical model of the site. The company then uses this model and runs thousands of AI-enabled simulations to generate the best project plan, including equipment and labor scheduling. That plan can then be fed into a fleet of semiautonomous excavators, bulldozers, and backhoes—giant robots that take care of the project. Instead of asking, "How many trucks can I sell you," companies like Komatsu ask their clients, "How much dirt do you need to move?"
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Today, we are on the verge of a manufacturing revolution, with a shift from products to services made possible by the advent of IoT. Manufacturing businesses around the world are investing heavily in sensors and connectivity, tools that will allow them to collect and transmit data. In this first stage of the revolution, IoT is focused on diagnostic systems that improve efficiency and productivity. Pretty soon, we'll be moving into a wider realm of possibilities.
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Take the company General Electric, maker of everything from kitchen appliances to oil rigs. GE now has a thriving data services business, operating its own social network for industrial machinery that includes data on fuel consumption, usage hours, and decay rates. Thanks to this network, GE doesn't have to rely on expensive and labor-intensive mass maintenance procedures to catch problems—its network sends the relevant signals from individual assets, allowing GE to fix problems much faster.
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With this level of connectivity, companies can view their products as whole systems, not individual units sold to strangers. They can give their customers what they really want—an outcome, not a product. Companies can also sell the same information to different types of customers. For example, Swedish company Ngenic sells a smart thermostat and offers three basic purchase plans: buy the unit outright; buy it for less with a small monthly subscription; or, buy it as part of a discounted bundle with an energy provider. By partnering with suppliers, it helps its customers to save energy and it conducts arbitrage with wholesalers to buy more electricity when it is cheaper. Ngenic's real value is not the device but the usage data from its customers that allows it to trade information across multiple suppliers.
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No more ownership
Ownership is no longer the imperative; access is. Subscription companies are growing eight times faster than the S&P 500 and five times faster than US retail sales. And, the model can be used everywhere.
Healthcare
The industry is transitioning—pharmacy chain CVS is buying insurance giant Aetna in reaction to the competition it faces from Amazon. New subscription-based primary care groups like One Medical offer same-day appointments. Magellan Health connects behavioral, physical, pharmaceutical, and social needs.
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Government
In Estonia, people don't just pay their taxes online, they use a one-click system that authorizes an online tax statement that's been fed real-time financial data over the previous year. Residents of New South Wales, Australia, can log onto Service NSW for access to more than 800 different government transactions.
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Education
Many colleges and universities are experimenting with MOOCs—Massive Open Online Courses. Professional learning platforms like Lynda.com, Kaplan, and Udemy are enjoying explosive growth. Textbook publishers, from established firms like Houghton Mifflin Harcourt to newcomers like Chegg, are offering online rentals.
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Insurance
Metromile offers pay-per-mile insurance via a simple connected device that fits in your car's OBD II port.
Pet care
Retail pet food companies are becoming digital pet health services, sending you the right food and products for your pet based on age, breed, and so on.
Utilities
Consumption-based digital services like SolarCity enable solar-powered homes to sell electricity back to the grid.
You can apply the subscription model across every aspect of your company; the following sections describe how. It all starts with a moment of shock.
No more silos
The video game industry is following the wider media industry, with falling sales of physical discs and rising online streaming subscriptions. Creating a new game costs billions of dollars, with studios typically taking two years to produce a new title, and marketing it can cost billions more. Imagine you're a developer and you tell your company: we can charge $5 a month for a subscription and offer lots of downloadable new content, giving us stable and recurring revenue. Win, win, right?
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Odds are, management will hate the idea. Marketing doesn't want to give up its big-media-blitz launch days; development has to come up with a whole new fluid-production schedule; finance doesn't know how to make the numbers work. The shock is all too much.
The twentieth-century product-based company was divided into silos, but in the new customer-focused company those silos have to come down and employees have to think in new ways. For finance, that means stop focusing on unit sales and start looking at pricing, packaging, and analytics. Sales and marketing have to shift from selling a transaction to selling a relationship. And, the people at the heart of the organization—the designers and inventors—have to turn a great product into a great service.
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Perpetual innovation
Innovation is iterative; and the best way to innovate is to enlist your customers as your partners, making a living, breathing experience instead of a static product. The idea is to create an environment that supports sustainable development.
The UK snack box company Graze exemplifies this approach. Every couple of weeks they send subscribers a box of four different snacks and ask for feedback in a simple online form. When they launched recently in the US, Graze didn't bother with a lot of market research, they just used their existing model—because it's a system that adjusts itself. The Graze team just watched the numbers come in on the review dashboard and adjusted their product distribution accordingly. They designed their service in conjunction with their subscribers—no more focus groups or phone surveys—and had their US distribution all figured out in under four months.
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Netflix also uses a form of perpetual innovation. It never orders pilots. For a show like House of Cards it knows there's an audience for political drama with popular actors, so it orders the whole show. Thanks to its fabulous user data, it has all the insights into what is going to be popular right at its fingertips.
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Companies like Amazon, Facebook, and Apple (or, in China, Baidu, Alibaba, and Tencent) have dashboards that let them see what their customers are doing, allowing them to make smarter decisions about allocating resources and spinning up new services. Starbucks has the Starbucks ID—it includes things like payment information, purchase activity, and some demographic details. Today, more than 13 million people have a Starbucks ID, representing more than a third of US company-operated sales, and one in every ten transactions in a US store is handled with its mobile app.
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Marketing and pricing
In the Mad Men days of marketing the focus was on the four Ps: product, price, promotion, and place. Advertising was all about pushing the product through channels and creating customer pull—driving customers to the channels to ask for your product. In the subscription model, however, the focus is on the customer, so this approach changes.
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Instead of placing your product in specific locations, the focus must be on managing a one-on-one relationship with the customer over time. With commercial transactions increasingly mediated through social experiences, the focus shifts to telling a story rather than trying to promote the product through ads. This means telling the story of your service and your users within a broader social narrative: first, articulate the context of your company; then, the value to the customer; and finally, the specifics of the product itself.
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Pricing is one of the most powerful growth levers for subscription services; in fact, it is the most important of the four Ps. It's also the trickiest, as you have to price an outcome rather than the cost of making a product for a profit. Give too much away for free and you'll spend years chasing down miniscule conversion rates. Make things too complicated and people won't sign up. A flat rate is simple, but you may have a few people being very heavy users of the service.
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The sweet spot is when customers are happy to add more services for more money. If 70% of your subscribers are in your basic package, then you have a respectable entry-level service—but one that is not sustainable. You need a growth path. This means picking the right unit that ties consumption to value. Similarly, the right packaging allows subscribers to add more features as their needs expand. The good news is, all the information you need to figure this out is already available, in your customer data.
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Sales and growth strategies
In the subscription economy customers have plenty of information about your company—but they also have so much information that it can be hard for them to make choices. How can you get the right information to the people at the right time? There are eight essential growth strategies for a subscription company; you have to be willing and able embrace many of them at any given time.
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Finance: the new income statement
Double-entry bookkeeping was formalized in the late 1400s by a Franciscan friar named Luca Pacioli. The basis is simple: for every financial transaction, the debt and credit columns have to match. A typical income statement starts with net sales, deducts costs of goods sold, and costs of things like sales, development, and administration, and ends with net income.
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But, the standard income statement does not differentiate between recurring and non-recurring revenue—which is a problem when recurring revenue is the cornerstone of the subscription company. Also, it treats sales and marketing as a 'sunk' cost, rather than the key to driving the business forward. Finally, it is a backward-looking picture of what has already been earned and spent, not a forward-looking view of the company.
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For a subscription company the key financial metric is Annual Recurring Revenue or ARR—the amount that subscribers will pay you every year. Every quarter the subscription company looks at how much their ARR has grown. Start the period with a specific annual recurring revenue number. Assume a certain churn rate (which you try to keep as low as possible). Then, deduct recurring costs; what you need to spend to service that ARR. The difference between your recurring revenues and your recurring costs is your recurring profit margin.
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The biggest accounting difference is that in a subscription business sales and marketing expenses are matched to future revenue—because the sales and marketing spend this quarter adds to the ARR, but the revenue from the ARR growth will come in future quarters. It is perfectly rational for a subscription business to spend all of its profits on growth, i.e., sales and marketing, as long as it can grow ARR faster than recurring expenses.
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In a traditional business the CFO spends most of her/his time telling people what happened, and only a small percentage coming up with forecasts and strategy; in a subscription company that time focus is flipped.
IT for subscribers
The IT systems of most traditional businesses are focused on stock keeping units, not on subscribers. In a subscription company the system has to be able to tell you who your subscribers are, so that you can monetize customer relationships over time. It has to be able to conduct rapid price testing when trying to gauge the appetite for a new offering. It has to be easy for customers to sign up, upgrade, and renew. It has to be able to handle sales to both individuals and large enterprises; and be able to cope with high-volume recurring payments. And, it has to be able to measure recurring revenue.
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Legacy enterprise resource planning or ERP systems are designed to track pallets; they can't cope with the dynamic world of subscriptions where customers are constantly upgrading, downgrading, suspending, renewing, or adding services. The subscription company needs at IT system that can change the subscriber experience; change the pricing quickly; and give a single view of the customer's entire subscriber life cycle. In other words, it should be circular, not linear.
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Netflix knows it can spend $8 billion on original content next year because it can quickly report on its key business metrics: recurring costs, recurring profits, and the margin available to spend. In sum, IT is where the subscription company competes.
Subscription culture
Being a customer-focused company requires engineers who continually experiment; marketing people who focus on subscribers; a sales force with a clear path to growth; a finance team that drives the business model transformation; and an IT team that is launching new services and iterating. But beyond all this, being a customer-focused company requires a cultural change.
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At Zuora we call this culture PADRE: which stands for Pipeline, Acquire, Deploy, Run, and Expand. It's a way to visualize the company as an integrated organization of subsystems, all tied to the customer, supported by three core back-of-the-house subsystems: people, product, and money. Pipeline is building market awareness of your story to get an interested potential base of subscribers. The Acquire subsystem encompasses the buyer's journey—how does the potential subscriber make decisions? What are their alternative solutions? Deploy is all about getting customers up and running as quickly and efficiently as possible.
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A subscription company's success depends on how well and how long your subscribers take advantage of the service; this is what we call Run. Finally, Expand: how do you retain and grow your subscribers.
These individual subsystems succeed thanks to cross-functional coordination. When there's a problem, such as an overly-slow process in getting people signed up to your service, people across all the subsystems have to be involved in finding the solution. Perhaps the sales group needs a clearer expectation-setting process for customers; while engineering can eliminate some of the onboarding steps; and customer support can develop new metrics for client feedback.
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The subscription model is the only one built entirely on the happiness of the customer—and, happy customers mean happy companies.
The Subscription Economy Index (SEI) is based on data drawn from Zuora's finance platform for subscription businesses. The following are some of the interesting insights it reveals.
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