How to Succeed with Subscription Models

July 28, 2020

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Gone are the days of “if you build it, they will come”. We as consumers, both in the home and workplace, can see that today’s most successful companies have embraced a customer-centric view. The world has moved from owning things to sharing, from purchasing goods to purchasing experiences, from products to servitization, and from solutions to outcome-based business models. Similarly, companies are adapting their commercial strategy and operations to be more customer-centric. Rather than indirect sales per unit or users, they are selling directly to consumers, and on a recurring basis. Here is how they succeed.

There are different types of business models that promote recurring revenue, from leasing, hard contracts, and service contracts, to “razors and blades”, vendor lock-in, and customer loyalty programs. The most popular, of course, being the subscription model. It is used in almost every industry, from software and media to industrial equipment or grocery retail… you name it. Meanwhile, this resurgent crisis will become an ongoing stress-test for companies’ economic model. Prioritizing profit and cash flow over loss-making market share gains will allow companies to cope with the further shocks that we believe this crisis will inevitably cause.

Although many companies have explored subscription models, this idea often resided on that list of “down the road” transformations that usually seemed too difficult, expensive, or disruptive in a stable or growing market. But right now, the advantages of shifting to a subscription model can be a matter of survival, even if the initial transition is not yet optimal in terms of execution.

When subscription models go wrong…

Unfortunately, there are plenty of subscription flop stories out there, and you may be reluctant to move to recurring revenue because an industry player tried it, and failed. That doesn’t necessarily mean that the subscription model is incompatible for your business. Rather, it’s likely that your competitor fell into one or more of these common pitfalls:

Sloppy design

If you don’t have a thorough understanding of what customers really want, the subscription design will limit its potential. A subscription doesn’t have to be one offer, and it makes sense to offer different tiers to capture different willingness to pay. A common mistake, however, is that the lowest offer is designed to be too attractive. Of course, you want to encourage people to subscribe and get them hooked, but don’t forget your upsell path. Make sure there is always a way to get more from that recurring business. Over-engineer your lowest tier, and you remove any incentive to move up.

Subscriptionization of everything

A subscription isn’t always the way to go. We’ve seen this in the automotive industry — a subscription for cars just doesn't work. However, automotive companies have found success in other areas, such as the monetization of data and services. It’s about identifying the parts of your business that are subscription compatible, and possibly exploring neighboring areas if all of your products and services really are restricted to a transactional basis.

Tailgating infrastructure

Finally, there can be technical bottlenecks. You will need a billing engine, and a customer service team capable of providing the associated support. From a financial perspective, you have to think about what your cash flow will look like when all of a sudden the money is coming in monthly rather than lump sums. All of these aspects need to be carefully considered before diving into a subscription model. 

It’s clear that subscription isn’t a silver bullet, and you may already be weighing up the risks in your mind. Is it really a sensible idea to be making a model switch in the middle of a pandemic? This is not the time to be putting your company through an insane pressure test — the crisis will already be taking care of that. So to emphasize: we’re not saying you have to switch your whole business to a recurring business model overnight. Instead, we recommend pursuing a hybrid approach. Your core business can remain transactional while you gradually introduce recurring revenue models for other things in and around your core business. Here we recommend following six important steps:

Six key steps for successfully launching a subscription model

1. Chart your transition path

Determine the right speed of change and revenue mix. How rapidly do you want to bring the subscription model to market? How rapidly do you want to shift your revenue from a one-time transaction to a recurring basis? If you quickly add a subscription to your revenue model arsenal, but the majority of revenues continue to come from the one-time purchase, then your transition path is adaptive. If you also rapidly shift your revenue mix to subscription, then your transition path is more revolutionary. Ultimately, you want to be clear on the goals driving the transition path and plan accordingly. For large companies, even a fast transition can take several years.

2. Set key parameters

To develop the offer structure, you need to carefully consider the key subscription parameters. Will you offer one tier or multiple tiers of subscription? How will you charge for a subscription product? What would be the shape of the payment function as usage increases? What are the billing and contract terms? Do you offer discounts for early payments? What about offering discounts for multi-year? These aspects need to be clearly laid out in advance and not left as an afterthought.

3. Benchmark your subscription offer and commercial strategy

Benchmarking against market or industry players and competitors will reveal points of defensive action that can become anchor points for your value story later down the road. It can also help catch weaknesses in your offer before you make any large investments in product reengineering efforts. Whatever your industry, it is very unlikely that you are the first to implement a subscription model. If there is an advantage in lagging behind, it’s that you can already learn what worked, and what didn’t.

4. Test the concept

Don’t just roll out a subscription model blindly. You need to road test. Checking in with your current customers is a good start, but they may have a skewed view of your product or service. You also need the perspective of your prospective customers to validate the value drivers of this application model. Prospect testing will also help you quantify the expected uptake rate for the subscription offering and build a realistic pro forma financial model.

5. Build out the unit economic model

Economic modelling with both commercial and cost elements typically starts right after step one, but to gain a full picture you also need the data from the benchmarking exercise and customer testing. Whether you are switching completely or just adding a subscription adjacent to your existing one-time revenue model, it's crucial to understand what cash flow implications the subscription offer will have on your business.

6. Get sales ready for launch

Before pressing go, you need to fully equip your sales team. Many subscription journeys have come to an unfortunate end because the sales team wasn't prepared to sell a subscription offering, didn't know how to position it next to the transaction business, or didn't quite understand how subscription revenue would impact their sales compensation plan.

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