Why Companies are Adopting Subscription Billing Models
We have discussed recurring and subscription revenue in the past as many operators have attempted to start WDF subscription, dry cleaning subscriptions, household subscriptions, etc. One could argue that route sales fall into the definition of recurring revenue, but the focus today is subscription revenue. As with many changes in the past 20 months, all were looking to replace traditional sales even though they are now coming back. Creating that Automatic Customer is the value driver for this month and a principal factor of developing value in your business.
Could you offer some sort of subscription plan to your customers? Here are six reasons to consider offering your customers a subscription:
- Predictability: When you have subscribers, you can plan what your business needs in the future. For example, the average flower store in America throws out more than half of its inventory each month because it’s too rotten to sell. At H. Bloom, a subscription-based flower company that sells flowers to hotels and spas, say they throw out less than 2% of their flowers because they can perfectly predict how many flowers are needed to fulfill their orders.
- Eliminate Seasonality: Many businesses suffer through seasonal highs and lows. At Mister Car Wash – where they offer a subscription for unlimited car washes – they receive revenue from customers in November and April even though very few people in the Northern east wash their cars in rainy months. This is also true in the Midwest during the ice and snow season, which I know personally.
- Improved Valuation: Recurring/subscription revenue boosts the value of your business. Whereas most small companies trade on a multiple of profit, businesses often trade on a similar multiple of revenue.
- The Trojan Horse Effect: Once you subscribe to a service, you become much more likely to buy other things from the same company. That’s one reason Amazon is so keen to get you to buy subscriptions to things like Prime or Subscribe & Save. Amazon knows that once you become a subscriber, you are much more likely to buy additional products. Not only are we all trapped by the convenience, but they are hoarding all of the available workers in many markets.
- The Sale That Keeps On Giving: Unlike the transaction business model where you must stimulate demand through advertising to get customers to buy, with a subscription-based model, you sell one subscription and it keeps giving month after month. Praise the Lord we do not sell hot tubs.
- Data & Market Research: When you get a customer to subscribe, you can start to see their spending and consumption habits. This data is the ultimate in market research. It’s how Netflix knows which new shows to produce and which to kibosh.
The Simplest Form Of Recurring Revenue Virtually Every Business Can Adopt
A service contract is an agreement to provide an ongoing level of service in return for a regular payment. It can be a way to transform an ordinary service company into a predictable subscription business.
Most small businesses begin life using the “break/fix” business model where a customer has a problem, and you swoop in to provide a solution. This business model may make you feel valued as a problem solver, but it comes at the expense of the value of your company. In the break/fix model, you must create demand, sell your product or service, deliver it, and start all over again, which is why acquirers place a lower value on these transactional businesses when compared to subscription-based companies.
By contrast, with a service contract, you create an ongoing stream of income that has the potential to grow the lifetime value of a customer dramatically. When you can accurately predict how much money you will get from a subscriber, you can invest more in wooing them.
The most compelling reason to adopt a recurring revenue model is the impact it can have on your company’s valuation. Dollar for dollar, recurring revenue can be worth more than twice that of transactional revenue, depending on your industry.
How to Create a Recurring Revenue Model That Appeals to Customers
The first step of creating a recurring revenue model for your business has nothing to do with your billing platform and everything to do with your target customer. The secret to reimagining your business into a recurring revenue juggernaut is to niche way down.
How Peloton Made Their Subscription Sticky
At Peloton, the fitness company that started with a souped-up stationary bike and now includes classes on everything from yoga to running, they have adopted a subscription model. Customers buy the bike (or the treadmill) and then subscribe to Peloton’s content package. To make Peloton’s subscription sticky, they didn’t just target people who wanted to get fit, many of whom were happy to go to a gym before the pandemic. Instead, they targeted affluent people who are too busy to go to the gym. While the single twenty-something sees a spinning class at his local gym as a chance to connect with like-minded people, Peloton knew the forty-something mom with three kids often doesn’t have the time to go to the gym. Therefore, they defined their target customer as relatively affluent fitness enthusiasts who don’t have time to go to the gym—a niche of a niche. Year to date for 2020, Peloton’s share price has more than tripled. If you’re stuck trying to come up with a recurring revenue model that would work for your industry, segment your customers based on what makes them buy from you. Then determine if one of your niches has a recurring need for something you sell. For a recurring revenue model to retain subscribers, it needs to provide an outlandishly attractive value proposition to customers who agree to continue with the service over the long run. To create that kind of delight, you must find a pain point where a group of customers feels uniform. That only happens when you niche way down.
The New Measuring Sticks
One of the most challenging aspects of building a subscription business is the
need to relearn the basics of how you measure your progress.
Traditionally, you have probably measured your business using a profit-and-loss (P&L) statement, which counts the amount of money you make after you pay your expenses and the cost to make whatever it is you sell. In a subscription business, instead of selling a finite offering, you are essentially renting access to your product or service over time.
In a subscription business, understanding your financial performance requires a new set of operating statistics. The foundation of your subscription business is built on your monthly recurring revenue (MRR). This is the recurring revenue listed on your company’s P&L every month. The next number you need to understand is the lifetime value (LTV) of a subscriber. LTV is calculated by multiplying your MRR by the number of months your customer stays with you, less the cost of serving them during the life of the subscription. If your average subscriber stays with you for 30 months, then the LTV of a subscriber is 30 × $99.00 for a WDF service = $3,000.
The next data point you need to assess the health of your subscription business is your customer acquisition cost (CAC). This is the amount of money you spend on sales and marketing to win a new subscriber. If your company’s total expenditure on sales and marketing last month was $2,000 and you acquired 25 subscribers, your CAC would be $80 during that period ($2,000 divided by 25). Your true CAC will be revealed after you pick the low-hanging fruit. Your friends, family, and best customers will likely subscribe to your new offering out of loyalty to you and a desire to encourage your new business, so you need to discount these early subscribers in your calculation.
Arguably the most crucial factor contributing to the viability of your subscription business is the rate at which customers quit subscribing; this is known as your churn rate. To calculate your MRR churn rate, take your MRR at the beginning of the month and divide it by the amount of lost MRR in the month.
You can also calculate your monthly customer churn rate by taking the number of customers who leave you in a given month and dividing it by the total number of customers you had going into the month.
The other number you need to consider is the cost of serving each new subscriber. Considered part of your cost of goods sold, this number varies based on how many customers you bring on. For most subscription businesses, it includes the salary and other costs of the people you hire to get new customers onboard and serve them over time.
One of the big decisions you need to make in implementing a subscription model is how you plan to win new subscribers. The more complex your offer, the more you will need to rely on humans to sell it.
What follows is a list of sales approaches often used by subscription businesses, ranked from most expensive to least:
- Field salespeople: These are the people who visit customers face-to-face.
- Telesales: Salespeople who contact customers remotely—via telephone and e-mail—work over shorter sales cycles.
- Self-serve: Subscribers don’t need direct salesperson access in this system. Many operators provide the option for a customer to sign up for services right on their website.
Either way, there is one more essential ingredient you’ll need in order to build a subscription business. Cash is to a subscription business as oxygen is to humans. If you don’t have it, no matter how healthy you are on other measures, you’re dead.
Until next time, have a wonderful holiday season, and enjoy building value.
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How Business Coaching Can Help
Service companies, trades, restoration companies, dry cleaning businesses, laundry businesses come to me for assistance in:
- Developing systems to create smoother operation, improving processes and removing bottlenecks
- Implementing team management practices including meetings, delegation and working with challenging communication issues
- Interpreting financial statements and using the information to make better decisions and become more profitable
- Sales and marketing help to get better clients and bigger projects
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