Building a Successful Subscription Business Model
Subscription business models are based upon the idea of selling access to a product or a service to customers on a recurring basis in order to receive monthly, semi- annual, or annual subscription revenue.
But how do you ensure your business is trending toward success?
Successful subscription businesses utilize specific metrics and pricing models to showcase growth.
What are Subscription Model Metrics?
CFOs, controllers, and financial analysts are currently facing a business environment that is more diverse and different than ever before. In the subscription world, there is a shift toward agile business models, with the focus being a customer-driven back office. The finance professionals want the ability to look forward into their subscription business to measure not only what’s happened in the past, but to analyze what is on the books today that is going to turn into tomorrow’s revenue growth.
This new way of measuring business performance is being noticed by investors too. Subscription metrics are becoming more prevalent on earnings calls. Take the New York Times - on their Q1 2020 earnings call, they referenced that their subscription business is growing at the highest rates ever.
Even during COVID, a few companies that have subscription services that are booming, such as the e-learning market, Netflix, LYFT, and Uber.
This is why companies need to create and make an investment to build analytics in their current environments. Business Intelligence is a system to provide historical, current, and predictable views of all of your business operations, sales, finance, marketing, development, and products. BI turns data into business insights that allows managers and C-level executives to make strategic and analytical business decisions more accurately.
Creating and using dashboards that show key metrics such as current MRR, expansion MRR, churn data, customer leads, and sales closed/won give power to the overall company. Being able to understand trends will streamline the efforts across the business teams and help grow and sustain the business.
Six key metrics that should be included in your dashboards are:
1. Monthly Recurring Revenue (MRR)
Monthly Recurring Revenue is the calculation of the dependable revenue the company can expect to have each month. It is the most important metric for a subscription business and the basis for the rest of the metrics below.
2. Customer Lifetime Value (CLV)
Customer Lifetime Value is the total revenue an individual customer is expected to generate over the lifetime of utilizing the products or services of the company. The goal is for the lifetime revenue to exceed the cost of acquiring this customer.
3. Customer Acquisition Cost
Customer Acquisition Cost is calculated by adding the costs of marketing and sales and dividing that by the total new customers gained in a month. This metric will indicate how well the balance is between acquisition and retention of the customers.
4. Net Recurring Revenue Changes
Net Recurring Revenue Changes are calculated using your beginning MRR balance plus “new adds” less churn to equal your ending MRR balance in a month. You can then split your “adds” by expansion MRR and growth MRR. Expansion MRR is your current customer base growth and growth MRR being new customers added in a month.
5. Average Revenue Per User
ARPU is important when you sell multiple products at multiple tiers of pricing which makes it difficult to see what a customer spends. If you plan on bundling or packaging services or products, this will help your marketing and sales teams coordinate the efforts by demographics, regions, or other variables.
Churn indicates the downgrades or cancellations of customers in a given month. The need to understand the causes and effects of churn are an important visual tool and will give insight to your overall customer and business health.
Top 4 Subscription Pricing Models
How you price your subscription is a key ingredient to making your company successful.
We all wish there was a secret recipe to create a pricing structure, but there is not. Ask yourself the following questions before choosing a method:
- Ideal customer
- Target market
- Value needed
There are various pricing models that you can choose from. Also, you can structure it around B2C versus B2B as necessary.
1. Flat Rate Price
Flat rate pricing is the simplest form of billing a customer: offering your product/service for a set fee. This pricing model is easy for customers and C-level executives to predict. Usually, you do not see this in a SaaS model since new features and technology are constantly changing. This can be great in a B2C model for businesses, with popular examples being newspapers, Google, or Apple Cloud Storage. In our new world, this option is not as common as a few years ago.
- Simplicity of billing to customers
- Easy for C-level executives to predict
- Hard to tell who your largest or smallest customers are
2. Usage-Based Price
Usage-based pricing is a pricing model that uses the pay-as-you-go or pay-per-use model. Determining whether to use this pricing model depends on what you are selling. If you are Netflix, you could use how many videos you download. For Wall Street Journal, you could use how many articles you read. For Liquid Web, we could choose to go off the bandwidth used in a month. This is a more sophisticated model of subscription billing.
- Agility to treat customers differently
- Better understanding of customer needs
- Predictability of service
- Understanding of future revenue and cash flow
3. Per-User or Per-Feature
You can charge and change the subscription based upon the amount of licenses that are required or sign-on for each user who needs access to the service that you are offering. If you want customers to only pay for what they need, the feature could be a great tool to leverage every purchase. Feature-based is becoming quite common since technology is changing and customers are becoming more aware of what they are paying for each month/year.
- Customers only pay for what they need
- Easy predictor of future revenue
- Easy to understand more about customers and what they are using
- Scales with the adoption of the product/service
- Users can share logins and steal your service
4. Tiered Pricing
With tiered pricing, different levels of the product/service or different features of the product/service cost more or less depending on the number of users, features to choose, usage, or bundling of products. Typically, you would create two to four different models that customers can choose in your store.
- Pricing will appeal to different customers across different platforms for optimal sales
- Time needed to construct tiers
- Complex tiers may drive customers away
Managing Your Pricing Model
Once you make the decision on which model best suits your business model and the subscription services or products you are selling, you need to manage the model.
Managing involves several factors such as free trials, changing pricing, and refining the product.
Free trials are a tool that subscription revenue companies should use to acquire new leads and opportunities. It gives the companies a mechanism to drive more MRR at a reduced cost of acquisition. All subscription business models should look into using free trials, since providing upsells or providing add-ons will help retain customers.
You need to be able to adapt to the market by testing and evaluating the pricing model you have chosen. The marketing and advertising teams need to work together to communicate when the market is driving for change. Companies should make it mandatory to review the model and pricing at least every 6 months.
Refining the Product
You need to listen and learn from your customers and revise your products accordingly. One size does not fit all, and today’s customers are more informed and intelligent than ever before. The customer’s ability to have choice will create a long-term customer and higher ARPU.
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David Gibb is the Financial Controller at Liquid Web. He has over 20 years of experience working in Finance. He is a CPA in Canada, CGMA in the United Kingdom, and a CPA in Australia.
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