Managing Subscription Businesses in the Age of COVID-19
The Subscription Business has been one of the dominant economic trends over the past decade based both on consumer and enterprise demands for the combination of on-demand delivery, ubiquitous applications, reduced demand for ownership, interest in having up-to-date services and upgrades, and need for time. Subscriptions have appeared across all aspects of the economy, ranging from software and cloud services to monthly food and health goods deliveries to the support of elevators and tractors on a per-use or per-month basis rather than as one-time purchases.
State of the Subscription Business
The world of subscriptions is both growing rapidly and still a miniscule portion of the overall global economy. Even as we see the world of subscriptions growing across streaming media, cloud services, food delivery, and digital experiences, Credit Suisse estimates the current size of the subscription-based economy to be over $530 billion in 2020, which is still less than one percent of the global Gross Domestic Product of over $87 trillion in 2019. Of this $530 billion, nearly 40% consists of cloud computing and Software as a Service offerings that have quickly been growing, even in the current pandemic recession.
Subscription services have maintained their overall growth even in a time of recession and uncertain financial futures because the subscription fundamentally provides several value propositions: the ability to consume on-demand, digital or remote channels to order and modify services, consistency of service delivery, and provisioning of up-to-date services and goods which lead to a closer relationship between the consumer and the company. This loyalty has been an important aspect of these businesses' success in the face of rapidly growing unemployment and increased personal savings rates that effectively lower disposable income. Key markets where Amalgam Insights notes growth during the COVID era include:
- Software as a Service, where apps that can be accessed across both laptops and smaller mobile devices are valuable for conducting work and supporting collaboration
- Digital Streaming Services, where digital experiences are replacing travel as people seek escape from a combination of social media, streaming media, and live interaction. Deloitte’s most recent Digital Media Trends study found that as of May 2020, approximately 80% of U.S. consumers subscribe to one paid streaming video services, which was an increase from 73% when they asked the same question in December 2019.
- Outside of streaming services, more direct collaboration is also occurring across a couple of fronts. Coaching is replacing on-site experiences ranging from gyms to salons to workshops and classes. Social Media and online gaming are also replacing sports as people seek both ephemeral and less serious entertainment.
- Delivery Services, including Food, Home Goods, and Healthcare have become increasingly valuable and popular as people seek to avoid crowded stores that are perceived either as uncomfortable or unsafe.
Key Metrics for Subscription Business
As companies consider either shifting towards or in managing their current subscription businesses, it is vital that they track the financial metrics that are associated with the long-term health of as-a-Service providers. Although traditional metrics on the income statement, cash flow statement, and balance sheet are required, they are not sufficient to manage the health of subscription-based businesses. In managing subscribers, companies should consider the following metrics across the customer life-cycle.
Lead and Close Velocity: How quickly are you obtaining users who show interest in your services and how long does it take for them to move from initial interest to a paid subscription?
Customer Acquisition Cost (CAC): What is the cost of acquiring a customer, starting from initial awareness to paid conversion? This metric requires tracking cost across all marketing, qualification, and business development channels. There's a well-worn saying from legendary marketer John Wanamaker saying 'Half the money I spend on advertising is wasted; the trouble is I don't know which half." Although you may not know what half of your marketing budget you're wasting, you at least need to know how much you're truly spending on customer acquisition.
Customer Churn Rate: By tracking churn on a monthly and annual basis, companies can quickly determine whether they are improving or regressing. The goal is to attain and maintain net negative churn on a consistent basis, as this trend leads to sustainable growth over time. Because churn rate and revenues are not perfectly correlated, there may be times when superficially poor financial metrics may actually be backed by negative churn and low customer acquisition costs that show long-term promise.
Monthly or Annual Recurring Revenue (MRR/ARR): What is the monthly or annual contract value of the customer? This revenue may be fully dependent on your organization's retail price or may be changed based on discounts, referral bonuses, tiers of service, tiers of users, or other revenue-altering conditions.
Lifetime Value (LTV) or Customer Lifetime Value (CLV): These terms are used interchangeably to describe the lifetime value of a customer. This assumes that the company understands how long a customer stays, how much they pay, and how customers upgrade or downgrade throughout their tenure. This metric can be challenging to calculate for relatively new companies or companies that have low customer churn, but Amalgam Insights recommends trying to shape customer tenure based on a distribution curve to estimate the potential lifetime tenure and value of existing customers.
Wallet Share: This is the percentage of a customer's spend your organization has within a specific category. By calculating or estimating wallet share, organizations can both understand what percentage of a Total Addressable Market they hold as well as their realistic Serviceable Addressable Market (addressable market based on the company's specific core operational capabilities) may be.
Subscription Business Execution
To manage these metrics and the challenges of the subscription business, Amalgam Insights advises focusing on execution in the following four areas of the business, which are connected from the customer's perspective and should be managed as a seamless and connected set of service capabilities.
Order Management - Companies need to manage their Configure, Price, Quote process and all potential client requests for quotes, information, and proposals
Invoicing - Subscription companies need to consistently bill and collect on a monthly basis. This is both straightforward and easy for a single service at a single price point, but as usage-based services, one-time services, multiple service levels, multiple billing cycles, and new product and service types emerge over time, subscription billing can become its own set of challenges. Historically, subscription billing started in the telecom vertical, which had its own monthly bills and plethora of features and services. Over time, this capability has been abstracted from a telecom-specific capability into a mainstream service that can support subscriptions and tiers across all businesses.
Financials - Subscription businesses require accurate revenue recognition based on ASC 606/IFRS 15 requirements that define performance obligations. Regardless of how the pricing and invoicing take place, companies must recognize revenue based on their delivery. This can result in accelerated or delayed revenue recognition if licenses or assets are delivered at the beginning or end of a term of service. Revenue recognition must also be considered from a planning, budgeting, and forecasting perspective especially where revenue and cash flow may be detached.
Customer Experience - Customer Service and Retention are vital categories for subscription businesses, especially because the pricing for a subscription is often modeled for a user to stay between 18 months and three years to become profitable. A commitment to subscription is a commitment to customer centricity. In the subscription model, highly satisfied customers who recruit and recommend the service can affect the financial model in a very tangible way, since customer counts, upsells, and churns are easily calculable on a monthly basis.
As companies seek to either pursue or augment their efforts in building subscription businesses, Amalgam Insights provides several recommendations in light of the current pandemic recession and the uncertainties and challenges associated with this environment.
First, unemployment continues to be a significant risk as over a million Americans are still filing first-time unemployment claims per week as of mid-July and, as of the end of June, over 32 million Americans (roughly 20% of the entire US labor force) were claiming some form of unemployment claims. Disposable income will be dependent on a variety of programs and policies, especially housing payment policies for rents and mortgages. According to a survey by online rental vendor Apartment List, 32% of respondents either have made partial payments or no payments on-time in July.
In addition, due to the unknown work environments that currently exist, personal savings rates are estimated by the United States Bureau of Economic Analysis to have risen from approximately 8% pre-recession to 23% in May, due to a combination of stimulus funds and uncertainty. With savings rates so high, price sensitivity is greater than ever. Again from Deloitte, 20% of streaming video subscribers bad cancelled at least one service in 2019, but after the COVID pandemic was officially announced, 17% of subscribers had cancelled one or more services, either due to the perception of higher costs or the expiration of introductory discounts or free trials.
In light of this trend, adjust your pricing, breakeven profitability schedule, and churn expectations based on the expectation of reduced discretionary income and the need for customer retention as the key metric for long-term success. If you can keep your customers in a recession, you have a good chance of keeping them after the turnaround in what may be a Winner Take All situation in your market. Companies in relatively strong financial situations should consider free trials to support customer acquisition but be aware of the risks for losing customers.
For organizations reliant on providing digital services, consider screen fatigue from at least three different perspectives.
First, remember the psychological aspect of the screen as office or school. You need to reset the experience so that it is visually and verbally different from the conference calls and remote education efforts taking place.
Second, the human need to connect with others is challenging simply because of the lack of visible body language, lack of video quality compared to "real life," and the delays in video and voice that can occur. This may require an investment in video, lighting, or other equipment to provide either a more entertaining or engaging experience based on your customers' interests.
Third, there are the practical physical aspects of eyestrain where there is only so much screen time that some people can take in succession.
In considering these perspectives (and perhaps others), Amalgam Insights believes it is vital that online streaming services provide structure and experience that do not fatigue your clients. Allow clients to access both scheduled and on-demand services. Make live experiences personalized, branded, and engaging if they are provided live. Give your clients the opportunity to speak back and augment the digital experience with physical gifts or reminders, if possible. Clients are seeking shared experiences and community; this is the opportunity to provide a different experience that is more than what people experience simply through a digital view.
By taking the view of the quarantined client into special consideration in designing either standalone digital services or digitally-enhanced services for a subscription environment, companies can stay true to the core tenets of supporting the subscription business where marketing, sales, and service are intertwined in supporting the voice of the customer.
To learn more, check out my recent video below.
Hyoun is the Founder and CEO of Amalgam Insights. He focuses on Technology Expense Management, data management, and model management challenges based on 20+ years of vendor, enterprise IT, and industry analyst experience. Prior to Amalgam Insights, Hyoun: • Led IT analyst practices at the Aberdeen Group and Blue Hill Research with over 300 research documents across analytics, mobility, finance, and collaboration. • Managed multi-million dollar technology budgets at Bose and Teradyne. • Managed billing data operations for two resale telecom CLECs. • Built prediction models for the first Fantasy Baseball website, mosey.com
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