Power play: US drama ‘House of Cards’ streamed on Netflix. The growth of subscription- based services is squeezing traditional providers such as the BBC
Power play: US drama ‘House of Cards’ streamed on Netflix. The growth of subscription- based services is squeezing traditional providers such as the BBC

Launching a subscription business is not easy. Just ask Apple, which last week decided to pay artists during the three-month free trial period of its $9.99-a-month Apple Music service, after singer Taylor Swift complained.

Shifting to a subscription model requires mindset, management and marketing changes — and an ability to anticipate, and sometimes absorb, the impact on suppliers, customers and financial results. Adobe Systems, the software group that in 2011 switched to selling cloud-based subscriptions rather than licences paid for in advance, had to endure three years of flat sales before this month reporting record quarterly revenues.

But the business model that in the pre-digital age was the preserve of periodicals, book-of-the-month direct sales companies and golf clubs is spreading fast. Companies in search of the magic combination of customer loyalty, predictable income and user information are selling pet foods, cosmetics, socks and cheese for monthly payments and challenging incumbents with more traditional models.

Dollar Shave Club, set up three years ago to ship fresh razor blades to customers every month, is reported to be worth $615m following a recent funding round, obliging Gillette, among others, to sharpen its approach. The BBC’s funding model, based on an annual licence fee, paid by anyone in the UK who receives its programmes, is under pressure as subscription-based services such as Netflix expand.

Peter Fader, co-director of Wharton business school’s Customer Analytics Initiative, expects subscription commerce to become “a mainstream part of our lives” over the coming years. The marketing professor says most companies are over-anxious about how customers will respond to change.

Why are subscriptions catching on now, centuries after newspapers pioneered the concept? One reason is the combination of technological and demographic change. John Warrillow, author of The Automatic Customer, subtitled “Creating a subscription business in any industry”, says everyone is now happier to use credit cards online and “young people are more comfortable with this notion of access rather than assets — [they] have no need to own things any more”.

Another reason, according to Prof Fader, is that earlier association of subscription models with aggressive direct marketing tactics is fading.

Technology has also helped the biggest collectors of customer data, such as Amazon, to retrofit subscriptions to existing customer choices. Amazon’s Subscribe and Save model invites users to select items they regularly reorder and put them on a monthly delivery schedule, with the added enticement of a 15 per cent discount on the usual price.

Loyalty is one prize for companies that get subscription services right, even in industries usually associated with big one-off purchases. In 1996, General Motors launched OnStar, its in-car “service assistant”, which links live advisers and in-car computer systems, in the US.

The idea was to create a separate stream of revenue from subscriptions that currently range from $19.99 to $34.99 a month (2015 buyers can connect their vehicles to a basic service for free for five years). Now OnStar is more about ensuring customers keep returning to GM vehicles. The group is about to introduce OnStar for its European passenger car. According to Dan Ammann, GM’s president, increasingly the important question is not how much metal can carmakers sell, but “who owns the customer relationship”.

Yet for many companies, shifting to a subscription model can be painful. A simple move from taking lump-sum payments upfront alters cash flow. To sustain a subscription model involves assessing what the lifetime value of customers, or groups of customers, is likely to be, and reviving some of the “direct marketers’ tricks”, Prof Fader says. One is “RFM analysis” — recency, frequency and monetary value: how recently and how often does the customer buy, and how much do they spend?

Phil Libin, chief executive of Evernote, the online workplace productivity tool, recognises some of these pressures. Last month, Evernote introduced a tiered “good-better-best” approach to pricing, adding more features for higher subscriptions, after realising only 5 per cent of customers were using the premium version.

Evernote’s most important insight was that customers were not choosing to use the basic service — they were defaul­ted automatically towards it. “Unless you took action, we never told you about the other version,” says Mr Libin. “When you go to a restaurant, there’s an expectation you are going to order something. You can sit there eating breadsticks, but at some point, you’re going to order. We were just letting people hang out.”

So far, the Evernote transition to a three-tier subscription system seems to be paying off. But Mr Libin is under no illusions about how hard it will be to keep satisfying customers, preventing their defection to rival services or halting a slide back towards the free version (renamed Evernote Basic, to underline its bare-bones features).

Greg Alvo, founder of OrderGroove, a subscription technology platform used by 80 brands (and advised by Prof Fad­er), says one pitfall of shifting to a subscription model is to focus only on the number of new subscribers rather than how to value and retain them, a mistake he equates to “pouring money into a leaky bucket”.

Mr Warrillow says subscription businesses should aim to “change the consumer’s behaviour in that first 30 to 60 days”. Ron Adner, of Tuck School of Business, whose book The Wide Lens looks at how companies sustain the wider structure of relationships that make innovative business models successful, says the consumer has to think “I’m getting so much more than I used to”.

Relying on customer inertia for re­newing the subscription is another weak strategy. As renewal dates approach, clever companies not only remind you to pay, they also push out an escalating series of messages reminding you to use the service. At the moment of renewal, the customer is more likely to remember why the subscription was useful.

At the same time, as Ms Swift’s initial rejection of the new Apple Music contract shows, neglecting any part of the chain of interests involved in sustaining a subscription model can be dangerous.

Prof Adner also warns that the proliferation of subscription offers could it­self create a problem. “I think there’s a household limit to how much you can possibly sign up for,” he says.

But others believe that customers and businesses are only just appreciating the real value of the subscription model. OrderGroove’s Mr Alvo says the most successful subscription-based companies will simplify customers’ existing behaviour.

He adds a word of warning, though, straight from the bad old days of direct marketing scams: “They have to be different from subscription services that lock you in and rip you off.”

Get alerts on Strategy when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article