What is a subscription based business model?

With the right insight and metrics, subscriptions offer a great way to build a reliable business and a predictable revenue stream.

Subscription based models are something every business should consider as part of their business model. They are a great way to maximise the value you get from each hard earned customer – and the length of time you hold on to that customer. It’s hard and expensive to win new business, so a subscription business provides a great source of recurring revenue.

The trick is being able to make sure your chosen subscription based model fits your targeted customer segments and getting the most from your model once you’ve chosen it requires the right combination of metrics.

Subscription based models aren’t just for technology businesses

Technology-based firms, particularly those offering software as a solution or cloud-enabled applications like accounting software, are probably already very familiar with a subscription based revenue model.

But more traditional businesses may wonder how to introduce a subscription model to their offering. The good news is, it may be easier than you think.

Have you ever been to a cinema where they have tried to sell you a membership card, allowing you to watch an unlimited number of films for a monthly fee. You’d be surprised how many other businesses that have been around for years are reinventing their revenue models and venturing into subscription based models.

In the cinema example, in exchange for a minimum subscription period of a year and paying £16.99 per month you can watch as many movies during the month as you want. Once a customer has signed up, it’s a predictable source of revenue for the cinema.

All businesses are being disrupted and I challenge you to think about how you could disrupt your own business or revenue model to make sure you don’t just grow your business, but stay in business. Some simple but powerful examples of subscription based businesses you wouldn’t readily think about include:

• Guilford Accounting – accounting & management information services provided monthly;
• Graze – pay monthly to receive a fresh box containing a selection of themed snacks to your door every week;
• HP ink cartridges – your printer sends a Wi-Fi signal and they deliver printer ink in time for when you need it;
• Cineworld– pay monthly and see as many movies as you want on their membershipcard;
• Briefd – pay monthly to receive new luxury underwear each month;
• London sock company – pay monthly and receive a new pair of socks as part of their sock club;
• Harrys – pay monthly and get razor blades delivered to your door.

The growth of online shopping, combined with the convenience factor for the time poor consumer, has created a real opportunity to expand into subscription. Many of these are successful through their ability to also add an element of curation to the process – so in addition to the convenience of delivery to your door, time-consuming browsing is also eliminated. The best newcomers combine this with data capture around subscribers’ preferences – making recommendations of new products and items to try based on previously caught data.

But before you invest considerable time and effort into developing your subscription model you need to be able to measure how your subscription model is performing. there are some specific metrics that are specific to subscription models that will help you.

Which metrics should subscription based businesses be monitoring?

Whether your business is set up to provide access to a service, or physical products, there’s a lot of scope to build in a subscription element to your revenue model (just look at ours – it doesn’t come more traditional than accounting!). And when these models work to their full effect, it’s a great way to grow your business – helping you to remove a lot of the time and cost from continually having to work your way through a sales cycle or customer acquisition process.

However, long term success with this model relies on providing your customers with a more convenient or customisable experience than they would experience elsewhere.

This is where having the right metrics can make a real difference and business owners should challenge themselves to delve deeper than the headline stats. Scratch the surface to reveal the full story behind your numbers and those high level metrics can not only masquerade the truth, they can also obscure a host of opportunities.

The metrics I see as the most important when it comes to assessing how effective your subscription model is at maximising how long they remain active customers – and the value you receive during that time – are:

• ARPU (average revenue per user)
• AMPU (average margin per user)
• MRR (monthly recurring revenue)
• CCR (customer churn rate, sometimes specified as a period and referred to as monthly churn rate)

To calculate these metrics, and bring out the benefit of using segmented data to get an even deeper understanding of your business, involves detailed calculations on these metrics.

Average revenue per user (ARPU)

ARPU is a number which you will want to see increase over time. Quite simply it shows you the average revenue each of your (average) customers is generating for you. If you have multiple products or services, it would be beneficial to calculate ARPU by these different products. Equally, not all customers are created equally – if you have different types of customers, you may be interested in segmenting your customer demographics to understand ARPU by customer segment. This is particularly useful to use when setting a strategy to target new customers.

Example

• You have 2 different products, basic and premium.
• You also have 2 basic customer segments: young professionals and families.
• Your basic product sells for £25 per month. You have 55,000 family subscribers and 40,000 young professional subscribers.
• Your premium product sells for £40 per month and you have 2,000 family subscribers and 25,000 young professional subscribers.
• Total basic product subscribers are 95,000 and total premium product subscribers are 27,000

ARPU   = total revenue / total users

= ((£25 x 95,000) + (£40 x 27,000)) / (95,000 + 27,000)

= £28.32

However, the £28.32 is a blended ARPU across your entire customer base. If we break this down by segment it tells us something more insightful.

Family segment ARPU              = family segment revenue / family segment subscribers

= ((£25 x 55,000) + (£40 x 2,000)) / (55,000 + 2,000)

= £25.53

Young professionals ARPU     = young professionals revenue / # of young professionals

= ((£25 x 40,000) + (£40 x 25,000)) / (40,000 + 25,000)

= £30.77

Drilling down to segmented customers and understanding ARPU by these segments gives us even more insight into our average revenue per segmented user. It would appear that we should be taking actions to target the young professional segment rather than the family orientated segment based on the £30.77 average revenue per user compared to just £25.53. However, be warned that metrics should not be viewed in isolation – which brings me on to the next metric of interest AMPU.

Average margin per user (AMPU)

If the business is operating a subscription model based on a product, such as razor blades,  you would also be interested in the average margin per user i.e. average revenue – average cost of sales.

If we continue with the above example and assume there is a cost for each sale made i.e. a product cost, we can work through an example.

Example

• Your basic product sells for £25 per month and we have 55,000 family subscribers and 40,000 young professional subscribers.
• Your premium product sells for £40 per month and we have 2,000 family subscribers and 25,000 young professional subscribers.
• The basic product costs you £5
• The premium product costs you £23
• Total basic product subscribers are 95,000 and total premium product subscribers are 27,000

AMPU                                           = (total revenue – cost of goods sold) / total subscribers

= ((£25 – £5) x 95,000) + ((£40 – £23) x 27,000) / (95,000 + 27,000)

= £19.34

Family segment AMPU            = family segment revenue / family segment subscribers

= ((£25 – £5) x 55,000) + ((£40 – £23) x 2,000) / (55,000 + 2,000)

= £19.89

Young professionals AMPU   = young professional revenue / young professional subscribers

= ((£25 – £5) x 40,000) + ((£40 – £23) x 25,000) / (40,000 + 25,000)

= £18.85

Drilling down to the right level can help you make more informed decisions

Now, taking both ARPU and AMPU into account – which segment would you choose? The segment with the greater revenue per user, or the segment with the greatest margin per user? Drilling down to the right level can help you make more informed decisions. Now it depends what your strategy is – do you want top line growth, or are you focused on margin? At least now, you are able to make an informed decision because you have the information and insight to make those decisions.

Monthly recurring revenue (MRR)

Your business may have different revenue streams. There may be one-off revenues, such as one-time purchases or upfront implementation fees. However, what we are interested in here is the revenue that is predictable for future months, based on subscribers. Given this, you will be able to reliably predict what your minimum revenue will be in subsequent months as it is, by definition, recurring (save for any customer churn, which we will go into below). MRR is a number you want to see grow month on month as it’s a good overall growth indicator.

 Customer churn rate (CCR)

Customer churn rate is a number you want to see as low as possible. Customer churn rate measures the number of customers you lose relative to the total number of customers in a given period (before new customers are accounted for). Typical periods used are monthly, quarterly or annual. Many businesses run different types of products and so customer churn rate is not always the same, largely due to the fact the price for each product is different.

Let me walk you through an example…

Example

• You have 2 different products, basic and premium
• Your basic product sells for £25 per month and you have 95,000 subscribers
• Your premium product sells for £40 per month and you have 27,000 subscribers
• Total subscribers are 122,000
• In month 1 you lose 5,000 subscribers from your basic product and 250 subscribers from your premium product.

Customer churn rate  = lost subscribers in the month / number of subscribers at start of month

= (5,250 / 122,000) x 100%

= 4.30%

So you can see that you are losing customers at a rate of 4.30% per month. We can look at customer churn by product.

Basic product churn rate         = basic product lost subscribers in the month / basic product number of subscribers at the start of the month

= (5,000 / 95,000) x 100%

= 5.26%

Premium product churn rate  = premium product lost subscribers in the month / premium product number of subscribers at the start of the month

= (250 / 27,000) x 100%

= 0.93%

 Using your metrics to get value from your model

So with these four metrics, you’ve now got a lot more insight into not just how well your model is performing, but what decisions you’ll need to make around continued growth. For example, based on the metrics around your two main user segments, there’s already a decision to be made on whether to focus on the young profession market – which brings in more revenue per user – or the young families market which provides better margin. In each case, the marketing and promotional decisions are likely to look quite different.

Elsewhere there are other decisions to be made. For example, given the much lower churn rate of the premium product, is it worth creating an introductory upgrade offer or trial to encourage more people to switch to the premium product? Or would you want to adjust the price point of the basic product to see if that improves retention?

Now over to you, are you tracking each of the above metrics at the right level to make informed decisions on your strategy? I challenge you to think how you could create a subscription revenue model for your business.