This article was originally created on 14th of December 2018.
Recurring Revenue, or subscription business models are an attractive source of secure income. When you are in the process of selling your business, this becomes very valuable.
For prospective buyers, it allows them to see the future potential of the company and more accurately estimate cashflow.
The likelihood is you do already have some form of recurring revenue within your company, but if you don’t, it’s time to start implementing them.
Looking for a handy checklist that will walk you through all that’s needed when preparing your business for sale? We’ve created one with all you need – and you can download it here.
What is a subscription business model?
Every good business knows that one of the most expensive parts of growth is acquiring new customers. The costs of advertising, promotion and onboarding new customers can be very high. We talk about the CAC (Customer Acquisition Cost) further in this article.
It is much more cost effective for a business to retain existing customers, but encourage them to spend more. This could be a higher spend value, or by encouraging more frequent, lower spends.
If you can systemise the number of times one customer spends with your business, you have a subscription model.
Benefits of a subscription business model
Let’s roll the clock back. Do you remember your first proper payday? The first time we had money to spend that we had earned ourselves.
Did we budget?
Did we make sure our rent and other expenses were set aside and covered?
Or, did we just blow it all down the pub on pay day?
As youngsters making our own way into independence, we had to learn to budget. Businesses are no different.
Managing cashflow for a business is no different to managing a household budget. So to make things easier, we buy our equipment on HP, we pay our rent monthly and we set up regular payments for the goods and services we use most. We do this to apportion our spending evenly across the year and make it more manageable.
Subscription models help to ‘budget’ your income.
Gym’s are the perfect example. Customers could join by paying an annual membership fee. Let’s say £240. Undoubtedly, the busiest time of year for new memberships is January. If a gym took on 100 new customers in January it’s a £24,000 boost to income, but there could be very little income for the rest of the year. So, that means the business has to budget carefully and not run out of cash by December.
In a subscription model business, that membership is broken down and paid by instalments. In this example, £20 per month.
Same income to the business, but balancing the monthly income against the monthly overheads becomes much easier.
The spin off bonuses
“If the income is the same, what’s the point in monthly subscriptions?” I hear you ask. That would be the spin off bonuses.
In creating a subscription model you are able to adjust the pricing.
Back to our gym. You may have seen examples whereby if you pay once, annually, you pay a lower price. In reality, the privilege of being able to pay monthly comes at a premium price. So instead of £20 per month, it might increase to £25 per month (£300 total) , but pay annually and it stays at £240. The benefit to paying more is that the customer also has help with their budgeting.
The other big spin off bonus is customer apathy. With a payment automatically being taken monthly, it is often forgotten about and continues to roll over and renew. Hit someone with a £240 costs each year and they will seriously consider if they still get value for money, thereby leaving your business at risk of cancellations.
6 popular subscription models
- The Simple Consumable
- The Sunk Money Consumable
- The Subscription Service
- The Sunk Money Subscription
- The Evergreen Subscription
- The Hard Contract
Below we take a look at each of these with working examples.
1. The simple consumable
This involves offering a subscription to a product that the customer needs to replenish on a regular basis.
The proposition is simple: life is too short to worry about mundane tasks like remembering to pick up dog food or razor blades; subscribe and you’ll never run out.
Coffee is a great example of this. Whether you crank up your filter machine on a daily basis or just for a weekend treat, you will be using a regular amount of coffee. Your favourite blends can be ordered on a regular subscription for delivery through companies like www.thecoffeefactory.co.uk. It arrives at your door before you run out. This is even advancing into technology. Because your printer is wifi connected it orders it’s own ink when it knows you’re running low.
The model works best when there is no enjoyment in shopping for the product. If you are a coffee connoisseur who gets enjoyment from tasting new beans and creating bespoke blends, this isn’t for you. If you are a busy family with young kids, taking one item off the shopping list is possibly a life saver.
Think about things like pet food, copy paper, razor blades and even nappies. Anything which us used consistently and repeatedly could be delivered instead.
These are still consumables which means shoppers will have a wide choice of who to buy from. If you can, brand or package your goods in a unique way.
- Make yourself stand out from the crowd
- Don’t underestimate delivery costs
- If you buy the product in bulk, ensure you have a strong and steady supply chain. You don’t want to run out.
2. The Sunk Money Consumable
For this, the customer has ‘sunk’ money into a product that they now have to purchase replacement elements for. You have an electric toothbrush, but now you need the replacement brush heads, recommended every 3 months. Oh and don’t forget to buy their branded toothpaste and mouthwash………
Nespresso did this in coffee pods, closely followed by Dualit and Tassimo. You will note that no coffee pod machine is compatible with another, so customers have to sick with your brand.
An emerging company which crosses the simple consumable and the sunk money consumable is www.splosh.com. Splosh’s manifesto is to reduce plastic waste. What they do is send concentrated refills through the post for laundry, kitchen and bathroom products. To get you started, you purchase full size branded bottles with refill lines marked up for ease of use. So every time you need to refill, you are presented with the Splosh name reminding you where to order from.
Apple are an extreme example. They make their range of products so easy to integrate with one another, it is hard to move to another brand. If your MacBook, iPhone, iPad and smart watch all talk seamlessly to each other, it takes a lot to switch brands. Whereas if you run a Dell laptop, you can’t buy a Dell phone so you move to Nokia, Samsung or another. They are not capturing you brand loyalty across a wider product base like Apple do.
Things to be wary of here are design and patent protections. The design rights to Nespresso pods has now expired and there are a number of ‘own brand’ replicas that are now available at a fraction of the price. The same happens to home printers with replacement cartridges just as likely to carry the Ryman or Viking brand than HP or Brother.
All examples so far are retail, but this model also works well in industry.
A client manufactured breaks for the moving parts of extremely large motors. So good, they became preferred to the original manufacturers. The consumable replacement parts being the pads to the break system.
For our client, they missed out on the initial purchase (the sunk money), but they have snatched the repeat regular breakpad replacements from under the noses of the originator by ensuring their brand and part number are prominent on every piece sold.
3. The Subscription Service
What immediately springs to mind is a magazine subscription. A perfect and traditional example of a subscription service. Others are National Trust or theatre memberships. In the business environment it includes things like Sage accounting, Salesforce CRM, Office365 and website hosting.
Generally speaking, there is an option to renew your subscription at the end of a defined term.
There are a couple of subsets to the subscription model. The first taps into our need for Peace Of Mind. Insurance perfectly demonstrates this. So when you buy your new washing machine, you may also buy a service and maintenance package, just in case there is a fault.
These subscription models rely on our need to be covered for every eventuality giving us the peace of mind we seek. We would rather pay for that up front, or by instalments, than pay for the repair if one is needed.
The second subset is the one which gets you to the front of the line. Priority, privilege, gold standard. Something which, where money is no object, we are prepared to pay for.
The kings of this Front Of The Line subscription model is Amazon Prime.
For just £79 per year you currently get (with eligible items);
- unlimited one day delivery
- unlimited same day delivery to certain postcodes
- amazon day, select one day when all your orders can be delivered each week, so you can be home.
- prime video
- prime photo
- prime music
- amazon music unlimited, discount
- kindle owners lending library
- kindle first
- prime reading
- prime wardrobe
- prime student
- twitch prime
- prime early access
- amazon family
It’s an attractive list. The reality is that most people will only use delivery and video and little else.
Things to note here is the psychology Amazon take users through. By paying an up front membership of £79, people are determined to get value for money. That means they order more often and for higher values.
According to a TIME magazine survey, Prime customers in the U.S. now spend an average of $1,400 per year vs. the average non-Prime customer who spends just $550.
Not only are they increasing sales revenue this way, but with 150m Prime members worldwide, they are also generating nearly £12bn in subscriptions alone.
The other thing to note is the branding and cross selling customers are exposed to. Each of these offer cross selling opportunities, and as customers are already invested in Prime, are they more likely to watch Prime Video than Netflix. Will they look at Prime Photo before something like Dropbox. Can you save on your Spotify subscription in favour of Prime Music?
“Why pay twice when Amazon Prime offers me so much?”
But Amazon didn’t invent this way of doing business. Golf clubs were here long before Jeff Bezos. They charge an up front membership for use of the club. In return members get priority over tee-times. Once you get use to that priority, it is hard to give it up.
Golf club members are also more likely to buy their balls and equipment from the on site pro-shop. Some will even insist that an annual deposit is put behind the bar which encourages members to take lunch and linger, increasing their annual spend yet again.
4. The Sunk Money Subscription
Think of this one as gateway that needs several keys for you to unlock it. Key number one unlocks to provide you with a product or service that you pay for initially. However, in order to maintain and update the product/service or access additional information, you need key number two. Meaning, further purchases are required for you to get the most out of the subscription.
A good example would be an app or computer game that’s been purchased outright but then demands further payments to unlock additional content.
Companies like Sky TV are another example. You sink your money into the original subscription and equipment but to unlock specific packages like film, kids or sport, you need to pay more. Want the biggest sporting events, like boxing, and you pay more even if you have the sport package already.
5. The Evergreen Subscription
Auto-rebilling – it’s the ‘secret’ to big brand success and huge growth. Auto renew by direct payment and it takes a particular effort for someone to cancel your service. All things being equal, if nothing has changed, renewal just goes through without question.
What subscriptions are you aware of?
- Spotify and Netflix fuel our need to be entertained.
- Uber Ride Pass make life that little bit easier.
- National Trust memberships allow us to demonstrate our charitable side.
- Perkbox shows our staff that we value them.
Subscription based revenue is booming. Research has found that more than 226 million of us have some form of subscription. What does your business have to offer?
6. The Hard Contract
This is the most secure of all the subscription models. Your customers are contractually obligated to continue working with you. Think of your mobile phone contract. Whilst you can now get SIM only deals, if you want a new handset, you are usually in a 2 year contract.
If you decide to cancel early, you still have to pay the balance of that 2 year contract. As a business, your income for that contract is guaranteed.
Hard contracts like this are much more common in industry. The catering companies who supply school lunches will be on a hard contract as will the transport companies who get the kids to school. The franchises issued by government to rail companies is a form of hard contract.
We look at the link between contracts and business value here.
Subscription model overlap
One thing you will have noticed with the examples we’ve been through is that there is a lot of overlap between models. The best practitioners of subscription model business straddle multiple ones.
Nespresso are a sunk money consumable, but they also make it very easy to reorder their pods and have them delivered regularly to your door (simple consumable). At the time of writing, Lavazza are selling their pod machines for just £1 (RRP £79-£129) when you sign up to a coffee subscription. Giving away their sunk money item (machines) because they know they will recoup the value in the ongoing pod subscription value.
You may subscribe to Office365 but when you begin exploring the additional functionality available through other apps, you begin to upgrade your package. It has taken you from a subscription to a sunk-money subscription.
Subscription business models and your business
I hope we’ve demonstrated that the introduction of subscription business models help with cashflow, predictability of income and can often boost the lifetime value of a customer with you because of increased loyalty.
It is important that you create models that your customers will support. That might mean you have to give something away for free to get them trying your product/services to start with. Amazon have that cornered too with a 30-day free Audible trial. If you enjoy the experience you simply won’t cancel.
Salesforce give their products away for free in trials before customers buy. They have the confidence to know that once a person uses the software, they will want to buy. Had they not had an opportunity to trial, they may have been reluctant to commit.
Subscription business models increase company sale value
When the time comes to sell your business, the fact that you have customers subscribing to your products and services is hugely important. That regular, predictable recurring income is looked at closely in the Ubuild coaching program we run under the Value Builder model.
Like Jeff Bezos, if you could demonstrate that you have £12bn rolling in from subscriptions year after year, a buyer will pay more for your business. Why? Because it is a less risky investment than a business which has to go and find that revenue from new customers repeatedly.
We’ve looked in detail here at 6 subscription models. There are many more so you are sure to find one which fits your business and increases your revenue and business value. No matter what sector you’re in.
If you would like to explore this topic more and the effects it has on business sale value, begin by downloading the 8 Drivers of business.