Subscribed: Why the Subscription Model Will Be Your Company's Future - and What to Do About It

by Tien Tzuo

You’ve probably seen the statistic—more than half of the companies that appeared on the Fortune 500 list in the year 2000 are now gone. Poof. Vanished off the list as a result of mergers, acquisitions, bankruptcies. The life expectancy of a Fortune 500 company in 1975 was seventy-five years—today you have fifteen years to enjoy your time on the list before it’s lights out.

Here’s how Forrester describes the new customer mindset: “The expectation that any desired information or service is available, on any appropriate device, in context, at your moment of need.”

Ecommerce, the thinking in Silicon Valley goes, is clearly the future. It now represents more than 13 percent of the total retail market and is growing at 15 percent a year, versus just 3 percent for brick and mortar retail.

We’ve had three big ideas at Amazon that we’ve stuck with over the years,” said Jeff Bezos. “Put the customer first. Invent. And be patient.”

Another favorite Bezos quote: “I don’t know about you, but most of my exchanges with cashiers are not that meaningful.”

So what’s changed about the monthly subscription services today? Well, the smart ones realize that if they really want to retain their subscribers, they need to focus on building a great service, without relying on lame tricks like hiding the cancel button. “If you are in the subscription business for the long term, especially in an age of lightning-fast communications among dissatisfied customers, you want to follow the golden rule,” says Robbie Kellman Baxter, author of The Membership Economy. “Make it easy for customers to leave if they want to. You can certainly ask them why they’re leaving, or try to win them back, but don’t get in their way—the digital equivalent of blocking the exit with a hulking security guard.”

So how did they do it? Well, once the executive team decided to pursue this model, it committed itself to relentlessly overcommunicating. The idea was to drown controversy with transparency, but they needed slightly different messages for each of their core constituencies. They started with their employees. There were some pretty serious organizational changes that had to happen. If some long-term employees were freaking out, you could certainly empathize. The finance team had to move from simple transactional sales to suddenly billing three to four million individuals every single month. The product team had to move from yearly to monthly feature updates, as well as tackle new challenges like uptime, disaster recovery, and security. Management put together a jokey self-help video for the sales team called “revenue addicts,” whose goal was to move the mindset (and commission structure) from quarterly numbers to long-term bookings.

While its hardware business was flat, management saw that most of its growth was coming from its new service acquisitions around security and collaboration. It was buying growth.

If you were in the railroad industry, would you be more interested in the business of laying the tracks or delivering the freight? One element is discrete and transactional (how many new rail lines do you really need?); the other represents ongoing value.

“I have options to talk to my customers about operating expenses and taking the lumpiness out of tech refreshes,”

Cisco isn’t just managing a dependable if relatively flat hardware business while it hunts for growth in software and services. It’s embracing subscriptions in a broad, systemic way in order to shift from selling boxes to selling outcomes.

Today almost a third of its revenue is recurring, which is resulting (as CFO Kelly Kramer is quite happy to point out) in a short-term hit to its GAAP revenue numbers. Again, standard revenue loss is a good thing. That’s a sign that you are carrying your book of business out into the future.

I think Nicholas Carr could have easily been right—thanks to rampant commodification, the tech industry could have been relegated to a steady if underwhelming sector of the global economy.

Here’s the secret we used to answer all of them in the affirmative—tease out the service-level agreement that sits behind the product. It works for everything. So instead of a refrigerator, it’s the guarantee of fresh, cold food. Instead of a roof, maybe it’s a guaranteed source of solar energy. Instead of excavators, it’s the expeditious removal of a certain amount of dirt.

As Final Fantasy producer Naoki Yoshida told GameSpot: With the subscription model, you have that constant flow of revenue. As game developers, creators of games, we want to be able to continue providing the best gameplay experience and sustain that. Of course, the initial subscriber numbers might not be as many as the free-to-play model, but we have that constant stream. We’re not thinking just about the business of the moment. We want to think about the long term and being able to have the funding to continue making updates. Some people might be focused on quickly gaining revenue, but you have to think about the long term.

Today finance teams are experimenting with a whole new rulebook and set of metrics: costs of customer acquisition, lifetime customer value, annual recurring revenue, average revenue per customer. The five-bucks-a-month plan sounds like a great idea, as long as your players hang on to the game for at least a year. What about the ones who drop off after a couple of months? How are they accounted for in your business plan? Today finance teams are increasingly defining the operating metrics that are distributed throughout entire organizations, such as pricing, packaging, and analytics. For example, how does Netflix justify spending $8 billion a year on shows that it doesn’t really “sell”? Its finance team obviously knows something that we don’t.

there is nothing more dangerous than profitable mediocrity.

The Manifesto for Agile Software Development was put together by a group of developers at a ski resort in Utah in 2001. It contains four simple but powerful value comparisons: individuals and interactions over processes and tools, working software over comprehensive documentation, customer collaboration over contract negotiation, and responding to change over following a plan.

As a result, storytelling has come to the fore. At Zuora, we use the Three Rooms mental model of storytelling. You need the story of your product—the how. You need the story of your market—the who. But most important, you need an overarching story that puts your service and your users within a broader social narrative—the why.

If you have more than 70 percent of your subscribers in your basic package, then you may have a perfectly respectable entry-level service that will ultimately kill you. You haven’t built a growth path—most of those subscribers are probably happy to stay put. Ideally, if you offer bronze/silver/gold tiers, that 70 percent sits in the silver and gold categories. That means your subscribers are taking advantage of the capability-driven growth path, which also means they’re using your service consistently.

Someone who’s about to enter into a relationship obviously wants to learn more about the other side. What’s this person’s philosophy? Does it fit with mine? Does this look like it’s going to be a solid partnership? If I go with this service, am I going to benefit from the collective intelligence of the rest of their client base? Or at least the clients who share my business needs? I know that this service is going to change and evolve—will it fit where I want to be two years from now, five years from now?

In the old world, you could grow by doing three things: sell more units, increase the price of those units, or decrease the cost required to make those units. In today’s world, you have three new imperatives: acquire more customers, increase the value of those customers, and hold on to those customers longer.

Hustling add-ons and locking people into onerous terms is a drag and serves only to get people upset.

What’s the first thing you need to do? Find the right kind of customers.

Second, it’s really important to avoid the temptation to ramp up a big sales force. Perhaps you are inside a multibillion-dollar company with a large sales force, and you think the best thing to do is to get all of them to sell your service. Bad choice. To begin with, they probably won’t know what they’re doing.

lots of traditional on-premise software companies let their people sell both the legacy big-ticket software as well as the lower-priced subscription offering. You can guess which option was more popular with the sales team. In big companies, this is probably the most popular way to kill a nascent subscription service that we’ve seen. And even if you had a captive sales team selling just your new offering (congrats to you!), you’ll want to keep that group small at first.

There is a moment in the life of every early-stage subscription business when they have to face down a potentially lethal churn rate. Early on at Salesforce, we had a quarter where we lost more subscribers than we acquired. That was tough. We had the same experience at Zuora. Back in the Qwikster days, Netflix had a quarter where its total subscribers decreased. Everyone goes through it. As opposed to the “WTF Moment,” the technical term for this situation is the “Oh Shit Moment.”

How can you tell if you’re running a successful subscription service? It’s pretty simple—you’ve tamed your churn rate. That marks the transition from adolescence to adulthood, from having a cool new service that people potentially might like to running a mature, successful business. Churn can be countered in part by contract commitments, but lots of subscription companies these days let you opt out whenever you want—that’s part of the appeal of their service. No contract length, however, will ever outweigh an utterly maniacal focus on keeping customers happily surprised on a regular basis.

If you find yourself flat or sinking, that’s an all-hands-on-deck situation.

To scale a sales team intelligently, you need to do two things—you need to set up a hybrid sales model, and you need to invest in automation. What do I mean by a hybrid sales model? Well, lots of companies see a self-service sales model and selling through salespeople (commonly called “assisted sales”) as two completely different worlds. Self-service is for small businesses, but the really big deals are done through real sales reps, the thinking goes. Don’t cross the streams. Well, that’s nonsense.

Subscription businesses need to constantly be optimizing revenue through pricing. In our experience, we see this philosophy reflected by companies that, generally, update their pricing at least annually (which means that they’re thinking about pricing constantly throughout the year). Why do you do this? Because pricing is the key growth lever behind the other seven strategies I just discussed. I can’t stress this enough—your subscription service could be sitting on vast amounts of unrealized value, simply because it hasn’t taken the time to test the market with new pricing strategies.