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

by Tien Tzuo

These car companies have spent decades crafting their vehicles and their brands, and as a result enjoy some forbidding advantages, but there is a red flag—if they don’t know their drivers by the time autonomy and access-based consumption roll around, they will lose out to a competitor.

the Big Three are currently in the midst of reimagining themselves as not just car manufacturers, but transportation solutions.

“We are seeing an evolution toward services rather than physical transactions,” Allison said at our conference. “There’s been a fragmentation of the customer experience. When you bought a car, or you leased a car, that was one interaction. Then as you went and needed service for your car, there’d be a different interaction at the dealership. And for all these years, the cars weren’t connected, so we really didn’t have a view of the journey that you’re on.” Allison is absolutely right about the fragmentation of the customer experience—most of the big auto manufacturers conceded the service aspect of their industry to thousands of dealerships and repair shops a long time ago. Today Ford is actively trying to remedy that. As Allison noted, “FordPass is a portal to a seamless customer experience.” FordPass app users can warm up their cars in the driveway on cold mornings, find and reserve parking spots, schedule service appointments, find nearby gas stations, and make mobile payments. Henry Ford had a famous quote: “If I had asked people what they wanted, they would have said a faster horse.” Today Ford understands that it can’t solve for mobility just by selling more cars.

The result is Surf Air, which is often called the “Netflix of Aviation” or the “Uber of the Skies.” Its members get access to limitless flights for a flat monthly fee—right now they’re in the western United States and Europe, and growing rapidly.

This is another classic example of building a successful business by starting with the customer’s wants and needs, attacking pain points with a machete in order to surface the best outcome, and growing a loyal subscriber base in the process.

“From a business perspective, we all know that airlines have struggled for years,” says Mac Kern, former vice president of commercial planning at Surf Air. “It’s a very capital intensive business, not to mention commodity-based. Prices get driven downward. It’s very competitive. The subscription model gives us predictive revenue—that’s something that no commercial carriers have. They don’t know if a flight is going to be profitable until the door on the airplane closes (and they still have to fly at that point!). Because of subscriptions, we know exactly how much revenue we’re going to generate at the beginning of every month. So we can scale our operation effectively, because we know exactly how much flying we’re able to execute. That kind of insight is basically magic in the aviation industry. No one has been able to do that before.”

Today there are airline companies, telecoms, streaming music services, and newspaper publishers all asking the same kinds of questions: What’s the value of this new service (or route) to our subscriber base? Is it receiving the kind of support that we predicted it would? How long are our members staying with us? What does our growth efficiency look like? What do our usage patterns tell us about where to apply more resources? Who might be at risk of churning?

Trains, bike shares, subways, shuttles, and car services are all locked in horizontal competition, but smart partnerships and platforms will help commuters carry their identity across all these networks seamlessly and intuitively.

In November 2011, Adobe’s CFO, Mark Garrett, told dozens of Wall Street analysts that he was going to try as hard as he could to make his company’s revenue earnings fall as quickly as possible. It was an understandably tense call. Adobe was going to stop selling its enormously profitable Creative Suite software in boxes and move to a digital subscription model: “The faster earnings fall, the better off we are as a company and the better off you are as investors, because millions of people paying us every single month is very compelling from a revenue perspective.” The overall revenue wasn’t going away, it was simply being pushed out into the future, and Garrett’s team took great pains explaining why and how they planned to accomplish that transition.

Gartner predicts that by 2020, more than 80 percent of software providers will have shifted to subscription-based business models. As a recent Deloitte paper notes, the big technology firms simply can’t afford not to offer subscription models: “As more and more customers demand more flexible payment models, the continued viability of many companies, and even entire industries, is being threatened. Those that fail to at least explore consumption-based offerings may end up on the path to obsolescence.”

IT buyers prefer opex to capex. Historically software companies have preferred capital expenditures (capex) for technology investments, as this afforded them the ability to take advantage of amortization and depreciation of the capital investments over a period of time. But as technology shifts to the cloud, there’s a complementary shift happening in favor of opex over capex. Operating expenses bear the advantage of a pay-as-you-go model for services used with comparatively little to no up-front investment. Not only is this a greater value prop, as a business is getting exactly what it pays for, but it’s also a strategy for freeing up cash to drive growth, and a way for large enterprises to be nimble rather than locked into expensive IT infrastructure that lacks flexibility and often serves as nothing more than a bottleneck for transformation.

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. A new management team at Cisco decided to go all-in on services, which by definition meant subscriptions. But how do you sell routers and switches on a subscription basis? By focusing on the data inside all that hardware—the freight, not the tracks. Cisco’s latest set of Catalyst hardware comes embedded with machine learning and an analytics software platform that helps companies solve huge inefficiencies by reducing network provisioning times, preventing security breaches, and minimizing operating expenses.

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. Its new cloud-based management services help mitigate the boom-and-bust effects of new product cycles. It doesn’t have to act like a retailer chasing after make-or-break holiday sales in order to make its annual number. 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.

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.

So what’s my company doing with Komatsu? The same thing we’re doing with Caterpillar—we’re helping them change the question from “How many trucks can I sell you?” to “How much dirt do you need moved?” By handling the subscription finances behind these services, we’re helping to power dirt removal as a service.

If the context of this book is the sweeping shift from products to services in retail, transportation, media, and technology, as well as the changes in business mindsets that this shift requires, then the industry that stands to benefit the most from that transformation is manufacturing. That may sound surprising.

IoT is the digitization of the physical world through sensors and connectivity. That may sound kind of jargony, but it’s accurate. When you digitize something, you convert it to data in the form of numerical digits, which allows it to detect, communicate, and respond to other digitized objects. Eventually, all the manufactured objects on the planet will be able to receive and transmit data. Analytic services based on all the data generated by these billions of connected objects will result in system efficiencies and business ideas worth trillions of dollars.

As industrial systems thinker Olivier Scalabre pointed out in a great 2016 TED talk, every sustained period of global economic growth over the last 150 years has been instigated by a manufacturing innovation—the steam train in the nineteenth century, the era of mass production at the start of the twentieth century, and the first wave of factory automation that began in the 1970s.

Lots of industrial machinery, of course, already has sensors, but right now the connectivity enabled by those sensors is the equivalent of trying to communicate with two tin cans and a piece of string. A typical oil rig, for instance, has thirty thousand sensors, but usually only 1 percent of the information generated by those sensors is examined in any meaningful way because those sensors are fairly single-minded—they’re just trying to detect individual anomalies, not optimize the system as a whole or peer around corners to make predictions.

All this new connectivity and network intelligence means that more and more manufacturers are beginning at the end. What do I mean by that? These days the leaders in manufacturing are partnering with clients to come up with an optimal end state—a health care IT firm signs a contract with a hospital promising to reduce its patient readmittance rate by a certain percentage, for example, or SpaceX signs an agreement with NASA guaranteeing a particular cabin environment to transport lab rats to the International Space Station—and then compiles the technology and resources to make that outcome a reality. Hive, a UK-based home security company, starts with a statement like “Our customers never want to come home to a dark house” and then assembles the technology and services to make it happen. Service-level agreements are replacing bills of sale.

What these companies are realizing is that IoT enables them to view their products as whole systems, as opposed to individual units that are sold to strangers. And these systems constitute a core competitive advantage. They allow them to give their customers what they actually want—the outcome, not the product. The milk, not the cow.

Suddenly, buildings are starting to talk to each other. FloorInMotion from France delivers connected floors that monitor human traffic patterns in order to manage building energy usage,

Again, let’s head to Sweden for some more enlightened thinking around creative usage and pricing strategies. Based in Uppsala, Ngenic sells a smart thermostat, or an “extra brain used to heat up your house.” Ngenic offers three basic purchase plans: buy the thermostat outright, buy it for a lower price with a small monthly subscription, or buy it as part of a discounted bundle with an energy provider. More than half of Ngenic customers wind up saving more than 10 percent of their heating costs over the course of a year. The device monitors their home energy usage by taking into account variables like sunlight, occupancy, and (this is where it gets really interesting) favorable electricity rates. Unlike here in the United States, where you generally get assigned a single power utility, Sweden has an extraordinarily deregulated energy market. There are more than 120 electricity providers, and most customers have rate agreements that can change on an hourly basis relative to supply and demand. Ngenic’s physical asset is relatively inexpensive to manufacture and assemble. And thanks to all this rampant free market activity in supposedly socialist Sweden (most kilowatt-hours are bought and sold at least six times before reaching the end customer), electricity there is really cheap. So how does Ngenic create value? It sells to consumers to help them save energy and protect the environment. It partners with suppliers to add “green intelligence” and differentiation to their value ...

“When you think about it, the old model was pretty much insane,” Scalabre says. “Piling up stock. Making products travel around the world. The new model—producing right next to the consumer market—will be much better for our environment. In mature economies, productivity will be back home, creating more employment, more productivity, and more growth.”

I would argue that the only true competitive advantage is your relationship with and knowledge of your customers. Think about it—what’s the first thing your competitor does when you put out a new product? It buys that product on the open market and sends it to the R&D lab, which then proceeds to dismantle it, benchmark it, and reverse-engineer it in a thousand different ways. Your competitors can’t do that with the collective intelligence of your customer base. That’s something that you, and only you, can own. It’s an incredibly powerful advantage.

We’ve all seen the explosive growth of professional learning platforms like Lynda.com (now part of LinkedIn), Kaplan, Udemy, and dozens of online coding academies.

Utilities. The big electricity, gas, and water companies used to follow a pretty standard playbook: spend lots to build a giant utility plant, spend lots to transfer that utility across a very long distance, then charge lots in order to pay down your infrastructure debt. Today things are changing. As The Economist notes, “Not only are renewables playing a far bigger role; thanks to new technology, demand can also be tweaked to match supply, not the other way round.” New consumption-based digital services like SolarCity are enabling solar-powered homes to sell electricity back into the grid, for example, and home energy management systems like Nest are helping utilities lower their power consumption at peak times in order to avoid shortages. Lots of people aren’t getting electricity bills anymore—they’re getting electricity checks. Yes, utilities are some of the oldest subscription-based businesses around, but today they’re moving away from big, monodirectional channels to smaller, responsive networks (notice a recurring theme here?). Thanks to sensors and connectivity, the entire industry is starting to “wake up” and unlock all sorts of new value: French electricity provider ENGIE (which traces its roots to the company that built the Suez Canal) now has an app-based service that lets you book home service appointments; Schneider Electric (founded in 1836) partners with municipal districts not to sell them more power, but to help them reduce energy consumption by 35 percent...

here’s the through-line: subscriptions lead to growth. Once customers can get the outcome they want, without having to worry about owning the physical assets, that’s where the demand goes, and that’s where new revenue streams are created. Every sector on the planet has the same potential to latch on to the same kind of growth that the technology industry has recently enjoyed.

organizing your company around a specific product line—made sense when everything was about scale, consistency, and any color as long as it’s black. It let management have a direct line of sight into development cycles and sales performance and provided for clear team ownership accountability. But while this product-based approach had some benefits in terms of assessing core transactional issues, it came at a tremendous cost. It created a siloed organization that lacked any kind of coordinated vision. It fostered internal competition for customers. And it contributed to a myopic mindset that blindsided management to sudden changes in the marketplace. These companies were built backward—oriented around the products, instead of their customers.

A funny thing happens to software companies right after they launch their first SaaS offering.

All of a sudden, they can see what their customers are doing!

the original point of beta was to let you put a product out before it’s ready, gather up lots of feedback from your customers, and then incorporate that input before you finally freeze the product and ship

if you can get out of that mindset and think about what you’re making as a living, breathing experience instead of a static product, then why not enlist your customers as innovation partners all the time?

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.

The idea is to create an environment that supports sustainable development—the team should be able to maintain a constant pace of innovation indefinitely.

No more focus groups, phone surveys, or user interviews. Also, no more hoping and praying you get a hit product. Why? Because the market research is already baked into the service. The Graze team had their US distribution completely dialed in three or four months because they could see what their customers were doing. They could drop that factory anywhere in the world and it would immediately start listening, learning, and optimizing itself. When you design your service in conjunction with your subscribers, and inform that service with usage and behavioral data, you can make something that they really love and that evolves with their needs.

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. Most companies (especially ones here in Silicon Valley) have a pretty good grasp of the first two stories. They know what they’re selling, and who’s buying. They have nice scrolling websites filled with all sorts of product features and client case studies. But lots of them are missing a foundational thesis. A bigger reason to exist. They don’t have a why (much less a why now). And that’s the story you should really be starting with.

In a perfect world, these stories are actually heard in a sequence—the 100,000-foot-high business transformation story, followed by the marketplace story, and only then the product story. You want to create your version of an art gallery, where the goal is to walk the viewer through three rooms in sequence. Room One really isn’t about your company at all—it’s about the context of your company. It’s about what you see going on in the broader commercial world that makes you relevant. Once you’ve established the context, only then do you head into Room Two and articulate the value—the objective benefits based on roles and industries. That’s when you start drilling a little deeper in order to provide specific role-based advice, industry trends, and relevant case studies. And finally, Room Three is the product itself, like the golden idol at the end of the tunnel in Raiders of the Lost Ark. In other words, what your service really does—its features and mechanics.

pricing for a product SKU is pretty straightforward. Your production expenses and desired profit margins determine your price. In the product world, this is known as “cost plus” pricing. Let’s say you build a fidget spinner. You know your manufacturing and sales costs, so you set a profit margin on that fidget spinner. If you sell millions of fidget spinners, you get to discount them in order to undercut your closest fidget spinner competitor and make up the difference in volume. A fidget spinner monopoly is born. Subscription pricing is trickier. Of course you have costs that you need to account for, but at the end of the day you’re not pricing an object, you’re pricing an outcome. But how do you express the value in a seat, minute, box, event, you name it? And what do you do about the fact that customers may assign different values to the same outcome? This ambiguity is intrinsic to the subscription model, and it can be either empowering or paralyzing.

there are two basic ways to build those growth paths into your service. First, there is consumption-driven growth, which simply means your subscriber is using more of the same base set of capabilities. This is done through pricing. A client business adding more users or storing more data would be examples of consumption-driven growth.

you’ll need to look for holes in your model, which usually happen at extremes—someone’s using your service too much or too little in relation to your price point. This is where a minimum or base fee can help you set a floor, and a subsequent tiered model can help you reduce the per unit fees at volume.

pricing is never finished. Second, there is capability-driven growth, which lets your subscribers grow into your service by adding more features as their needs expand.

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.

After you get some initial traction, at some point your business will reach a state of subscription equilibrium, a steady state that occurs after your service has been out there in the market for a while, and you’ve got enough customers to start noticing some trends. At that point, depending on your churn rate, you could be growing, flat, or sinking. If you’re losing more customers than you’re taking in, then it doesn’t matter if you’ve got a great sales team. If you find yourself flat or sinking, that’s an all-hands-on-deck situation. Don’t panic, though. Everyone has to negotiate their own OS moment. But now’s the time to ask the hard questions: Are there customers you should not be pursuing (at least not right now)? Are there customers you should fire? What are the real features and usage patterns that really equate to customers finding ongoing value? Are your customers just kicking the tires but never really becoming true ongoing subscribers? Do they need a little push? Could your service be designed or packaged in a different way?

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.

Cross-selling also provides an impetus for innovation. Subscription companies that want the ability to cross-sell need to be continually adding new services, features, functionality, and offerings to entice customers to get more value out of the service. Your subscription service is an ongoing experience that can represent wildly disparate margins of financial value. The more you put into that service, the greater the yields. The real work starts after the sale. That’s why all these companies like Amazon and Netflix keep surprising us with cool new stuff. If you’re just managing expectations, instead of creating new opportunities, you’re not doing it right.

Box is a great example of a company that successfully moved upmarket. When it first started as a cloud storage and file-sharing company, its revenues through a sales team were less than 1 percent. In other words, it was pretty much a pure freemium service with almost all self-service sign-ups. Now, even though so many of Box’s customers are individual users, almost all of its revenue comes from businesses—with the vast majority of its revenue being produced through its sales team. Box CEO Aaron Levie summed up how this happened: “You make your service as easy as possible to adopt but you make it so a large enterprise can fully adopt it across their entire company.” According to Levie, “There’s probably not a single enterprise that we ever sold to that didn’t start with users in that organization having adopted Box.” When enough individual users within an organization have adopted a service, organizational adoption is the next logical step.

Companies typically wait too long to go international. It’s a legacy of old thinking. The old way is anchored on geographical and political boundaries. But the world is different now; it’s really based on language. The reason is pretty simple—the language you use to engage with the internet and your social graph dictates the kinds of results you’re going to receive. There are no customs checks when you visit an IP address in Europe.

According to business intelligence platform ProfitWell, the average amount of time a company spends per year on pricing is less than ten hours.