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

by Tien Tzuo

At Graze we didn’t spend a dime on market research when we launched in the US. We just took our existing product line and dumped it on the US market, because the system adjusts itself.”

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.

We all know how committed Netflix is to user data. It looks at millions of customer touch points (or “plays”) a day, including when you pause, rewind, and fast forward, as well as user ratings, searches, geolocation data, viewing times, device information, and social media feedback. If you play one title, then what did you play before, or after? What did you quit watching after five minutes? It also tags every single show on its platform with more than a hundred different designations, including things like violence levels, geographic settings, what time of year the story is occurring, and even what kinds of jobs the characters have.

Once you establish a secure identity with a customer that includes things like purchase activity, payment information, perhaps some demographic details, or maybe some location alerts, then you can do amazing things.

deliver on a basic aspiration: to deliver technology that enhances the human connection.”

today you communicate your brand through experiences, not ads. The best sales pitch for Netflix is binge-watching a great Netflix show.

You’ve been paying big bucks to get demographic information from things like Acxiom, BlueKai, Experian. Heck, last year companies spent more than $10 billion on this stuff in the US alone. But in the Subscription Economy, your engineers and product developers have already taken care of this—they’ve given every one of your customers a subscriber ID and tracked every transaction and process back to those individual subscriber IDs.

But what happens when that first P—Product—gets turned into an S? You can no longer look at the other three P’s the same way.

Autodesk didn’t cut out the resellers—in fact, they doubled down on their commitment to them. They used the newfound knowledge of their subscribers to make the channel even more successful, in a way that individual resellers couldn’t do themselves.

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.

First, there is consumption-driven growth, which simply means your subscriber is using more of the same base set of capabilities.

Second, there is capability-driven growth, which lets your subscribers grow into your service by adding more features as their needs expand.

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.

Ideally you’ll take advantage of both levers, pricing and packaging, because what they essentially represent is increased adoption (consumption-driven) and service innovation (capability-driven).

Because in the Subscription Economy, there’s no more looking elsewhere for answers. No more customer surveys, no more paying for lists, no more waiting six months for a campaign to finish. All the information you need is right there in front of you. Now it’s up to you to write the story.

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.

ACQUIRE YOUR INITIAL SET OF CUSTOMERS

REDUCE YOUR CHURN RATE

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?

EXPAND YOUR SALES TEAM

INCREASE VALUE THROUGH UPSELLS AND CROSS-SELLS

recent report by McKinsey & Company, subscription companies (with revenue in the $25 to $75 million range) that had the lowest churn were those that cross-sold multiple services to about one third of their customers. The takeaway is pretty clear: the ability to solve for a broad range of customer problems, with a broad range of solutions, increases retention.

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.

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.

Your marketing team needs to be able to come up with bundles that make sense. Your sales team needs to be able to offer these new options when they’re appropriate—giving a subscriber a nudge when they’re about to hit a data limit, for example. And your finance team needs to be able to handle the downstream impacts. You also need to be able to measure whether they’re successful or not.

By diversifying its service line and focusing on cross-selling to its devoted base, New Relic not only is increasing earnings per customer and thus overall revenue, but is also poised to grab a larger market share of the global IT management tools market.

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. Note, however, that unlike self-service routes, enterprise adoption usually begins with a lengthy sales cycle that involves reps, buyers, requests for proposals, and lots of due diligence and negotiating (otherwise known as “haggling”!). But having that process begin with people within an organization who are already using your service is clearly a huge advantage (here Slack also comes to mind).

GO INTERNATIONAL 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.

to go international, you need to consider three issues: First, the regulatory stuff—business licenses, taxes, data residency requirements. Second, the payments stuff—alternative payment gateways, local currencies, credit cards. Chinese prefer e-wallets, Indians prefer debit cards, South Koreans are more likely to charge smartphone purchases directly to their phone bill, etc. Third, the shop itself—HR, staffing, etc.

The key is to realize that if you are selling in an English-speaking country, you are selling to all English-speaking countries.

MAXIMIZE THE GROWTH OPPORTUNITIES OF YOUR ACQUISITIONS

Successful acquisitions can help a growing subscription business increase its market visibility and market share while enhancing its offerings to build out a more comprehensive solution. You need an integration plan.

OPTIMIZE YOUR PRICING AND PACKAGING

pricing is the key growth lever behind the other seven strategies I just discussed.

The key to Invoca’s success is that all of those price triggers match customer requirements and demonstrate value.

As you grow, you’ll probably be addressing at least two or three of them at any one time.

First, the traditional income statement does not differentiate between recurring and nonrecurring dollars. It’s like saying there’s no difference between a dollar and a dollar that keeps happening every year for the next ten years.

Second, sales and marketing is matched to past goods sold. It’s essentially a sunk cost.

And finally, this is a backward-looking picture—it’s all about money already earned, expenses already paid, actions already taken. Subscription businesses are all about forward visibility: how much money I know I can count on over the next twelve months, so I can account, plan, and spend accordingly.

Here’s the key takeaway—it is perfectly rational for subscription businesses to spend all their profits on growth, as long as their bucket doesn’t leak. Remember, as long as you are growing your ARR faster than your recurring expenses, you can step on the gas. As Ben Thompson of Stratechery notes, “You’re not so much selling a product as you are creating annuities with a lifetime value that far exceeds whatever you paid to acquire them.”

Now why is this chart so important? Because this is how Tyler guides our whole company on how to be a great business. We’ve seen how the financial model behind all these subscription businesses can be so powerful. It’s why Box, despite all the hand-wringing by analysts during its IPO about its profitability, has seen its revenues grow by more than 100 percent since the IPO. This is the opportunity that publishing CFO was missing out on—the

First, we use it to manage our recurring expenses. In other words, we use it to budget.

Second, we use it to manage the trade-off between recurring expenses and growth expenses.

if you can demonstrate that you know exactly what your return on growth spend will be, you can tell your CTO that instead of hiring five new engineers this year, she’ll be able to hire twenty new engineers next year. We’ve frequently made that offer to our department leaders—if you can stay lean for three quarters, for example, the dividends we generate from our business model will be worth it. This is also why recurring profit margins are so important for subscription businesses in terms of their ability to grow.

Third, we use this chart to govern our sales and marketing spend with a concept called the Growth Efficiency Index, or GEI.

at the end of the day, a business model is different from a budget. A budget is about handing out headcount and expense against assumed revenue. A business model is a mix of strategy, insight, and ideas that winds up as a quantitative but fluid framework—it both effects change and reacts to it.

Unfortunately, this data lives in different software silos. Bookings fall into CRM, billings and cash flow live in your General Ledger or ERP system, and revenue is too often calculated in a series of complex spreadsheets. Good luck stringing all of that together.

IT is where you compete. It’s where you spin up new services, new experiences. It’s where you set up test beds and experiments. It’s where you iterate and scale. It’s where you find the freedom to grow. And more and more business systems are enabling this kind of freedom because they’re based on subscribers, not SKUs.

Everything feels fluid but also cohesive, informed as well as inspired. It’s that “digital transformation” experience that everyone is always talking about.