As the Internet continues to mature, so too do business models delivered over the Internet. The past two decades have seen an explosion of businesses delivering content and services online in a variety of ways. In the past ten years, a trend has developed for businesses to provide their products and services on a subscription basis. There are a lot of reasons both businesses and customers are drawn to the subscription model.
- The price per month is generally low. Customers are comfortable with the lower-risk price point, especially when they can cancel at any time. The business likes this because it increases the number of subscribers. A sufficiently low price also means customers tend to subscribe longer.
- More stable and recurring revenue stream. Businesses can more easily forecast revenues on a monthly and annual basis by calculating anaverage subscription price, current number of subscribers, average new subscribers per month, and average subscription cancellations per month. This helps smooth cash flow and allows the business to make long-range plans based on their expected future cash position.
- Fresh content. Businesses tend to keep the content fresh and features relevant to entice new subscribers to join, and existing subscribers to stay. This keeps customers interested, and helps maintain the value proposition.
- Offloading IT and hosting infrastructure requirements to a third party to reduce the risks or costs a customer would otherwise have to incur to use a product managed internally.
Whether brick-and-mortar or ecommerce, the traditional transaction process between business and customer once followed consistent linear steps:
1. Businesses offers a product for sale;
2. Customer indicates desire to purchase;
3. Business ships the product to the customer;
4. Customer pays business for the product.
As I discussed in my Revenue Recognition post, the subscription business model fundamentally changes the nature of the interaction between the business and the customer. This has implications not just for the company's revenue model and accounting requirements, but also for the ongoing nature of how the company will need to interact with the customer as the service is provided over time.
Here are six areas in which a subscription business model introduces challenges — and opportunities — for a business to engage successfully with their customer base and increase their revenues.
In the traditional ecommerce world, receiving an order triggers a fulfillment process (pick, pack, ship). A customer may come back to your site to check the status of their order, but the transaction is otherwise complete.
When the customer purchases a subscription, the "fulfillment" starts when the company sets up the customer's account so they have access to the subscribed to service, and continues over time until the subscription ends. With online software or access to a website portal, this can often be an automated process. If your company has not already automated the account provisioning process, beware — many customers have an expectation of instant or near-instance access. Waiting days, or even hours, can be a harmful way to start this relationship.
Canceling a subscription
Unlike canceling an order for widgets, subscription cancellations can get tricky for a number of reasons:
- Do we provide the customer a refund?
- If so, do we refund the full amount? Or only a prorated amount based on how many days they have used the service?
- If the subscription allowed them to download files or products, do they continue to have access to that media? Or does their access end with their subscription?
- What are the accounting impacts in the back-office, especially if the revenue has been partly or fully recognized?
Average subscription duration is one of the key metrics in analyzing profitability of subscription revenue. Making it easy for customers to cancel though online self-service portals can be an enticing reason for the customer to sign up: If they know it's easy to cancel, the perceived risk is lower, and it becomes easier to attract new subscribers. However, the tradeoff is that an easier path to walk away often decreases the average lifetime value of subscribers. There's a balance every business must strike between increasing and protecting subscription revenue and making the customer feel "trapped" into their subscription.
Offering separate subscription modules
Offering multiple modules, features, or services to which a customer can subscribe can offer great benefits to both the customer and the business:
- Businesses will benefit from additional opportunities for revenue with a "land and expand" approach. Customers will often be enticed to purchase access to one service, and if their experience is good they are likely to expand their subscription to include additional services.
- Segmenting the offerings can allow the development teams to focus their efforts on specifically tailored offerings. Rather than releasing few iterations on monolithic applications, companies and dev teams can roll out incremental updates to focused service offerings.
Customers receive several benefits from this model as well:
- Customers often enjoy the "a la carte" model, as they don't feel they're being charged for features they aren't using, and the individual features are often less money when taken individually.
- The risk of trying out a new service is again low, reducing the barrier to entry. This gives the business another mechanism for attracting new subscribers.
However, this approach can introduce complications from a customer account and subscription management standpoint, such as:
Let's assume each "module" is purchased with an annual subscription, and each costs $100 per year.
- If I subscribe to module 1 on January 1, my subscription ends on December 31. What happens if I subscribe to module 2 on March 1? It should lapse on February 28. (But what about in a leap year?) But from a subscription management standpoint customers often want to co-terminate, or "co-term," their subscriptions so that all of their renewals happen on the same day.
- Do we give customers the option to co-term or not?
- If we do, how do we pro-rate the $100 subscription fee for Module 2? Per day? Based on the value?
Often this issue will be solved by "contract management" software. This introduces the notion of a "contract" the customer agrees to in purchasing the first module, and this contract has a start and end date in line with that module. Any services added to or removed from the contract over the duration of that time are simply treated as additions or removals, rather than entirely standalone purchases. The data gets more complicated to manage, but the visibility for the customer — and the analytics for the business — become much more powerful.
This issue is a small nuance of the billing logistics involved in subscription management, but is very often overlooked. Assume your company offers a monthly subscription, and the customer is billed on the same day of the month.
For example: If the customer signs up on January 15, they will be billed on February 15, March 15, etc..
How will the company bill the customer if they sign up on March 31? They can't be billed on April 31 because that day does not exist. Even if they sign up on January 29, we cannot necessarily bill them the next month, unless we happen to be in a leap year. For any number of reasons, the billing method your company chooses for recurring subscriptions needs to be well thought out, and consider the following points:
- Companies vary in the approach they take to solve these problems
- Introduce fixed days of the month on which billing occurs
- Push everyone's billing date up to the 1st or back to the 28th if they fall on a problematic day
- Let the customer pick their desired billing date, but do not offer the 29th, 30th, or 31st as options
All of these options have benefits and risks depending on the overall structure of your subscription model and how you allow your customers to manage their subscriptions.
When renewal time comes, the easiest way to ensure the company gets paid is to bill the customer's credit card. This is a great way to shorten the order to cash cycle by eliminating invoicing and waiting for customers to pay. It's also a way to retain customers by avoiding the question, "Do you still want this service?" However, automated renewals come with some caveats that a business should be aware of:
- Secure storage of credit card information: Do not run afoul of PCI compliance. Storage of credit card data for future charges has to adhere to strict rules, and failure to do so can open your company to painful penalties, not to mention loss of customer trust (and their business). There are a number of options to manage this including standalone services, merchant account services, and ERP systems with integrated capabilities.
- Customer relationship: While automated renewals are great for the business, they can sometimes irritate customers. If your company plans to automate renewals, consider a series of notifications leading up to the renewal (i.e., 14 day, 7 day, day of). Proactively communicate with your subscribers so they aren't caught off guard by the charge.
- If your company offers the multiple subscription packages model, and has co-termination dates, make sure the customer is charged for the right amounts, and that the new subscription duration for all modules is timed properly.
Tracking expenses and revenue in the correct period
This element of a subscription business is almost entirely a back-office consideration, but is important nevertheless. Just as my Revenue Recognition post discussed the importance of only recognizing the revenue as it has been earned, businesses should be cognizant to only recognize expenses as they are incurred. Two examples include:
- Cost of Sales: Certain cost of sales expenses can be amortized over the duration of the subscription, just like the revenue is recognized as the services are delivered. Imagine a customer that requires multiple lunches, demos, and incentives to close the deal. These expenses may be available to amortize, depending on how they are categorized.
Commissions: When a sales rep is involved in the sale, it may not make sense to book all commission liabilities in the period the sale closes. Instead, some companies will "smooth out" their commission expenses over the duration of the subscription. This can have an additional benefit: Because the sales rep compensation is tied to the subscription lifecycle, it incentivizes sales reps and account managers to ensure customers remain happy with the service.