The Secret To Long-Term Consumer-Tech Success: Subscription Pricing
Recently Warner Bros. made front-page news with its decision to release all its 2021 movies to theaters and online streaming service HBO Max simultaneously. One sentence from a Wall Street Journal article on this development caught my eye: “The decision follows recent similar moves by other studios and cements a new reality in Hollywood: Subscriptions are more important than box office.”
I couldn’t agree more. As an investor in online consumer companies, I’d go further and argue that most consumer businesses should seriously consider migrating to a subscription-based business model if possible.
Subscription-based consumer businesses like Amazon Prime, Peloton and Netflix are redefining the customer experience and unlocking tremendous financial benefits. Not only is cash flow more predictable at subscription companies, but our proprietary data shows that customer lifetime value (LTV) increases three times when a company switches to a subscription model. Amazon Prime customers spend much more than their nonPrime counterparts, and both parties win: The consumer gets a better experience, while Amazon captures more wallet share. This virtuous cycle can crush the competition.
Founders need to look hard for opportunities in their business. If your industry has historically been transactional (such as retail and entertainment), what subscription offering can you deliver that will give you the Netflix and Amazon advantage in your category?
Making The Switch
Not all transactional businesses can go subscription. But more are trying and succeeding in shifting consumers to a new model. Recent examples include Urban Outfitters, which introduced a subscription clothing business called Nuuly, and DoorDash with its monthly DashPass service.
Similarly, dog-walking service Wag, one of our portfolio companies, released a monthly offering, which bundles pet services including walking, sitting, boarding, training and unlimited vet telehealth.
Many consumer businesses are arriving at the same conclusion: A subscription pricing model aligns incentives between the company and its customers. When a customer subscribes, they are “locking in” to that platform. In return, the platform can reward that customer with exceptional service while generating greater profits over time.
And it’s not just companies offering subscriptions. Newsletter service Substack and communications app Marco Polo (another of our portfolio companies) provide a platform for individuals (e.g., teachers, consultants, coaches, therapists, etc.) to build their own mini-subscription businesses.
What Is The Payback?
Switching to a subscription model of any kind is smart, but when you switch, you should go annual immediately. Why? Economics. Customer LTV and customer retention rates are both a lot better for annual subscribers versus monthly, and both eclipse the average transactional customer.
Even experienced founders are biased toward monthly subscriptions — but the economics for annual are very convincing. Based on our research, month-12 customer retention rates are three times better for annual subscribers (roughly 50%-60%) versus monthly (15%-20%).
Here are four things entrepreneurs should consider when introducing a new subscription model:
1. What Do Your Customers Already Buy Regularly?
Build your subscription model around regularly purchased items, and create the feel of a discount for multiple purchases or another added benefit (such as a free gift each month). Be creative: High-frequency consumables such as razors, personal care items and medicine are the most obvious repeat purchases, but the recent popularity of clothing subscription services demonstrates that many consumers are willing to “rent” items that previous generations would have purchased. Every company’s best path will be different. Some subscription models are designed around maximizing convenience. Others add an element of surprise by shipping an assortment of items curated for the customer.
2. What Do Your Highest-Value Customers Tend To Purchase?
Dig into your customer data. How can your subscription model nudge lower-value customers to behave like higher-value customers? Can you convert the customer who buys the occasional nail polish into a regular buyer of higher-ticket items? Building a subscription model that mixes high- and low-ticket items might nudge those customers into becoming subscribers.
Don’t just look at items purchased, either. Think about what your high-value customers crave: Do they want personalized advice? Exclusive experiences? A dedicated customer service representative? An air of exclusivity or VIP treatment can engender the kind of loyalty that turns buyers into subscribers and monthly subscribers into annual subscribers.
3. Can You Use A Premium Product As A Subscription ‘Hook’?
Before Peloton, you’d buy an exercise bike, and that was it. But Peloton recognized that the initial purchase could be a gateway to a better product experience: premium content and exclusive community layered on top of the bike, increasing customer retention, Net Promoter Score and revenue. Amazon Prime did the same thing: By pioneering free shipping on everything, Amazon removed a key friction point for transactions and captured huge market share.
Ask yourself: What’s an experience you can layer around your core transaction that customers will pay extra for? My hunch is it will be worth it for you in the long run.
4. Test, Test and Test Again
High-frequency, quick-feedback-loop testing is crucial for any consumer offering — and for consumer subscriptions. Roll subscriptions out slowly, testing different options and price points. See how it impacts conversion, and watch engagement and retention like a hawk. Also, pay attention to the subscription on-ramp. Should you offer the full subscription service for a fixed time with a forced conversion to pay or a free limited version to whet the appetite? Do you ask for the credit card upfront, or do you wait until the customer has tried out the service? Netflix, Disney, Peloton and Github have tested various approaches and come to a wide range of conclusions so make sure you are constantly evaluating options to see what works best for you.