Why Are Subscription Businesses Soo Sexy?
Once upon a time there was regular guy named Mike. Mike worked in marketing. He didn't have an MBA or fancy degree. But he had an idea: send people fairly priced razors every month so they do not have to go out and buy them. Sounds like a simple idea, right? Would you say that sending people razors each month is a billion dollar idea? Probably not.
Well, you would be wrong.
Dollar Shave Club was acquired after four years for $1 billion in cash by Unilever.
Wow! That is a lot of money for cheap razors, isn't it? How does this even make sense?
Let's look at the numbers:
- Revenue at time of acquisition: estimated $200 million
- Subscribers: 1.1 million
- Average revenue per subscriber per month: $15.15
Without being an expert in the e-commerce razor market, it seems like a lot of revenue growth over four years for a pretty inexpensive product. The number of subscribers does not necessarily seem like a lot...but what do I know? The revenue per month per subscriber...hmmm, pretty meh. Right? 15 bucks?
So what is happening here?
Dollar Shave Club, like all successful subscription businesses, thrived by keeping their customers happy. Once you get a customer you want to keep them for as long as possible. That is it.
They were not innovative in what they were selling or how they were selling it.
I mean they are selling razors.
Razors are basically a commodity and selling stuff by mail has been around since the Sears catalog came out in the late 1800’s. What is the one main difference between selling in the Sears catalog and Dollar Shave Club? It’s the subscription part.
Dollar Shave club signs up customers to get a monthly razor subscription. Once the customer signs up, they automatically receive their monthly package of razors and shaving related goodies. Dollar Shave Club gets recurring revenue.
Of course, a lot of their success is attributed to their great marketing and building their brand. That was the hard part: they had to build a brand. The result of their hard work is predictable recurring revenue. That is why Dollar Shave Club was worth so much. (Among other things, for Unilever the data and this type of business was also so valuable, it is an easy fit in their portfolio, etc. But you get it.)
What Is A Subscription Business Anyway?
A subscription business in one that sells a product or access to a service that is related to time. The customer gets something each month, for example, and the company keeps charging the customer. This isn’t a new concept and you have probably even had a subscription to something in the past: a magazine, newspaper, wine club of the month, etc.
Nowadays, though, you see subscription businesses popping like crazy. Some of the most popular types of subscriptions are:
Membership sites - These can include magazines, specialty groups or educational sites. Here the customer pays for access the site for a certain amount of time. Examples include: Mixergy and The New York Times online.
Software and Other Technologies as a Service - It used to be that you would have to buy Office and download it to your computer. Now, Office is offered a Software as a Service (SaaS) and you pay an annual fee to use it on your computers. Examples include: Microsoft Office 365 and Dropbox (Infrastructure as a Service IaaS).
Other Services - These enable you access to a service for a certain amount of time. Examples include: Fancy Hands and your local gym.
Are all service businesses made equal? No. Some of these service businesses aren’t going to do well for whatever reason. Why do razors seem to work? It is something that people need to buy every month. Do people want to / need to receive dog toys and treats every month? I’m not sure.
What Are the Keys to a Successful Subscription Business?
In theory the keys to a successful subscription business are pretty simple:
1 - Build a solid product or service offering.
Like we saw with Dollar Shave Club, their actual product, razors, is not really special. In fact, it is not even defensible. A competitor could easily come in and sell razors at a better price or quality or whatever. What Dollar Shave Club built was brand loyalty. That is what you need to create a solid offering: something that is better than the rest and cannot be easily copied.
2 - Maintain a loyal customer base.
No matter what business you are in you probably want loyal customers. But subscription businesses need customers to stay for a long time or the business model just doesn’t work.
Check out this table under Subscriber Lifetime Value (LTV). Look at line B. Monthly Churn percent line and D. Lifetime Value. In this example if your customer is paying $9.99 per month and 1% of your customers leave you, then the total amount you can expect to get from one customer is $500. If 2% leave you each month, then you will earn $250. That is a huge difference!
The keys to managing any successful business are testing, measuring and adjusting. For a subscription business it is no different. Here your metrics are:
Monthly Recurring Revenue (MRR) - This is the total amount of booked revenue per month. Notice I said “booked” not received, projected, GAAP or anything else. Booked is revenue that you will earn because you have entered into an agreement with the customer for a future period of time. So if you have 10 customers with a year contract paying you $100 per month, your MRR is $1,000. The great thing about MRR is that it builds. So if you sign up two more customers for next month, your MRR goes to $1,200. MRR does not include any one time fees, so make sure you do not count those in your MRR calculations.
Lifetime Value (LTV) - This metric answers the question: How much money is one customer worth to me over the lifetime of our business relationship? In the beginning, you will not be able to get an accurate LTV because you do not have enough history. But over time you will be able to see a trend. You always want to find a way to make the LTV higher. You will use the LTV to know how much you can spend to acquire a customer.
Customer Acquisition Cost (CAC) - How much does it cost me to get one customer? There are a few different ways that this is calculated but essentially you are adding up all of your marketing and sales costs, including salaries and overhead for marketing and sales people and expenses, and then dividing that by the number of new customers. This will show you how much it costs to get one customer.
Churn - Usually expressed as a percent, here you are measuring how many customers are leaving you. Low churn is key to building a successful subscription business.
Why Is It So Hard To Build A Successful Subscription Business?
1 - The beginning will probably suck.
Successful subscription businesses are based on acquiring and maintaining customers for as long as possible. The value you will get is from having a lot of customers that stay with you for a long time. In the beginning you will have to work hard to acquire those customers AND keep them happy. And until you get good at those two things down, you will get frustrated and tired. Remember, subscription businesses are about the long term value. Keep your eye on the prize.
2 - Customer retention is harder than you think.
You might think that your product or service is really great and once someone signs up they will never want to leave. But the truth is that there are tons of companies that offer something similar to you, an alternative, or what you have just isn't a must have. Sorry to be the one to tell you this.
Keeping customers is like any other relationship. You need to work at it. Yes, you may have some customers that stay for a long time because you have them on auto renew and their credit card gets charged and then they are stuck with another year, eh hem GoDaddy, but for the rest of your customers you will need to continue to win them over and prove why they should not leave you.
I am a big fan of Mixergy, a membership site with exclusive interviews and master classes from entrepreneurs and business people. If Mixergy stopped posting new interviews and master classes, I wouldn’t have much reason to keep paying for the service. Make sense?
And your business probably won’t be like Microsoft Office, if you need Excel there is really no alternative. Sorry Google Sheets, but you are cumbersome, slow and just don’t work for building large spreadsheets. Although the Microsoft Office monopoly still reigns, it is losing ground.
3 - Upfront investment can be significant.
The upfront investment may be time or time and money. But no matter what if the barriers to entry for a successful subscription business were really low, than everyone would have their own.
In the beginning you need to build. A lot. For Mixergy, do you think they started with one interview behind a paywall and got tons of customers? I don’t know how they started but I’m sure it wasn’t like that. They had to build an audience. And you need to build a customer base. If you are building software, your job is doubly hard: first you have to build the software, then get customers, then improve the software, get more customers, etc. It is a long cycle so be sure you are ready for the commitment.
So why are subscription businesses soo sexy? Because once you have overcome the initial hurdle of building a product or service and have gained a customer base, the revenue upside is almost infinite.