Early in my career I learned the benefits of building a recurring revenue stream. The importance of customer retention, free trial offers and tiered packages designed to provide tailored options for different types of customers.
My first experience with subscription pricing was Delphi — an online service that competed directly with America Online, Prodigy and CompServe. We had very successful co-marketing programs with magazines, radio stations and manufacturers peripherals. AOL used an extremely aggressive marketing approach by sending free CDs along with almost every magazine and computer (referred to by some as “carpet bombing”). Here’s a post from Quora by Steve Case about the economics of their promotions:
The answer to the question “how much did it cost AOL?” was over $300 million. As Steve points out, the all-out effort to acquire customers through free trial paid off for AOL as it became the most successful online service and eventually acquired Time Warner (the fiasco that happened after that is another story).
Of course, there are now thousands of sites built on MRR — or monthly recurring revenue. Netflix, Dropbox, Google Apps, GoDaddy, all have compelling economics of subscription-based services.
More recently there’s been a growing trend towards “subscription-based things”. Some new companies have recognized that there are products that we use consistently that can be packaged and delivered more economically by subscription rather than one-off purchases at the store. The best example of this is Dollar Shave Club which offers discounted razor blades by subscription. For the customer, it’s more convenient and more cost effective than paying the exorbitant prices for name-brand blades at the store. They company launch with a brilliantly fun and informative video. The video now has more than 8.5 million views and has driven strong demand for their service. It’s a great example of viral marketing and tongue-and-cheek humor (and a fantastic way to drive traffic to their site).
It’s rare to be this lucky with marketing, but with a subscription-based service it’s exceptionally valuable.
Let’s use Dollar Shave Club as an example subscription-based economics:
Assume that .5% (.005) of the people who viewed the video either signed up or caused someone to sign up. That’s 42,500 subscribers at an average of $6 per month or $255,000 per month. That’s a run-rate of over $3 million for the first year. That may not seem like a ton of money, but when you look at this as an annuity, it’s really impressive. Not all of these customers will stick with the services. Some will cancel each month. This is the attrition rate or “churn”. For this illustration, let’s assume that 33% of these initial subscribers cancel per year. Of course, the cancelations would take place over time, not in big chunks each year, but for the simplicity of illustration assume that cancellations are yearly. Here’s how the numbers look:
You can see with attrition at 33% per year, the total revenue over the next six years is about $8.5 million. If retention programs help reduce churn to 25% per year, it increases revenue over the six year period by $1.6 million.
These numbers can also be tweaked up by cross-selling new products or service. For example, Dollar Shave Club could offer toothpaste, toothbrushes and dental floss as one upgrade for another $6 per month. With this type of complementary offering they could significantly increase their revenue per subscriber.
One other interesting thing to note, is the math of attrition. In the chart above, I’ve chosen to extend the time horizon 6 years. The reality is the chart can extend an infinite period of time if attrition stayed exactly the same. There are some business that acquired subscribers years ago who continue to enjoy significant revenue without any marketing expense. That’s the beauty of annuity: it just keeps going and going.