The Automatic Customer by John Warrillow

The Nine Subscription Business Models

The Membership Website Model (1)

If you have an expertise or passion, no matter how obscure, there may be people willing to pay for access to what you know. Subscribers get access to unique content, including articles, videos, webinars, and forum discussions on specialized topics.

Dream of Italy is a site of information to inform people who want exclusive information about Italy. None tourist trap restaurants, exclusive hotels and zones, etc.

This model works for people who have exclusive information or highly specialized information that changes overtime.

What do you know that nobody else does?

If you have developed an unique approach to running your business or have been able to achieve above-average profitability in a competitive industry, then other companies in your industry want to know how you did it.

Restaurantowner.com helps aspiring chefs create profitable restaurants.

Membergate is a software platform that allows you to set up a membership website.

In summary, the membership website establishes a commercial relationship with a subscriber. While it can be profitable most membership website operators use the subscription relationship as a platform to cross-sell additional things.

The membership website is for:
1. A highly defined niche market.
2. Access to steady flow of unique knowledge or expertise, insider information that is constantly changing and that subscribers need to stay in the know.
3. Another product or service you can sell to your subscribers.

The All You Can Eat Library Model (2)

The all you can eat library subscription model offers unlimited access to a warehouse of value. Like a library, you’ll never consume all the information available, but the breath of content that’s available promises to always have something you like. The business model is simple: the provider accumulates a wide selection of content, and the consumer rents access to it.

Acquiring Your Buffet

Like the membership website model, the best way to win subscribers for your all-you-can-eat library model is to invite them to share in content they care about – and then ask them to subscribe for more. The formula is: get unique visitors to your website by subscribing by email newsletter (or join a Facebook fan page, or Tweet, etc), the convert opt-ins to paying subscribers through sales funnels. The largest determination of where you will land on the conversion scale is how many subscriptions and products you offer. If you only have one paid subscription offer, you’ll likely be one the lower end of the scale, but if you have multiple products and subscription available. You can expect to convert more visitors into subscribers.

The all you can eat subscription model is for:
1. A libray of “evergreen” content – or the where withal to acquire one.
2. A legion of existing fans (blogs subscribers, Twitter followers, etc) who already consume your content.

The Private Club Model (3)

The private club model offers subscribers ongoing access to something rare. While it is mostly used with exclusive sports-club it is also used by businesses selling to other businesses. The perks of the private club mode is not only to access something rare – but to a chance to meet with a network of other people who made the cut.

Who Rather Than What?

Joe Polish create a club of $25.000 a year authors, entrepreneurs, and innovators would meet twice a year at his head quarters and once at an exclusive location to hear conferences and network with the other members. It has to have a limit to the numbers, that’s what makes it exclusive.

Could it work in your industry?

Instead of thinking it couldn’t work in your industry as yourself: “How could this model be applied to my industry?” and “What part of this model could be applied to my industry?”

 The private club model is for:
1. Something that’s in limited supply – almost always: a service or an experience – and on high demand among affluent consumers.
2. A market of achievement-oriented “strives”, who are always attracted to greener grass on the other side.

Front of the Line Model (4)

The front of the line subscription model involves selling priority access to a group of your customers. The model was popularized by the software industry but can be used by any company with customers willing to pay to jump the service queue.

Down the Front of the Line Subscription

When you adopt the front of the line subscription mode, you’re publicly declaring that all of your customers are not treated equally. This is done everyday when you prioritize your largest customer over your smallest customer.

With the front-of-the-line subscription model you’re being transparent about who gets served first, which in some ways is fairer than prioritizing some customers without telling them why.

To offer front of the line subscription you’ll need to think through how you plan to handle customers who pay for special service queue. You can use software like Zendesk or Desk.com, you can easily route your subscribers to the front of the queue. You can create a special call center for your subscribers.

The front of the line model is for:
1. A relative complex product or service.
2. Customers who are not overly price sensitive.
3. Customers for whom waiting in line can have catastrophic consequences.

Take into account:

1. This model can be used in conjunction with other subscription models to add and additional annuity stream of recurring revenue.
2. You already need to have a good reputation for baseline service.

The Consumables Model (5)

In the growing e-commerce category of subscription-based companies, these companies offer a product rather than a service on a subscription basis. Unlike software or service providers, subscription-based-e-commerce companies have the added complexity of acquiring a supply of whatever it is they sell and then dealing with the logistics headache of shipping the product to subscribers. It involves offering a subscription to a product that the customer needs to replenish on a regular basis. The value proposition is simple: life is too short to worry about mundane tasks, so subscribe and you’ll never run out.

The Everything Subscription

The biggest challenge facing customers subscription companies like Dollar Shave Club and Black Socks is how to differentiate their offerings from what big on-line retailers like Amazon and WalMart can offer. In this case subscription and price are not an value proposition.

Your Best Defense Branding

It’s possible for small businesses to succeed to the consumable subscribe model as long as you build brand equity and guard your supply chain.

Build an unique brand requires that your position meet two criteria: it needs to be important to customers and make you unique. You need something other than price and selection to compete against big players.

The consumable model works for:
1. Something to sell customers that naturally runs out.
2. Something to offer that’s annoying to replenish.
3. Invite customers to fall in love with your brand through experience you provide. Don’t compete on price, delivery or speed, choose something else for customers to pick you.
4. Make sure you have a steady flow of supply.

The Surprise Box Model (6)

The second form of subscription-based e-commerce that companies leverage is the surprise box model. This model involves shipping a curated package of goodies each month, and as the name suggest part of the fun is discovering the new set  of products each month.

Such boxes are usually built around a theme the subscriber is passionate about:

TrendHunter.com

The Curator

A big part of the value of these subscription companies provides is curation, which has become increasingly important as Google has made choice infinite. Today any product is a search away but there’s no guarantee you’re buying a good-quality product from a reputable supplier.

To make the surprise box model work, you need to find a large and varied network of manufacturing companies who are willing to give you a deep discount for one time order and who have the capacity to  subscribe.

The Trojan Horse of the surprise box model is that they’re trying to build their own e-commerce store that gets the subscriber to spend money on.

The blessing (and curse) of data

The data becomes both a blessing and a curse for companies with this model for when customers tell you what they want, they expect you to use that information to improve the subscriber experience. It gives you tons of valuable data, that you then have to figure out how to personalize for each of your subscribers.

When you layer in customers preferences and their physical location, the shipping complexity of these businesses can become daunting – so you need to be comfortable with logistics, or partner with someone who is, in order to succeed.

The surprise box model is for:
1. A passionate, clearly defined market of consumers.
2. A large and varied network of manufacturers that are willing to give you a deep discount for a one time order and have capacity to fulfill it.
3. The capacity to handle the logistics of shipping a physical product.
4. A desire to use subscription to establish Trojan-horse style, a large e-commerce site.

The Simplifier Model (7)

Technology is supposed to simplify our lives so why is it that the more applications and programs someone has on their phone the more overwhelmed they feel?

System Overload

Taken separately, no one system is too complex for the average person to master. It is the number of systems – along with our generally over-programmed lives – that cause our mental overload. When that happens we want to outsource scheduling, planning, and time management to our technologies. This is evidence by the meteoric rise of productivity apps designed to help us organize recurring tasks off your customers to-do-lists. Any company serving busy customers can benefit from offering a simplified subscription.

Your House or Subscription

H.O.M.E (Home Owneship Made Easy) is a subscription model that for a monthly fee will manage the routine tasks that pile up on a home owner’s to do list. Change light bulbs, make sure your fire alarm is working, the pipes are running, etc.

Up-selling and cross-selling subscribers

Like many subscription models, the frequency of customers contact inherent with monthly simplifier model subscription is great for up-selling and cross-selling subscribers.

Set-It and Forget-It

The simplifier model promises two things – not only with you take the to do list of your customers lives but you’ll remind him that the task must be done. The simplifier model works in many industries. The customer doesn’t need to remember to call; instead the company sets up an agreed upon contract of frequency and services needed per subscription.

The simplifier model is for:
1. A service that your customers need on an ongoing basis.
2. The ability to sell to a relatively affluent customers, buys customers.
3. A personal service business like pet grooming, massage, tutoring, window cleaning, carpet cleaning, book keeping, etc.
4. Discover your simplifier model by interviewing your customer. Have her describe a typical day and ask hr to how you a to do list. Ask yourself what you could offer to tick something off that list.
5. The value proposition is based on keeping a tight schedule to do the service.
6. Don’t put everything on the contract, just make sure that the extra services aren’t something that must be done regularly. You can add more services depending on the subscription.

The Network Model (8)

One of the defining characteristics of the network model is that, unlike the private club mode, the utility of the subscription increases as more people subscribe.

Think of the phone company, or WhatsApp for modern times.

User Marketing

One thing that makes the network model unique is that the users themselves have a vested interest in promoting the subscription because the more people who subscribe, the better it is for everyone.

If you’re going to rely on an army of customers advocate make sure your keep an eye on what they’re saying about your product before they drive away customers in droves for your bad service.

The network model is for:
1. A product or service whose utility improves the more users join in.
2. The network model works best when you offer a remarkable experience people feel compelled to share.
3. The more socially connected your customers, the faster your network will grow.

The Peace of Mind Model (9)

The peace of mind model offers insurance against something your customers hope they’ll never need. You are here to help your customers when they need your service, but otherwise you stay out of their way. You make money from charging more in subscription revenue than it costs you to deliver the service when called upon. Think insurance companies.

Would it work in your industry?

If you sell something people care about, you can consider the peace-of-mind model for your subscription business. One the challenges of guessing how frequently your customer will need your services. Underestimate and you’ll end up spending more than you collect in premiums. Overestimate significantly and you will be susceptible to competitors offering to insure your customer at a lower rate or having your customer opt to “self-insure”, which means they opt out to bypass insurance altogether.

The peace of mind works for:
1. Something that’s difficult, impossible or expensive to replace.
2. A business that allows you to absorb the cost of a claim by leveraging your existing assets rather than paying out cash.
3. A history of customer service calls that helps you predict the likelihood and frequency of claims.

The New Math

In a normal business model you measure your success of the business through the profits and losses model, measuring how much money you have left over after all expenses are made. In the subscription business the purchase is once and automatic. The revenue spreading over many subscribers and the length of the contract is made to last. A month, a year, number visits, etc. If you use P&L your business will look ugly.

The subscription business is built on your monthly recurring revenue (MRR), this is the recurring revenue listed on your company’s P&L every  month. When a customer subscribes to a membership website for $99/year, the company gets to recognize that the revenue on its P&L at the monthly rate of $8.25 ($99/12).

The next number to look at is lifetime value (LTV) of a subscriber. LTV is calculated by multiplying your MMR by the number of months the customer stays with you, less the cost of serving them during the life of the subscription.

Average stay: 30 months = 30 x $8.25/Costs of serving = $247.50

The next number you have to take into account is the customer acquisition cost (CAC). This is the amount you spend on sales and marketing to win a new subscriber.

$2.000 month/25 new subscribers = $2.000/25 = $80 CAC

Once you know how much a subscriber is worth to you and how much it’s worth to acquire one, you can estimate the viability and performance of your subscription business.

Lifetime value > 3X Customer Acquisition Cost (CAC)

$247.50 = 3.09

The Churn Rate is the rate at which customers quit subscribing. To calculate take your MRR at the beginning of the month and divide it by the amount of lost MRR at the end of the month.

Month 1st

1.000 sub. X $500/month = $500.000

Month 31st

932 sub. X $5.000/month = $491.000

MRR 18 x $500 = $9.000 so your churn rate is 1.8%.

Makes sure that you’re looking at your churn rate so that over the life of your subscriber they’re worth three times as much as it costs you to gain her .

The other number you have to take into account is the number that costs you to serve each new subscriber. In a subscription business is not just the cost of logistics but customer service, executive assigned to your customer, brick and mortar store if needed, etc. This process is called reducing your churning rate. Add the cost of on boarding and dividing it by every $100 of MRR.

Costs of goods sold  $17/$100 = 17% which means they make $83 in profit.
(COGS)

Hupspot 2011
Customer Acquisition Cost                              $6.025
Average MRR per customer                              $ 429
Monthly Churn Rate                                            3.5%
Margin                                                                       83%
LTV                                                                       $10.074

To calculate its LTV:CAC you take MRR x Margin and divide it by the churn rate.

$429 x 83% = $356.07 divided by 3.5% = $10.074

LVT:CAC = $10.074/$6.025 = 1.67

Matching Your Sales Channel to the Complexity of Your Offer

The most complex thing you’re going to have focus on is how to win thew news subscribers. The more complex your offer, the more you will need to rely on humans to sell it.

Most expensive to least:
1. Sales people fields: in which people have to visit in person the customer to gain to business.
2. Telesales: sales people who work remotely by contacting people over the phone or email.
3. Self-serve: subscribers don’t need to direct sales person to access in this system.

In order to stay afloat, thought, you’ll need cash.

CAC Payback Period

The CAC Payback Period measures how many months it takes you to make back the cost of acquiring a customer.

CAC Payback Period = Total Sales and Marketing Costs for the Month/New MRR Added for the Month

To put an example imagine you acquire one customer to paid you $100 per month. It if cost you $500 in sales and marketing expenses to win that $100 in MRR, then would have a CAC payback period of 5 months. But, you have to take into account the gross margin of your subscription.

Let’s say you make 70% gross profit after paying the expenses of on boarding and any hard costs associated with adding each new subscriber.

CAC Payback Period = Total Sales and Marketing Costs for the Month/New MRR Added x Gross Margin

You’ll need to spend heavy on branding and system up-front which you’ll need cash to fund. You’ll need to raise that money up front through three choices:

1. Cash source: Rob Peter or Pay Paul.
You can use cash from none-recurring sources of your business to build your subscription offering. You take the profits of your traditional business, and instead of putting them in your pocket you use it to invest on your business. It takes loner than raising the money from outside, but you get to keep control of your product and take your time building it.

 2. Outside money:
If you can prov that your LVT:CAC ratio is worth 3:1 at scale, and your market is large enough you’ll probably attract a mountain of investors for your business. The problem is you’ll give up a lot of control and equity in return for cash flow. The good side outside money is that such money comes from well connected people and smart hard won experience.

3. Charge Up Front:
In this model you get paid before you deliver the service. Instead of charging by the month, your company charges an entire year of subscription up front. In order to elevate this you must use the CUF:CAC (cash up front, the amount of money a customer pays when he sings up, and customer acquisition cost).

The Psychology of Selling a Subscription

 Selling subscription is different than selling a product for instead of a one-time purchase, you’re inviting the customer to enter a long term relationship with you. Each party looses a little bit of freedom. The subscriber looses the freedom of choice in exchange for what he hopes will be a better deal in a committed relationship.

The 7 Ways to Sell a Subscription Service

Idea #1: Think 10x vs 10%

Someone with subscription fatigue wont subscribe to save 10% on a product, but will subscribe if she makes/enjoys ten times the value of the alternative. The idea is to offer a “ridiculous” amount of value. Spotify allows customers to listen to millions of songs for the price of an album. You have to give your customers ten times the value they’re paying for the service. Think “ten times” whenever there is an easy way for your customer to get your product or service without committing to a subscription.

Idea #2: Appeal to Their Rational Side

The rational appeal is used mostly on the B2B subscription. Take H. BLOOM for example, who sell fresh flowers to hotels, by explaining the logistic nightmare of sending their product from the farmers garden to the final customer: hotels. They also take around 48 hours for the flowers to get the final destination. With this pitch, the company has made a rational case for the subscription.

Idea #3: Giving the Customer an Ultimatum

If given the choice, most customers would prefer to keep their freedom and buy your product on an as-needed basis. You need to make your subscription the only way to get your products. You can’t buy a disk of SalesForce, you can’t buy a single movie from Netflix, you can’t  buy a single certificate from Ancestry.com. Your product on this model is “all or nothing”. The ultimatum strategy can be doubly important if you’re getting target customers who are already buying you on a one-shot basis.

Idea #4: Give Them a “Freemium” Option

If you’re going to force people to subscribe as your only pricing mode, one way to convince them is by giving them a taste of what they will get from a full-blown subscription. It’s virtually impossible to sell first-time visitors a subscription to an information product like a magazine until they’ve sampled the content. In the “freemium” model you’ll want to leave plenty of value off the table to instill a sense of intrigue about what the customer will get from subscribing.

Idea #5: Offer a Trial

If you have a product or service that is very hard to understand/describe and the customer have to use it before understanding the benefits of subscribing, you may want to offer a free trial. The point of the free trial isn’t so much getting the customer to buy the product but the use the product.

Idea #6: Offer Your Subscription as a Gift

When you gift someone something you’re showing the how much you love that person. So giving someone a gift through the subscription mode is an easy way to show them you love them overtime. The problem with this model is that’s increasingly difficult to renew the subscription by the customer. Since they didn’t buy them themselves, getting the customer to buy is incredibly difficult to do.

Idea #7: Set Fire to the Platform

It’s human nature to wait until you absolutely need to act unless there is something you will miss out on by procrastinating. So as cliché as it sounds, one way to get people to subscribe is to set fire to the bridge and artificially stimulate a burning platform that causes the customer to act to avoid losing something. You have to give them a reason to no only subscribe, but to subscribe today.

The Toughest Sale of All

The best way to sell your customer something is by first selling it to your own employees. The toughest part though, is to get them to part with their usual business model into a subscription model. The best way to do this is by telling them how much more predictable their workload will be instead of having peaks and valleys of customers demand-monthly, daily and yearly.

Scaling Up

If your purpose is to create a larger and larger business, you have to take into account two things: first the cost or acquiring customers can’t be more than a third of their lifetime value. Second, you need to reduce the number of customers who cancel on you (churn).

The Treadmill to Nowhere

Most subscription businesses follow a traditional pattern of growth. Your MRR grows quickly at the start, and nobody pays much attention to churn. Eventually more customers leave, making you search for customers that’ll replace what you’ve lost every month. And eventually you reach the treadmill to nowhere when you can’t acquire enough customers to pay for what you’ve lost.

New MRR = Churn Rate x MRR

Lowering Your Churn

The first steps to reduce your churn is to figure out why your customers are leaving and do what you can to improve your offering. Here are some basic ideas to reduce your churn:

Idea #1: Be a Rogue Jet
Somehow you need to disrupt the inertia that keeps your customers going about their daily routines on autopilot so you can insert your product or service and form a new routine for your customers. Churn is directly related to use: the more your subscribers use your service, the less likely they are to churn. The stickiest subscription business make it their mission to insert themselves into the daily lives of their customers. You’ll have a less churn if your subscriptions is something your customers must use to complete their daily tasks or if your subscription makes those daily tasks much easier or go away.

Idea #2: Watch the 90-Day On-Boarding Clock
In normal subscription business, 90 days is the number of days you have to successfully on board that subscriber. Get it right and she’ll subscribe for years.

The first 90 days you have to take into account several important customer experience factors:
1. Customers expect high levels of interactions.
2. They expect to be asked for personal information.
3. They are in “switch mode” and open to new offers.
4. They are much more likely to defect before “bedding in”.

One of the biggest reasons people stop subscribing to any service, is the perception that they are paying for something they’re not using. Therefore the biggest competitor for your subscription business is the customer’s inertia in not using your service. For a subscription to stick, customers need to change their behavior and actually use the service. You have a short window to break your customer’s old habits and insert yourself in their daily lives. The window is the first few weeks after they have purchased, before the excitement of their purchase wears off.

Idea #3: Reduce Your Time to Wow

Charging up front of your subscription means you’re locking in a year’s worth of a renewal and getting your customers cash up-front. More importantly, it prompts a customer to make a bigger commitment to learning and adopting your subscription, making them much more likely to renew.

Idea #4: Communicate Like a Giddy Lover

Think of your new subscriber as a new lover. New lovers have a thirst to understand you intimately. An older subscriber will find your constant communication annoying after a while, whereas a new subscriber welcomes your contacts and takes time to consume them.

Idea #5: Drop a “Happiness Bomb”

As with any relationship; it’s important to keep a degree of spontaneity and surprise in your dealings with your subscribers. The best subscription companies always sprinkle in a little something surprising for their subscribers.

Idea #6: Target Larger Businesses

If you target small businesses for your subscription service, your churn rate is going to be much higher. Larger businesses on the other employees and are less likely to change their business strategies on a dime. Note that you’ll want to pick your target marketing in the context of your customer acquisition cost (CAC). While larger companies are stickier customers, they’re also harder to win.

Idea #7: Focus on the “Net Churn”

Another way you can make up for lost revenue is to focus on upgrading your existing customers.

Net Churn = Gross Churn – Upgrade Revenue

Idea #8: Reduce “Logo Churn” by Cross-Selling

Logo Churn is the cardinal sin of any subscription company. It means a company or an individual in a business to consumer situation, has stopped doing business with you altogether. The key to reducing “logo churn” is by offering a number of different subscription to the same company or person. If a customer decides that a plan is not right for them, allow them to switch to a different plan.

Idea #9: Go Evergreen

If you have an end date for your subscription, attribution may not be because the product stinks; it could be because the subscriber changes her e-mail address or that he is on vacation when you send th renewal notice. In order to combat this, don’t put an end date on your subscription and instead make them (the customer) turn off the service if they no longer want it. Marketers call this the “negative option” because the customer has to exercise the option to cancel rather than being asked if they wish to continue. The only exception to the evergreen rule is selling expensive subscriptions to large companies.