The subscription economy: disruptive, divergent and developing at a dramatic pace
With 100 per cent yearly growth the subscription economy is booming – now is the time to invest
As a result, it’s making serious money. A report by subscription management platform Zuora revealed subscription businesses are seeing revenues increase five times faster than S&P 500 company revenues and US retail sales.
How the subscription economy is disrupting traditional business models
We are in the midst of an unprecedented shift, as companies move away from flogging products to selling services.
The subscription economy is no longer the domain of newspapers, music and movies; there are exciting new business models emerging across myriad industries, including beer, groceries, cars, travel and beauty. You can hire a car, clothing, even furniture.
“The subscription economy is not limited to one or two industries,” said Dr Carl Gold, chief data scientist at subscription management platform Zuora. “We’re now seeing sectors far and wide placing subscriptions, over pure-play products, at the centre of their businesses to achieve rapid and sustained long-term growth.
“Our Subscription Economy Index report showcases the transition to subscriptions beyond the boundaries of traditional SaaS (software as a service) organisations into the manufacturing and business services sectors, exposing the phenomenal value of the subscription business model in today’s digital age.”
The rise of the subscription economy has been a major disruptor to the traditional business model – particularly in retail. By offering services instead of stuff, innovators have created customer loyalty and the holy grail of retail – recurring revenue.
The disruption is largely driven by environmentally-aware millennials, who value access over ownership. The 2019 End of Ownership survey, which polled more than 13,000 consumers across 12 countries, found that
51 per cent of 25-34 year olds in the UK of agree subscriptions are the future. And 74 per cent of consumers believe people will subscribe to more services and own less physical goods.
What is the subscription economy business model?
As a result, a whole new industry is emerging, based on sharing or renting everything from clothing to cars and household essentials to electronics.
Michiel De Smet, head of the finance programme at Ellen MacArthur Foundation, which promotes a circular economy, says the traditional retail model has “stagnated”.
"The business model where you decrease the cost of an item and increase its volume has reached its limit globally,” he explains. “Which is why new sharing or subscriptions models are growing massively.
“It’s not just better for the environment – it’s better for the modern consumer. This new generation want the convenience to change their wardrobe every month, without having to buy new clothes.”
So subscriptions models are good for consumers, great for the environment and a boon for business. But how can investors benefit?
The biggest benefit to investors is recurring income, which means predictable revenue, enabling businesses to aggressively invest in growth. In addition, subscriptions lead to greater customer engagement, and a deeper understanding of their needs, which means subscription businesses are in a stronger position to predict those growth areas.
How to invest in the subscription economy
Making a smart investment is not just about recurring revenue. According to Zuora there are three metrics to monitor, which can help you make a smart investment:
- Churn rate
- Annual recurring profit margins
- Growth efficiency ratio
Churn rate is a key concern for the subscription industry. According to a 2018 report by management consultants McKinsey & Company nearly 40 per cent of e-commerce subscribers have cancelled their subscriptions. The higher the churn rate, the more difficult it becomes for subscription e-commerce companies to cover acquisition costs and scale revenue.
Those that churn, do so quickly. More than one-third of consumers who sign up for a subscription service cancel in less than three months, and over half cancel within six. The meal-kit industry has particularly high rates of cancellation within the first six months (60 per cent to 70 per cent and higher), which reflects the competitive nature of this niche.
Challenges of the subscription economy
Another challenge for the subscriptions business is acquisition. The McKinsey report says signing up for a recurring order “dampens demand” and makes it harder for firms to acquire customers.
“Consumers do not have an inherent love of subscriptions. Rather, they want a great end-to-end experience and are willing to subscribe only where automated purchasing gives them tangible benefits, such as lower costs or increased personalisation.”
This demand for personalised services is backed up by that fact that curation services are by far the most popular subscription model, representing 55 per cent of the market.
Lindsay Willott, CEO and founder of customer feedback experts Customer Thermometer, cites the rise of word-of-mouth marketing as another factor in the failure of some subscription services.
"There has been a marked increase in the sharing economy – customers can easily complain online and share the word, which means it’s now much harder for a bad product or service to succeed,” she says.
The future of the subscription economy
Despite the challenges of acquiring and keeping users, the industry shows little sign of slowing down. According to the Internet Retailers top 500 list the largest retailers generated more than $2.6 billion in sales in 2016, up from $57.0 million in 2011.
This strong growth has attracted big brands such as P&G (Gillette on Demand), Unilever (Dollar Shave Club) and Walmart (Beauty Box). Dollar Shave Club CEO and co-founder Michael Dubin (above) starred in his own promo video, launching the company and paving the way for the modern subscription economy. Now even Ikea is testing a subscription-based furniture leasing service.
A report of UK subscription services concluded “subscription-based services are the future” with 22 per cent of all subscribers (and 44 per cent of 16-24-year-olds) expecting to use more services in the next two years.
Future industries to watch include VoD (with 14 per cent of users considering signing up soon), utilities (10 per cent), music streaming services (10 per cent), fitness services (10 per cent), TV (8 per cent) and software/storage (8 per cent).
Willott of Customer Thermometer says it’s “no surprise” that companies want to shift their operating model to take advantage of the opportunity to accrue long-term, stable revenues.
“To make the shift successful, the company needs to get customers involved in their ecosystem,” she explains. “They have to put the customer at the heart of the business, from how it promotes itself, to what it’s like to deal with digitally, to creating delightful experiences that generate on-going word of mouth.
“This results in a subscription that gives the customer a better experience and a feeling of connection with the brand."