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The Automatic Customer: Creating a Subscription Business in Any Industry by John Warrillow
Airbnb, airport security, Amazon Web Services, asset allocation, barriers to entry, call centre, cloud computing, discounted cash flows, high net worth, Jeff Bezos, Network effects, passive income, rolodex, sharing economy, side project, Silicon Valley, Silicon Valley startup, software as a service, statistical model, Steve Jobs, Stewart Brand, subscription business, telemarketer, time value of money, Zipcar
My hope, however, is that by seeing the range of subscription models that are out there, you’ll be able to jot down a few possibilities for launching your own subscription business or complementing your existing business with some recurring revenue. I hope you agree that while cloud-based software companies and media titans have pioneered the subscription business, it is a model that you too can leverage, whether you own a law practice, a coffee shop, or a day-care center. Next, let’s dig into the hard work of actually building a subscription business. PART THREE Building Your Subscription Business Many traditional businesses become successful based on the sheer force of the owner’s personality. When sales are down, the owner leverages his network and brings in business. When a customer is unhappy, it is the owner who uses her diplomacy to smooth things over. But in a subscription business, the very structure and nature of the business usually means you will go relatively quickly from handling a few customers at a time to juggling a larger group of subscribers.
I’ve had a radio production business, a design agency, an events company, a quantitative research business, and a software company. I’m involved in my second subscription business, and while subscription businesses are in many ways more rewarding than the others, they are also more challenging in many respects. Metaphorically speaking, a traditional business requires more brawn, while a subscription business requires more brain. In a subscription business, any decision you make affects your entire base of subscribers all at once. Sending a single e-mail can trigger an avalanche of cancellations. Rather than collecting a few invoices, you have to figure out how to charge potentially thousands of credit cards a month, each with its own expiration date and credit limit. While gathering more customer data is great, your subscription business may collect so much data that you have to figure out which bits of information are critical and which are just noise.
MOSQUITO SQUAD 2013 Customer acquisition cost (CAC) $93 Average MRR per customer $50 Monthly MRR Churn Rate 2.3% Margin 58% LTV $1,261 LTV: CAC 13.5 As you build your subscription business, you’ll need to go beyond the P&L statement and develop a new set of measuring sticks to track your progress. Your LTV:CAC ratio is the hardest working statistic of the bunch because it is derived from all the key numbers you’ll want to track. If you can get your LTV:CAC above 3:1, you may want to step on the gas. If you’re below 3:1, it may be time to slow down and tinker with your model until you can crest the 3:1 milestone. Either way, there is one more essential ingredient you’ll need in order to build a subscription business. Cash is to a subscription business as oxygen is to humans. If you don’t have it, no matter how healthy you are on other measures, you’re dead. In the next chapter, we’ll discuss how to find the money to grow your subscription business. CHAPTER 13 The Cash Suck vs. the Cash Spigot Understanding your LTV:CAC ratio helps you understand the theoretical long-term viability of your subscription business.
Albert Einstein, Atul Gawande, Black Swan, business process, buy low sell high, capital asset pricing model, Checklist Manifesto, cognitive bias, correlation does not imply causation, Credit Default Swap, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Dean Kamen, delayed gratification, discounted cash flows, double entry bookkeeping, Douglas Hofstadter, en.wikipedia.org, Frederick Winslow Taylor, Gödel, Escher, Bach, high net worth, hindsight bias, index card, inventory management, iterative process, job satisfaction, Johann Wolfgang von Goethe, Kevin Kelly, Lao Tzu, loose coupling, loss aversion, market bubble, Network effects, Parkinson's law, Paul Buchheit, Paul Graham, place-making, premature optimization, Ralph Waldo Emerson, rent control, side project, statistical model, stealth mode startup, Steve Jobs, Steve Wozniak, subscription business, telemarketer, the scientific method, time value of money, Toyota Production System, tulip mania, Upton Sinclair, Walter Mischel, Y Combinator, Yogi Berra
Why not present them with a new offer to make them active customers once again? Netflix is a company that uses Reactivation brilliantly. If you cancel a Netflix subscription, three to six months later you’ll receive a postcard and/ or e-mail from Netflix with an offer to resubscribe at a reduced rate. If you don’t reply, they’ll send another message every few months until you resubscribe or request to be removed completely from their system. Since Netflix is a Subscription business, every reactivated customer means a new monthly stream of income, which greatly enhances the Lifetime Value (discussed later) of each customer. Reactivation is typically a quicker, simpler, and more effective approach to increasing revenue than attracting new customers. Your old customers already know and trust you, and they’re aware of the value you provide. You have their information—you don’t have to find them.
Lifetime Value is the total value of a customer’s business over the lifetime of their relationship with your company. The more a customer purchases from you and the longer they stay with you, the more valuable that customer is to your business. One of the reasons Subscriptions are so profitable is that they naturally maximize Lifetime Value. Instead of making a single sale to a customer, Subscription businesses focus on providing value—and collecting revenue—for as long as possible. The longer a customer remains Subscribed and the higher the price they pay, the higher the Lifetime Value of that customer. The higher your average customer’s Lifetime Value, the better your business. By understanding how much your average customer purchases and how long they tend to buy from you, you can place a tangible value on each new customer, which helps you make good decisions.
When a customer purchases Proactiv, they aren’t just buying a single bottle of face goo—they’re signing up to receive a bottle every month in exchange for a recurring payment. The Lifetime Value of each new Proactiv customer is so high that it doesn’t matter that Guthy-Renker “goes negative” on the initial sale—the company makes a ton of money, even if it loses money on a few customers who don’t continue with the program. The first sale is sometimes called a “loss leader”—an enticing offer intended to establish a relationship with a new customer. Many Subscription businesses use loss leaders to build their subscriber base. Magazines like Sports Illustrated offer gimmicks like football phones and spend a fortune on their annual Swimsuit Edition in an effort to attract new subscribers. These enticements may absorb up to a year’s worth of Subscription revenue, but the company comes out ahead when you consider the Lifetime Value of each customer. Each new subscriber allows Sports Illustrated to charge their advertisers higher prices, which provides the bulk of the company’s revenue.
European Founders at Work by Pedro Gairifo Santos
business intelligence, cloud computing, crowdsourcing, fear of failure, full text search, information retrieval, inventory management, iterative process, Jeff Bezos, Lean Startup, Mark Zuckerberg, natural language processing, pattern recognition, pre–internet, recommendation engine, Richard Stallman, Silicon Valley, Skype, slashdot, Steve Jobs, Steve Wozniak, subscription business, technology bubble, web application, Y Combinator
Hinrichs: I did, let me think. I did in May 2004. I did some things for the insurance and the rates at half a million euros. Santos: Okay, and the objective of that round of funding, was it to grow internationally? Hinrichs: The company was cash-flow positive as of ninety days of operation. So when I funded the company, the company was already cash-flow positive. I wanted to hire some more people. Since it's a subscription business, we had the issue of that we have liabilities on the one side. You can't book the entire revenue you get into the months, so you have to have accrual over the time. In bookkeeping, it's a liability, and to solve this kind of liability problem, yes or no, it's a theoretical problem—does it work? I decided to take the venture capital angel money. Half a year later, when the angels saw how good the system was, everything went well, they said they wanted to invest another time.
You could point to both yourself and also to a potential investor and say, “Hey, this is actually a real business. It's working. It's generating revenues. There is a clear revenue stream. You take money from people. You send them discs. And as long as you keep offering them a good service, you've got a good business.” People at the time really understood, this was in a down economy, that a subscription business was a very good, predictable revenue model. People looked at mobile phone companies. People looked at cable companies and said, “Okay. I understand the economics of a business like this.” In terms of “Is there a need? Is there a market? Is there a good business model?”—it ticked all the boxes. Santos: So, you decided to go forward with this business. What was the first thing that you did to actually put it on the ground?
Television disrupted: the transition from network to networked TV by Shelly Palmer
barriers to entry, call centre, disintermediation, en.wikipedia.org, hypertext link, interchangeable parts, invention of movable type, James Watt: steam engine, linear programming, market design, pattern recognition, recommendation engine, Saturday Night Live, shareholder value, Skype, spectrum auction, Steve Jobs, subscription business, Telecommunications Act of 1996, Vickrey auction, yield management
Subscription is often discussed when financially modeling streaming video and some Internet-based businesses. For whatever reason, the only successful pure subscription-based content businesses in America seem to be HBO and the other premium channels (some of which are still all movies, all the time) and businesses that provide one of the “Four G’s”: girls, God, games and gambling. (A fifth “G,” gay, has developed a significant following in recent years.) But, you can simply place the subscription businesses into their actual business categories: pornography, religion, video games (casual and console) and gambling. Pay-per-view Pay-per-view (PPV) has been around since the late 1970s.The modern version of PPV is simple: you select a program, pay for it, and watch it. There are several technological versions which we will discuss in more detail later. As business models go, PPV is extremely good for adult movies, pretty good for major sporting events (like boxing) and a nice business for wrestling, extreme fighting, concerts and, of course movies.
Free Ride by Robert Levine
A Declaration of the Independence of Cyberspace, Anne Wojcicki, book scanning, borderless world, Buckminster Fuller, citizen journalism, correlation does not imply causation, crowdsourcing, death of newspapers, Edward Lloyd's coffeehouse, Firefox, future of journalism, Googley, Hacker Ethic, informal economy, Jaron Lanier, Julian Assange, Kevin Kelly, linear programming, offshore financial centre, pets.com, publish or perish, race to the bottom, Saturday Night Live, Silicon Valley, Silicon Valley startup, Skype, spectrum auction, Steve Jobs, Steven Levy, Stewart Brand, subscription business, Telecommunications Act of 1996, Whole Earth Catalog, WikiLeaks
Spotify announced that it would launch in the United States before the end of 2010—after planning and postponing a 2009 debut—but couldn’t arrange deals with the major labels in time. The company uses a “freemium” model: users in the U.K. can hear a limited amount of music with ads for nothing, pay £4.99 a month to eliminate the restrictions and commercials, or pay £9.99 to use it on a mobile device. The major labels like the company’s subscription business—it has been reported that they own shares in the company99—but they’re concerned that its free service is good enough that consumers won’t feel they need to pay for it. “Our perspective is that you really need to restrict free, so that it’s basically a customer acquisition vehicle and not a service alternative,” says a major-label executive who deals with digital services. “If the free service is really good, what’s the incentive to convert?”
Exponential Organizations: Why New Organizations Are Ten Times Better, Faster, and Cheaper Than Yours (And What to Do About It) by Salim Ismail, Yuri van Geest
23andMe, 3D printing, Airbnb, Amazon Mechanical Turk, Amazon Web Services, augmented reality, autonomous vehicles, Baxter: Rethink Robotics, bioinformatics, bitcoin, Black Swan, blockchain, Burning Man, business intelligence, business process, call centre, chief data officer, Clayton Christensen, clean water, cloud computing, cognitive bias, collaborative consumption, collaborative economy, corporate social responsibility, cross-subsidies, crowdsourcing, cryptocurrency, dark matter, Dean Kamen, dematerialisation, discounted cash flows, distributed ledger, Edward Snowden, Elon Musk, en.wikipedia.org, ethereum blockchain, Galaxy Zoo, game design, Google Glasses, Google Hangouts, Google X / Alphabet X, gravity well, hiring and firing, Hyperloop, industrial robot, Innovator's Dilemma, Internet of things, Iridium satellite, Isaac Newton, Jeff Bezos, Kevin Kelly, Kickstarter, knowledge worker, Kodak vs Instagram, Law of Accelerating Returns, Lean Startup, life extension, loose coupling, loss aversion, Lyft, Mark Zuckerberg, market design, means of production, minimum viable product, natural language processing, Netflix Prize, Network effects, new economy, Oculus Rift, offshore financial centre, p-value, PageRank, pattern recognition, Paul Graham, Peter H. Diamandis: Planetary Resources, Peter Thiel, prediction markets, profit motive, publish or perish, Ray Kurzweil, recommendation engine, RFID, ride hailing / ride sharing, risk tolerance, Ronald Coase, Second Machine Age, self-driving car, sharing economy, Silicon Valley, skunkworks, Skype, smart contracts, Snapchat, social software, software is eating the world, speech recognition, stealth mode startup, Stephen Hawking, Steve Jobs, subscription business, supply-chain management, TaskRabbit, telepresence, telepresence robot, Tony Hsieh, transaction costs, Tyler Cowen: Great Stagnation, urban planning, WikiLeaks, winner-take-all economy, X Prize, Y Combinator
In his 2005 book, Free: The Future of a Radical Price, Chris Anderson built on the lower cost positioning of the disruptor, noting that pretty much all business models, and certainly those that are information-based, will soon be offered to consumers for free. The popular “freemium” model is just such a case: many websites offer a basic level of service at no cost, while also enabling users to pay a fee to upgrade to more storage, statistics or extra features. Advertising, cross-subsidies and subscription business models are other ways of layering profit-generating operations on top of what is essentially free baseline information. Kevin Kelly expanded further on this idea in a seminal post entitled “Better than Free,” which appeared on his Technium blog in 2008. In digital networks anything can be copied and is thus “abundant.” So how do you add or extract value? What is valuable for customers? What is the new scarcity?
3D printing, A Pattern Language, additive manufacturing, air freight, Airbnb, augmented reality, autonomous vehicles, barriers to entry, Baxter: Rethink Robotics, c2.com, computer vision, crowdsourcing, dumpster diving, en.wikipedia.org, Firefox, future of work, Google Chrome, Google Glasses, Google Hangouts, Hacker Ethic, Internet of things, Iridium satellite, Khan Academy, Kickstarter, Mason jar, means of production, Minecraft, minimum viable product, Network effects, Oculus Rift, patent troll, popular electronics, Rodney Brooks, Shenzhen was a fishing village, side project, Silicon Valley, Skype, slashdot, social software, software as a service, special economic zone, speech recognition, subscription business, telerobotics, urban planning, web application, Y Combinator
In these days, where the life of a company is often measured in months, you’ve been at this for quite some time. Has growth been pretty consistent? Or have you seen a pretty large uptake recently with the whole maker movement? Kaplan: Yeah, what happened was there was an inflection point. We consistently grew—we were growing linearly every year, getting more customers, getting more subscribers, because with the subscription business, some percent renew every year, and then you keep adding more people. Then a bunch of things happened all at the same time. Kickstarter launched, transaction volume on Etsy broke $100M l sellers using Fulfillment by Amazon stowed more than one million unique items in their fulfillment centers. Then we started getting inquiries from start-ups and actual people who were doing their Kickstarters and needed the materials.