What Buyers of Businesses Value
To appreciate the impact of recurring revenue on your company’s value, you have to understand what buyers are buying when they acquire a business.
Most owners want buyers to value their past achievements, such as last year’s profits or an industry award they’re proud of.
Financial buyers are really buying only one hing when they purchase a company: a future stream of profits.
A growing cohort of mobile, technically savvy young people who value access over assets. They prefer to stay nimble and rent a home rather than own one; listen to a song on Spotify rather than buy it from iTunes. The Access Generation is behind the explosion of the new “sharing” economy.
Today, businesses are closer to their end users than ever before. All those customer interactions are being fed into mathematical models, which are run by computers that are now capable of storing and processing billions of data points in seconds.
Data has become an asset, and nobody has more customer information than a subscription business. Traditional companies are launching entire subscription offerings just for the data they provide.
You just expect the lights to come on because electricity has become so dependable. The Internet is becoming almost as pervasive and reliable.
The more reliable Internet access has become, the more we are willing to entrust to the Internet.
The Long Tail
As Chris Anderson argued in The Long Tail, the Internet has lowered the cost of distribution for many products and services, and our appetites have broadened as a result.
Customers want to express their individuality, and increasingly they are using subscriptions to do that.
These four factors—the access generation, light-switch reliability, delicious data, and the long tail—have led some of the world’s most successful companies and promising start-ups to shift their business models to a focus on subscriptions.
Whether you like it or not, you are now competing in the new subscription economy, and it’s up to you to decide if you’re playing defense or offense. Defensive players will decide how to minimize the impact of subscription offerings from giant companies like Amazon and Apple. Ultimately they will shrink and live on the economy’s table scraps. Or you can play offense and launch a subscription offering of your own.
Why You Need Automatic Customers
Here are the eight reasons subscribers are better than customers:
1. They Increase the Value of Your Largest Asset
If you’re like most business owners, your largest asset is not your house or a portfolio of stocks. Your wealth is tied up in your business and how it is valued by potential buyers.
The most common methodology used to value a small to mid-size business is called discounted cash flow. This methodology forecasts your future stream of profits and then “discounts” it back to what your future profit is worth to an investor in today’s dollars given the time value of money.
- For example, what would you pay today for an investment that you hope will be worth $100 one year from now? You would likely “discount” the $100 by your expectation for a return on investment. If you expect to earn a 7% return on your money each year, you’d pay $93.46 ($100 divided by 1.07)
Using the discounted cash flow valuation methodology, the more profit the acquirer expects your company to make in the future—and the more reliable your estimates—the more your company is worth.
To improve the value of a traditional business, the two most important levers you have are (1) how much profit you expect to make in the future and (2) the reliability of those estimates.
24–48 × MRR (2–4 times ARR) These are typically very small software companies with less than $5 million in recurring annual revenue. Companies in this first bucket are usually growing modestly, with subscription cancellation rates (i.e., “churn”) in the area of 2–4% per month.
48–72 × MRR (4–6 times ARR) These are larger software companies with recurring revenue of at least $5 million annually, which they are growing at the rate of 25–50% per year. Their net churn is typically below 1.5% per month.
72–96 × MRR (6–8 times ARR) These are the rare, fast-growth software companies that are growing more than 50% per year, with at least $5 million in annual revenue and net churn below 1% per month. These companies usually offer a solution (typically an industry-specific one) that their customers need to use to get their jobs done.
2. The $29 Sale vs. the $4,524 Sale
The most obvious benefit of the subscription model is that it increases the lifetime value of a customer. When you sell a customer a subscription, that one sale can create a long-term relationship thanks to the magic of recurring revenue.
3. Smooth Out Demand
One of the biggest challenges in a traditional business is estimating demand.
By contrast, the subscription business model smoothes out demand so that you can plan your business effectively. Knowing within a few percentage points how many customers you will have next month helps ensure you have the right number of staff and adequate supplies. Optimizing your labor and raw materials means lowering your costs—and your blood pressure.
4. Free Market Research
Want to find out what your customers would like you to offer next? How much they would pay and what features they would insist on?
A subscription business gives you a direct relationship with your customers and an ability to track their preferences in real time.
5. Get Paid Automatically
Assuming customers pay for your subscription by credit card, a subscription model means you get paid on the day you’re supposed to get paid.
6. Make Your Customers Sticky
Subscribers knowingly enter into an agreement in which the convenience of uninterrupted automatic service is exchanged for their future loyalty. Rather than buying once without returning, subscribers stick around—hopefully for years.
7. Subscribers Buy More
A subscription business model allows you the opportunity to talk to your customers on a regular basis as they enjoy the benefits of your subscription. This means you get an opportunity to up-sell them on products and services beyond their basic subscription.
You don’t need to throw away your entire business model to start a subscription service. By adding a subscription offering, you create a legion of customers who interact with your company each month. Every touch point represents another opportunity for you to sell more to your existing customers.
8. Recession-Proof Your Business
When you create a steady flow of recurring revenue, you insulate yourself from the worst of a potential recession.
The Challenges of Adopting the Subscription Model
The biggest risk is spreading the cash you receive from a customer over the life of the subscription. This usually means your customers are more valuable to you over time, but in the short term, you may get less cash up front when they decide to subscribe instead of buy.
The second-biggest challenge in moving to a subscription model is getting your employees onboard. Employees often view themselves as having expertise in a specific industry, an expertise that they are renting to you for the time being. They see themselves first as part of an industry, and second as your employee. Sticking to the way your industry has always done things means you can be taken hostage by free-agent employees who hire themselves out to the highest bidder.
The Nine Subscription Business Models
“How could this model apply to my industry?”and “What part of this model could I borrow for my company?”
1. The Membership Website Model
If you have a specific expertise or passion, no matter how obscure, there may be people willing to pay for access to what you know. The membership website subscription model involves publishing your know-how behind a paywall that requires members to buy access to your secrets.
Consider the membership website model if you have:
- A tightly defined niche market, like ambitious dance studio owners or Italy junkies or woodworking enthusiasts.
- Access to a steady flow of unique knowledge, or expertise insider information that is constantly changing and that subscribers need to stay in the know.
- Another product or service you can sell to your subscribers.
What the Insiders Say
- The most profitable membership websites are usually those of business-to-business companies that solve a real problem, offering “must have”information and maintaining constantly evolving forums that require that a subscriber stay loyal over the long term.
- Most successful operators produce a piece of content in multiple formats (e.g., video interview, podcast, and written transcript) to accommodate subscriber preferences for consuming information and increase the chances the site will be found by Google’s search engine.
- It can be difficult to make a good living from just the revenue you get from subscribers alone, especially with a consumer-oriented site, so having other ways to monetize your subscribers through adjacent products and services (e.g., conferences, coaching, courses) is the best way to build a significant business around a membership website.
2. The All-You-Can-Eat Library Model
It offers unlimited access to a warehouse of value. Like any library, you’ll never consume all of the information available, but the breadth of content that is offered 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.
Consider the all-you-can-eat library model if you have:
- A library of “evergreen” content—or the wherewithal to acquire one.
- A legion of existing fans (blog subscribers, Twitter followers, LinkedIn connections, etc.) who already consume your free content.
What the Insiders Say
- Successful all-you-can-eat library model operators sprinkle just enough new content into the offering to keep subscribers loyal while relying on a large library of “evergreen”content as the foundation of membership.
- To prevent subscribers from cherry-picking the best parts of your library, it may be necessary to give customers an ultimatum: subscribe to the entire library or you can’t access any of it.
- The acquisition of your library is a chicken-or-egg conundrum. Unless you have a truckload of money, look for creative ways to partner (e.g., licensing, revenue-sharing agreements) with content owners to build a library that’s large enough to impress subscribers.
3. The Private Club Model
It offers subscribers ongoing access to something rare. While it is most commonly associated with exclusive sports clubs—think golf, tennis, skiing, yachting—it is also used by businesses selling to other businesses. A large part of the value of the private club model is not only accessing that which is rare but also the chance to meet with a network of other people who—like you—made the cut.
Joe Polish is careful to cultivate an air of exclusivity around his subscription. That exclusivity is what makes this private club model so appealing. As he puts it, “When there is more demand than supply, everyone wants to buy.”
Consider the private club model if you have:
- Something that’s in limited supply—almost always a service or an experience—and in high demand among affluent consumers.
- A market of achievement-oriented “strivers,” who are always attracted to the greener grass on the other side. What the Insiders Say The secret to making the private club model work is not offering à la carte access. Force customers to make a decision: if they want access to something truly rare, the only way they can have it is by entering into a long-term relationship.
- The greatest strength of the private club model is also its biggest weakness. By definition, what you’re selling is in limited supply.
4. The Front-of-the-Line Model
It involves selling priority access to a group of your customers.
Consider the front-of-the-line model if you have:
- A relatively complex product or service.
- Customers who are not overly price sensitive.
- Customers for whom waiting in line can have catastrophic consequences.
What the Insiders Say
- A front-of-the-line subscription model can be used in conjunction with other subscription models to add an additional annuity stream of recurring revenue.
- To use this subscription model, it’s important that you already have a good reputation for baseline service. If your customers have been satisfied with your basic service, they can reasonably assume that paying for the next tier up will wow them.
- Leverage technology and systems (e.g., Zendesk or a dedicated phone number staffed by experienced support staff) so that you don’t lump your standard customers in with those who are paying for a special tier of service.
- The front-of-the-line subscription model can work doubly well when your customers are small and mid-size businesses that lack their own in-house resources to get their questions answered. Apple’s Joint Venture subscription offering is designed for small companies that do not have a full-time IT person on-site, so the prospect of training staff on a new system is daunting.
5. The Consumables Model
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 like remembering to pick up diapers or razor blades. Subscribe and you’ll never run out.
Building a unique brand requires that your positioning meet two criteria: it needs to be important to customers and make you unique.
Consider the consumables model if you have:
- Something to sell consumers that naturally runs out.
- Something to offer that is annoying to replenish.
What the Insiders Say
- To compete with Amazon (and the other big-box e-tailers) you need to brand what you sell as your own. Name the product yourself, even if you’re buying it from a supplier.
- Invite customers to fall in love with your brand through the experience you provide. When big e-tailers can win on clinical points like price, delivery speed, and breadth of product selection, you need to give customers a different reason to choose you.
- Make sure you have a steady flow of supply. Either take control of the manufacturing process or ensure you can find enough supply when you need it.
- Don’t underestimate the logistical challenges involved in fulfilling orders for a physical product or in providing service for thousands of subscribers.
6. The Surprise Box Model
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 to your subscribers each month. As the name suggests, part of the fun for the customer is discovering a new set of products each month.
Consider the surprise box model if you have:
- A passionate, clearly defined market of consumers.
- A large and varied network of manufacturers that are willing to give you a deep discount for a onetime order and have the capacity to fulfill it.
- The ability to handle the logistics of shipping a physical product.
- A desire to use subscriptions to establish, Trojan Horse–style, a larger e-commerce site. What the Insiders Say
What the Insiders Say
- A big part of the reason people subscribe is the joy of finding something new. Consider how you’ll keep surprising subscribers with new products, month after month.
- Don’t underestimate the challenge of logistics and fulfillment. The more data you collect from your subscribers, the more they will expect you to customize their experience by sending them items based on their reported preferences. This increases the complexity of fulfillment exponentially.
7. The Simplifier Model
System Overload Taken separately, no one system is too complex for the average person to master. It is the number of systems we each must now use on a daily basis—combined with our generally overprogrammed lives—that causes our mental overload. When that happens, we want to outsource scheduling, planning, and time management to our technologies.
The hard drive in our collective brain is getting dangerously close to overload. This has given rise to the subscription model I call the simplifier. With the simplifier model, you offer to take one or more recurring tasks off your customers’ to-do lists.
Virtually any company serving busy consumers can benefit from offering a simplifier subscription—and the richer your customers, the more acute their need for simplification.
Consider the simplifier model if you have:
- A service that your customers need on an ongoing basis.
- The ability to sell to relatively affluent, busy consumers.
- A personal service business like pet grooming, massage, tutoring, window cleaning, carpet cleaning, bookkeeping, etc.
What the Insiders Say
- Discover your simplifier model by interviewing your target customer. Have her describe a typical day and ask her to show you her to-do list. Ask yourself what you could offer to tick something off that list.
- Part of the value proposition of the simplifier model is that you will remember to do a task so your customer doesn’t have to. Therefore, make sure you set up a regular schedule for delivering your service.
- An ongoing service contract is a platform for cross-selling and upselling. Delivering the tasks associated with your service contract offers a built-in way to see what else you could provide your customer.
8. The Network Model
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.
Consider the network model if you have:
- A product or service whose utility improves as increasing numbers of people join in.
- The network model works best when you offer a remarkable experience people feel compelled to share. If your product is only, say, 5% better than the alternative, this is likely not the best model for you.
- Tech-savvy customers and prospects. The more socially connected your customers, the faster your network business will grow.
What the Insiders Say
- You need subscribers to build the network, but you need a network to attract subscribers. Focus your limited resources on a small, tightly defined group of early-adopting customers. Build density before moving to your next market.
- The network model is best for companies that have a lot of capital or entrepreneurs who are good at raising it.
- The good news is that once you build the network, the cost to enter the market, coupled with a network of happy users who benefit from promoting you, becomes a protective shield against would-be competitors. The word of mouth from your passionate user base helps guide and fuel your growth by providing free market research about the new products, features, and benefits they want you to offer next.
- The bad news is that if subscribers flip from happy to dissatisfied, the same powerful force that helps you grow a network model subscription business can start to work against you.
9. The Peace-of-Mind Model
It offers insurance against something your customers hope they’ll never need. You are there 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. You can also jack up your profits by investing the money your customers give you before they need your service.
Consider the peace-of-mind model if you have:
- Something that is difficult, expensive, or impossible to replace.
- A business that allows you to absorb the cost of a claim by leveraging your existing assets rather than paying out cash. In the roofing example, you already have the crew, ladders, and trucks for installing roofs, so your cost to honor a claim may be minimal.
- A history of customer service calls that helps you predict the likelihood and frequency of claims.
What the Insiders Say
- Limit your risk. Premiums may look like free money, but you need to ensure you have the resources and infrastructure to honor your commitment in case your customer calls.
- The peace-of-mind model is different than the simplifier model, in which you set up a service contract to preemptively service your customers. In the peace-of-mind model, you’re offering an insurance to help only if your customer needs it.
Building Your Subscription Business
In a subscription business, any decision you make affects your entire base of subscribers all at once.
The New Math
One of the most challenging aspects of building a subscription business is the need to relearn the basics of how you measure your progress.
Traditionally, you have probably measured your business using a profit-and-loss (P&L) statement, which counts the amount of money you make after you pay your expenses and the cost to make whatever it is you sell.
In a subscription business, instead of selling a finite offering, you are essentially renting access to your product or service over time. This means your accountant will spread the revenue you get from a subscription over the life of the agreement between you and your customer. The moment you switch to a subscription model your P&L will start to look ugly.
The New Measuring Sticks
In a subscription business, understanding your financial performance requires a new set of operating statistics. The foundation of your subscription business is built on your monthly recurring revenue (MRR). This is the recurring revenue listed on your company’s P&L every month.
The next number you need to understand is the lifetime value (LTV) of a subscriber. LTV is calculated by multiplying your MRR by the number of months your customer stays with you, less the cost of serving them during the life of the subscription.
The next data point you need to assess the health of your subscription business is your customer acquisition cost (CAC). This is the amount of money you spend on sales and marketing to win a new subscriber.
The Viability Threshold
Once you know how much a subscriber is worth to you, and how much it costs to acquire one, you can start to estimate the viability and performance of your subscription business.
The most important metric for evaluating the performance of a subscription business: LTV > 3 × CAC
Based on his experience running companies, and after evaluating hundreds of others for his venture fund, Skok has found that in order to be a viable subscription business over the long term, a company needs to have an LTV:CAC ratio of at least 3:1.
You may offer a subscription as a loss leader just to build a relationship with a customer who will buy more from you because he is a subscriber. You may also be able to monetize your subscribers through advertising or build a subscription offering just to collect data about your customer preferences. But if your goal is to build a stand-alone, scalable subscription company, focus on getting the LTV of a subscriber to be at least three times what it costs you to acquire her. Only then will you know it is time to hit the gas.
Arguably the most important factor contributing to the viability of your subscription business is the rate at which customers quit subscribing; this is known as your churn rate. To calculate your MRR churn rate, take your MRR at the beginning of the month and divide it by the amount of lost MRR in the month.
Most important, churn viewed in isolation is not as meaningful as looking at churn in relation to how much it costs you to win new customers. Using Skok’s formula, you need to get your churn down to a point where, over the life of her subscription, your average customer is worth at least three times what it costs you to acquire her.
The other number you need to consider is the cost of serving each new subscriber. Considered part of your cost of goods sold, this number varies based on how many customers you bring on. For most subscription businesses, it includes the salary and other costs of the people you hire to get new customers onboard and serve them over time.
Matching Your Sales Channel to the Complexity of Your Offer
One of the big decisions you need to make in implementing a subscription model is how you plan to win new subscribers. The more complex your offer, the more you will need to rely on humans to sell it.
What follows is a list of sales approaches often used by subscription businesses, ranked from most expensive to least:
- Field salespeople: These are the people who visit customers face-to-face.
- Telesales: Salespeople who contact customers remotely—via telephone and e-mail—work over shorter sales cycles.
- Self-service: Subscribers don’t need direct salesperson access in this system. Ancestry.com sells access to its archives and a simple family tree software package without employing outbound salespeople; instead, it relies on marketing copy and videos to explain the offering.
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.
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.
The Cash Suck vs. the Cash Spigot
There is a big difference, however, between viability on paper and viability in the real world, and the difference is a little something called cash.
The more aggressively you grow, the more of your cash gets sucked up in acquiring customers, which is why the number of months it takes you to recover the costs of winning a subscriber matters.
CAC Payback Period In layman’s terms, the CAC payback period measures how many months it takes you to make back the cost of acquiring a customer.
BVP, along with most professional investors, adds a twist that takes into consideration the gross margin of your subscription. Let’s say you make 70% gross profit after paying the expenses of onboarding and any hard costs associated with adding each new subscriber.
Three Choices to Fund Your Growth
Since your MRR per customer is almost certain to be a lot less than your CAC, you’re going to need cash to grow your subscription business. Most successful subscription businesses also need to invest heavily in systems and branding up front, which is why a lot of them go outside to raise capital.
Cash Source 1: Rob Peter to Pay Paul
You can use cash from nonrecurring sources of your business to build your subscription offering. With this model, you take the profits from your traditional business, and instead of putting them in your pocket, you reinvest them into building your subscription offering. Pursuing this strategy usually takes longer than raising a seven-figure seed round of outside money, but you get to keep control of your product and take your time building it. Jason Fried and David Heinemeier Hansson used this cash-flow strategy to build their company, 37signals, which was renamed Basecamp in 2014.
Cash Source 2: Outside Money
Your second option when building your subscription business is to go outside for capital. If you can prove your LTV:CAC ratio is north of 3:1 at scale, and your market is large enough, you’ll probably have a line of investors willing to give you money to fund your subscription business. Here you’re giving up equity, and usually some control, in return for the cash to build your subscription business.
Cash Source 3: Charge Up Front
The third strategy is to flip the traditional subscription-business cash-flow model on its head so you’re getting paid before you deliver the service.
In order to evaluate the impact of this strategy, I came up with a metric I call CUF:CAC, where CUF stands for cash up front, the amount of money your subscriber pays when he signs up for your subscription. CAC is your customer acquisition cost.
In order to grow your subscription business while minimizing the amount of cash you need from other sources, shoot for a CUF:CAC ratio north of 1:1.
The Psychology of Selling a Subscription
Selling a subscription is different than selling a stick of deodorant. With a subscription, you’re proposing a relationship over time.
In a subscription relationship, the customer agrees to stay loyal on a long-term basis, while you agree to keep your partner’s interests at heart. Like all long-term relationships, each party is giving up a little bit of freedom in return for what he hopes will be a better deal in a committed relationship.
Subscription Selling Idea # 1: Think 10 × vs. 10%
Consumers are aware that a subscription relationship is much more valuable to you than a onetime purchase. So to get them to commit you’ll need to give them a big return on their investment. A consumer with an acute case of subscription fatigue is unlikely to subscribe just to save 10%, but she might be convinced to subscribe if you could make a case that she will enjoy 10 times the value of the alternative.
Think “10 times” whenever there is an easy way for your customer to get your product or service without committing to a subscription.
Subscription Selling Idea # 2: Appeal to Their Rational Side
The subscription business model has gone mainstream, and people are demanding that their subscriptions offer better value than the alternative. In short, we’re buying more rationally.
Panda told me that it starts with targeting a corporate buyer, like a restaurant owner or spa manager, for whom professional invoicing and reliability are important. Based on that knowledge, Panda coaches his sales reps to explain the H.Bloom approach to selling flowers, which sounds more like a logistics lecture than a Mother’s Day sales pitch.
This strategy can work when selling a subscription to a consumer, but it is essential when you’re selling a subscription to another business.
Subscription Selling Idea # 3: Give Customers an Ultimatum
If given the choice, most consumers would prefer to keep their freedom and buy your product à la carte, on an as-needed basis. Depending on your appetite for building a subscription business, you may want to consider making subscriptions the only option for buying what you sell.
Subscription Selling Idea # 4: Give Them a “Freemium” Option
If you’re going to force people to subscribe as your only pricing model, one way to overcome their anxiety about committing is to offer a free taste of what they will get from a full-blown subscription.
In this “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. A good taster gives you just enough to assess the product but leaves plenty of temptations behind the curtain. Use the freemium model when you have something that impresses your potential subscriber while still leaving them wanting more.
Subscription Selling Idea # 5: Offer a Trial
If you have a product or service that is very hard to describe and that customers have to use before they will understand the benefits of subscribing, you may want to consider offering a trial. Unlike a freemium offer, which is typically available to a consumer forever, a trial usually has a start date and an end date.
which leaves me to draw the conclusion that getting people signed up for a free trial is the most important first step in converting a user into a paid customer.
Throughout the free-trial process, Zendesk’s focus was not on getting me to buy the product, it was on getting me to use it—a simple but important distinction. Zendesk knows that once you use its product, there’s a greater chance of your becoming a subscriber.
In some cases, the combination of a freemium version of a product and a free trial is the key to signing up a subscriber. At FreshBooks, for example, while the company offers a free 30-day trial of the software, a customer can also continue to use the free sample version, which is limited to billing just one customer.
Subscription Selling Idea # 6: Offer Your Subscription as a Gift
A word of caution: the challenge is that gift subscriptions are notoriously difficult to renew.
Subscription Selling Idea # 7: Set Fire to the Platform
From a consumer’s point of view, the best part about a subscription offering is that it is always on.
This “always on” feature is fantastic for consumers but can be frustrating when you’re trying to sell a subscription. If your service doesn’t change from one day to the next, why should a prospect buy today?
Therefore, as cheesy and clichéd as it is, one way to get people to subscribe is to set fire to the bridge and artificially simulate a burning platform that causes the customer to act to avoid losing something.
The burning platform strategy can, of course, backfire. If what you’re offering is always on sale and you’re always offering another deal, you train the customer to wait to see what offer will come next. Therefore, the very best salespeople set fire to the platform only when the customer has made the decision to subscribe and it is only a question of when.
However, if you decide you want to expand and grow your subscription business, there are two main things you need to focus on. First, as we saw in chapter 12, you need to find a way to consistently acquire customers for no more than a third of their lifetime value. Second, you need to reduce the number of customers who cancel (churn).
Churn is often ignored in the early days of a subscription business because lost revenue from customers who leave is easily made up by new customers. But the larger your business becomes, the more corrosive effect churn has.
A little bit of churn will always happen, and trying to winnow down your churn to zero is a futile battle. People move, couples divorce, some customers go bankrupt and others merge. There is a point of diminishing returns where eliminating all churn is so costly that you undermine your entire business model. It is the avoidable churn that leaves you running on a 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. As each month goes by, more customers decide to leave, and replacing what you’ve lost each month becomes a bigger and bigger task. Then at some point you step on the Treadmill to Nowhere, where you can no longer acquire customers at the rate you’re losing them. Your MRR starts to shrink. The equation is simple: New MRR = Churn Rate × MRR
People may quit your subscription for any number of reasons related to the product or service itself. Your first step to reducing churn is to understand why people leave and to do what you can to improve your offering.Lowering Churn People may quit your subscription for any number of reasons related to the product or service itself. Your first step to reducing churn is to understand why people leave and to do what you can to improve your offering.
Churn-Lowering Idea 1: Be a Rogue Jet
As you build your subscription business, your job is to be the 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 businesses make it their mission to insert themselves into the daily lives of their customers. If your customers can avoid your product or service and still get their jobs done, you’ll have much higher churn than if they need to interact with your service to complete their daily tasks.
Churn-Lowering Idea 2: Watch the 90-Day Onboarding Clock
By the time the clock has ticked for 90 days—the Customer Onboarding Period—the customer’s lifetime value and profitability will have been practically set in stone. The first 90 days after any new account opening are an especially sensitive period characterized by several important customer experience factors:
- Customers expect high levels of interaction.
- They expect to be for personal information.
- They are in “switch mode”and open to new offers.
- 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 are not using.
Therefore, your biggest competitor for your subscription business is not the rival service; it is your 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 customers’old habits and insert yourself in their daily lives. That window is the first few weeks after they have purchased, before the excitement about what your subscription offers wears off.
Optimizing your onboarding experience is an inexact science that most subscription companies are always tweaking. The most challenging part of testing your subscription’s impact is that you cannot immediately see the effect of your changes on your churn. Instead of waiting years to see if your changes are having the desired effect, you may want to consider 90-day markers.
Churn-Lowering Idea 3: Reduce Your Time to Wow
Like surfing, part of getting people to adopt your subscription product or service in the first 90 days is to give them a quick win that provides the motivation for them to learn more.
Churn-Lowering Idea 4: Charge Up Front
One of the secrets to driving more of the behavior change you need in the onboarding window is to charge up front. Charging up front for your subscription means you’re locking in a year’s worth of renewals (unless you provide refunds) and getting your customer’s cash up front. More important, it prompts a customer to make a bigger commitment to learning and adopting your subscription, making them much more likely to renew.
The cycle is intuitive: the more your customers pay up front, the more motivated they are to make the behavioral change needed to “get their money’s worth.” The more they adopt your service into their daily lives, the stickier they become down the road.
Churn-Lowering Idea 5: Communicate like a Giddy Lover
Think of a 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 the time to consume them. After the 90-day mark, the new subscriber settles into the relationship, and overcommunication can actually cause churn.
Churn-Lowering Idea 6: Drop a “Happiness Bomb”
As with any good relationship, it’s important to keep a degree of spontaneity and surprise in your dealings with your subscribers.
Often employees will appreciate a small but unexpected thank-you present more than a predictable annual bonus. The best subscription companies always sprinkle in a little something surprising for their subscribers.
As you build your subscription business, you will accumulate a truckload of data about your subscribers. Using that information to surprise them from time to time can go a long way to keeping the relationship alive and well.
Churn-Lowering Idea 7: Target Larger
Businesses If you target other businesses with your subscription service, your churn rate is going to be higher if you attract primarily small businesses. Therefore, one way to lower your churn is to target slightly larger businesses. Larger businesses are generally more stable.
Churn-Lowering Idea 8: Focus on “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
Churn-Lowering Idea 8: Reduce “Logo Churn”by Cross-Selling Logo churn is the cardinal sin of any subscription company. It means that 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 to offer a number of different subscriptions to the same company or person. If a customer decides one subscription is not right for them, allow them to turn off a single subscription while continuing as a subscriber to other services.
Churn-Lowering Idea 9: Go Evergreen
The company was losing two thirds of its customers because it was asking them to proactively resubscribe. Today, Raz*War has gone to an evergreen model in which customers need to proactively turn off the service if they no longer want it. This has reduced its churn rate dramatically.
The one exception to the evergreen rule is selling expensive subscriptions to large companies.