Risks of Starting a Subscription Business

When I started in the financial services industry in 2003, getting to meetings when I was on the road was pretty straightforward—I took a cab. Just like executives had for more than seventy-five years.

And, everything I needed to run my meeting was on my laptop in a series of Microsoft Office files—software I had purchased on CD ROM via a one-time transaction and installed on my machine.

In those days, the more successful and time-challenged of my peers (who were too busy to take care of all those time-consuming tasks like picking up dry-cleaning or groceries) solved the problem by hiring an assistant.

Today, things are markedly different—you can make the choice to pay a monthly subscription to companies that provide those services. I have replaced what used to be a single transaction—taking a cab to a meeting—with a subscription to a company like Zipcar, where you pay a recurring membership fee so that I can grab a car in practically any city, whenever I need it. And, that CDROM version of Microsoft office I bought is now an automatically updated, cloud-based software service I subscribe to. All of the software as a service (SaaS) companies operate on this model.

Tien Tzuo, CEO of Zuora, calls this new paradigm the subscription economy—and he believes it’s the start of a revolution. Many merchants and businesses have moved away from the traditional pay-for-product pricing models and begun to implement subscription-based pricing. The business model implies predictable monthly revenues and consistently excellent service for clients—but it’s not without its risks.

The subscription economy explained

The subscription economy is different than the sharing economy that has been talked about for years. It’s closer to the software as a service (SaaS) model. Simply put, it is a service model in which the focus has shifted from fulfilling individual transactions to ongoing service delivery that customers subscribe to on a monthly basis.

For instance, if you want custom exercise plans and workout help, you can subscribe to Daily Burn and get help anytime you want it. Need to share or store files in the cloud on an ongoing basis? Try Amazon Web Services. Or if you like a good bike ride but don’t want to buy your own bike, you can ride whenever you want by signing up for a bike sharing program. These are just a few examples of the thousands of companies that make up the subscription economy.

Why did the subscription business model arise?

Subscription-based pricing models have been around for hundreds of years, but the recent explosion of companies using the model has its roots in a fundamental change in customer expectations over the last ten years.

This change grew out of the emergence of mobile and cloud-based technologies that give everyone the opportunity to interact with businesses anytime and anywhere. After years of using this technology, consumers became used to getting what they wanted on demand. At the same time, they started to expect better and better levels of service. And, having gotten used to the software they used being updated on a continuous basis, they began to expect the products and services they purchase to also continually improve over time.

As companies reacted to these new expectations, a fundamental shift in thinking about how to serve customers took place.

What has changed because of the subscription business model?

In the subscription economy, companies have moved their focus from producing, selling, and shipping products (traditional transactions) to developing and monetizing lifetime relationships.

In the traditional “production model” based on a series of one-time sales, the key driver of growth was continually attracting new customers. Now, in a subscription-driven world, the business driver becomes how well you serve your existing client base. It’s all about building awesome client experiences, continuous monitoring and improvement of the relationship, and ultimately, client retention.

Really, the biggest lever a company has in this world is its ability to deliver value to its customers. That’s what builds loyalty.

To deliver great value, you first must understand your customers in deeper ways than ever before. All my career, I’ve listened as people talked about the importance of identifying customer needs and finding pain points. But, now, the subscription model has taken that process to a much higher level. For the first time, we have the ability to actually reach a fundamentally deeper understanding of customers.

That’s because we now have access to so much more data. Everything from payment preferences, to product choices, to sales histories, to browsing habits, to returns patterns is captured. And the software necessary to sift all that big data and refine it into actionable business intelligence is now available to everyone.

When companies succeed in delivering on this new model, they create high levels of customer satisfaction and retention. The lifetime value of each customer is much higher than in a production model business, and subscriptions can even out cash flow, reduce volatility, and make forecasting more accurate. But there are some risks that go along with these opportunities.

3 risks of the subscription business model

1. Not understanding how to approach it differently

The biggest risk in adopting a subscription business model is not understanding how different it is from the traditional model, and not taking the right actions.

Specifically, companies need to fully prepare all of their business processes to ensure that everything they do is oriented toward delivering on job one—providing outstanding value for all customers.

2. Failure to deliver value

Failure to deliver that value will lead customers to bail on their subscriptions. Churn will rise, and lifetime value will fall off. To learn more about tracking metrics like churn and lifetime value, check out this article next.

3. Not setting up the right billing and technology infrastructure

Not investing in and mastering the technology needed to collect and interpret the data that will reveal what clients need can have similar results.

And then there are chargebacks—a less obvious, but potentially serious risk.

The subscription model requires customers to be billed automatically on a monthly basis—usually as a recurring credit card charge. That’s a convenient process for company and customer alike, but it needs to be closely monitored.

In my business, we know all too well that recurring payments have a higher than average decline rate. In some cases that’s due to outright fraud. But in a percentage of cases, it’s down to expired or incorrect card information that causes a decline. Either way, too many declines will increase your Chargeback to Transaction Ratio (CTR) and that can have serious repercussions for a business.

Why your chargeback to transaction ratio matters

A company’s CTR is one-way card brands determine if you fall into their high-risk vendor category. It tells them how good a job you’re doing at keeping card data up to date and managing fraud prevention. If your CTR rises over the one percent threshold, you will be placed on a watch list and can see increased credit card processing fees.

To reduce chargeback risk, companies using the subscription model need to monitor credit card information closely. That means flagging soon-to-expire cards and asking customers to update their info. And, to avoid declined transactions caused by customer confusion (i.e. they don’t recognize the billing name of your company), make it easy for clients to contact you with questions before they dispute a charge.

To keep fraud from negatively impacting CTR, seek out payment processors and card vendors with robust chargeback management systems. These software systems immediately flag all chargebacks so that the company can quickly address the problem. And the best software uses artificial intelligence algorithms to identify potential fraud. They monitor all transactions in real time looking for fraudulent patterns or red flag behavior. Top subscription businesses have the people and processes in place to monitor and deal with chargebacks so they don’t become a drag on company’s bottom-line.

Wrap up

The subscription economy is on the rise because the model capitalizes on companies’ abilities to deliver awesome client experiences day after day and leverage a regular revenue stream.

You can successfully mitigate the risks inherent in the model by using big data and leading edge service processes to maintain the highest levels of customer satisfaction, while also making sure you minimize incidental credit card declines and fraud by using the best vendor technology and internal processes.

Although the risks are real, they are solvable—making the subscription model a boon for well-prepared companies.