Understanding the New Boom in Subscriptions

TheatrophoneMore than a century before Netflix and Hulu and Spotify first charged subscribers to satisfy their daily media cravings, another device existed called the Théâtrophone.1 From 1881 to 1932, telephonic devices called Théâtrophones were made available to dignitaries and guests in luxury hotels who required their daily fix of live opera performances via subscription fee — 50 centimes for five minutes.

While the Théâtrophone was an impressive invention in its day, the subscription model itself has a prolific and fascinating history of enabling innovation throughout the world. Subscriptions have helped companies pioneer new distribution models across a diverse set of business applications; all in the name of seeking efficient annuity revenue streams that outweigh the cost of production and distribution. From an end-customer “subscriber” perspective, the convenience of easy access or repeat consumption can greatly outweigh the incremental cost of subscribing.

Subscriptions have historically also found ways to take on greater social meaning through the signaling of a certain status by way of access to a secret society, social club or charitable organization. In the 1700s, by “subscribing” to become a benefactor to a charitable organization or society, individuals were able to achieve certain significance among their peers. Subscriptions to charity balls and full-seasons of theatre access were as much of a status symbol as they were convenient. Country clubs, yacht clubs, athletic clubs, fraternities and other private clubs have almost always been entirely member funded by way of the subscription membership model. Memberships, dues, donations and even tithing from the Catholic Church were achieved via scheduled “subscription” payments.

During the 18th century, the notion of subscription that we know today arrived when subscriptions to periodicals, magazines, books and theatre events became common. These subscriptions typically included delivery of the printed material and were sold for a specified number of issues or a period of time.

During the 1800s, the idea of pay-as-you-go subscriptions emerged to support the need for staple items such as heating oil, coal, milk, ice and even diapers to be delivered to your home. In Paris, a five-franc annual tariff was levied on all residents for their “subscription” to a hectoliter of drinking water per day.

Throughout history, we observe some interesting commonality across each of these examples. Whether we’re talking about subscriptions for the purpose of convenience, pay-as-you-go consumption, engagement or status, the underlying business driver has always been that subscriptions provide the ability to generate capital in the form of an attractive annuity revenue stream. From a financial perspective, companies that are able to generate a growing audience of subscribers producing predictable revenue streams are far more capital-efficient than companies that need to acquire, and then re-acquire, each customer interaction. (If you’re ever curious about this assertion, just ask yourself why so many insurance companies occupy the largest buildings across all major cities in the United States.2 By definition, insurance is an annuity-based, subscription business.)

Fast forward to today. We are in the midst of yet another explosive expansion of subscription business models. From traditional media moving to digital media, to the rapid adoption of SaaS and cloud-based businesses, mobile and social products, applications and services are all careening toward some form of subscription-based offering. This is largely because the cost of developing and launching new businesses has declined to such an extent that it requires a very different level of up-front capital investment to chase these opportunities.

Why are subscription models everywhere today? The following intersection of trends is powering the recent appeal for subscriptions:

From the business perspective, there has always been a strong appeal in creating a predictable stream of revenue. Beyond that, the notion of maximizing lifetime value from existing customers is something that has always existed, but is now enabled through better visibility into activity. Traditional e-commerce companies like eBay have long focused on optimizing the “Triple A’s” — Acquisition, Activation and Activity. With today’s technology in place, we now have the ability to solve for all of these variables in a way that is not only more palatable to the end customer, but in many respects the optimization is couched in a way that is actually a benefit to the customer. (Think about the recent reminders you’ve likely received from your oil changer, dentist or even hair stylist that it is time for you to come back for your next appointment.)

Consumers have evolved a long way from the cable and magazine subscriber of yesterday as well. Today, consumers expect to have a range of choice in their offerings. They’ll commit to subscribe particularly if they have the ability to select from a range of feature/pricing options that best suit their own preferences.

There exists a psychological minimum. If a service is offered at a price level that feels low enough in relation to the marginal benefit that they receive, a consumer will subscribe. Conversely, they will elect to cancel if the marginal benefit wanes and is no longer worth the cost to continue subscribing. Managing the perceived value of any subscription product or service over time creates a relationship between the consumer and the service provider, each of whom seeks to maximize the value they are receiving from the other.

At the same time, the upfront capital investment required to launch a new enterprise service has declined to such an extent that it affords businesses a greater opportunity to test and learn as they go. As recently as 10 or 12 years ago, during the first dot-com boom, companies raised massive amounts of money not only to signal a coveted first-mover market position, but also to fund the huge amount of investment required to scale out a company. Today, we have cloud services and SaaS/PaaS offerings like Amazon Web Services and RackSpace.

The Web has become too fragmented to sustain ad-only revenue models.
Ten years ago, venture capitalists were inundated with companies seeking funding for ad-supported business models. Today, the Web is far too fragmented to support businesses seeking to aggregate massive ad dollars.

There has been a 100X reduction in the cost of software infrastructure within 10 years.
Here is an example: In just over 10 years, the “rented” application infrastructure model once offered by Kontiki (before it was called SaaS/PaaS) would have cost a customer approximately $100,000 per month to launch a business. Today, the same offering is delivered by Amazon Web Services for approximately $1,000 per month.

The cost of storage has plummeted 16X in the last 10 years.
Today, it costs you $0.085 per GB to store data. Ten years ago, it cost $1.39/GB. This decline in storage costs has created the opportunity for subscription-based file-sharing and backup companies like Box.net and Dropbox.3

The cost of Internet bandwidth “transit” has declined 75X in the past 10 years.
Entirely new business models have emerged due to the proliferation of inexpensive and ubiquitous broadband connectivity. This has allowed companies like Hulu and Netflix to have distribution to large markets at economically sustainable rates.4

Open-source software has eliminated the need for expensive licenses.
Ten years ago, companies aiming to deliver a service at scale were likely to sign up for expensive Oracle and Microsoft licenses. Today, startups have an impressive roster of free open-source software to choose from to run their operations.

On the Web today, the confluence of these trends is creating new markets and opportunities. The functional role of marketing has evolved to become increasingly data-driven.

Financial CRM allows the consumer to get what they want, and the business to provide a well-crafted migration path of high-probability options for cross-sell and up-sell options in the future. The management of this path for monetizing users post-sale has become an even more critical discipline for maximizing enterprise profitability than the sexy and creative brand-building efforts on which companies have traditionally focused.

All of these factors combined increasingly lead entrepreneurs to a similar conclusion. It is now far more efficient to offer products and services via subscriptions. Subscription pricing easily attracts customers, eliminates their purchase anxiety and, if designed well, keeps them happily paying over a longer period of time. Subscription models not only allow for attractive and efficient pricing, but also alleviate the need for a heavy-handed sales pitch. Ultimately, customers appreciate that they are in more control — always having the ability to upgrade their service, or to cancel and move on to something better.


1http://en.wikipedia.org/wiki/Théâtrophone
2http://en.wikipedia.org/wiki/List_of_tallest_buildings_in_the_United_States
3http://www.archivebuilders.com/whitepapers/22004p.pdf
4http://drpeering.net/white-papers/Internet-Transit-Pricing-Historical-And-Projected.php

Based in San Francisco, Dan Burkhart is the CEO and co-founder of subscription billing service Recurly, Inc. He was also an executive at eBay and NBC Internet.


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