Finance Essentials for Subscription Businesses
Today's businesses are constantly evolving as customers' wants and needs evolve, but also as they gain more options to compare and choose from. There is pressure on subscription businesses to compete when it comes to things like free trials and promotions in a manner that can quickly become a race to the bottom.
Having the right metrics, and using them to extrapolate key learnings can help you make informed business decisions, forecast business demands, and fuel sustainable growth.
In this article, we look at those key financial metrics and consider how to maximize their benefits and increase your chances of achieving the KPIs of your subscription business.
Increasing revenue on both a monthly and annual basis is important for any business. For subscription businesses, this can be done in two ways - increasing the volume of sales and increasing the value of each sale/ subscription. In an ideal world, you will be aiming for both and there are three recommended ways to do that:
While cost is an important driver for customers, for long-term relationships what's actually most important is delivering value in your product or service. This stems from knowing what's important to your customers and what they want the subscription to provide for them. As a result, when it comes to creating different package offerings, focus on the business value it provides to the individual.
Research has found that placing terms like 'unlimited' into package offerings doesn't yield much return, but personalizing packages delivers value for customers and increases the likelihood of purchase or upgrade.
Keeping pricing up to date over time rather than making sudden large changes is much more likely to land well with customers and can make a significant difference to your recurring revenue. A small amount added to the subscription of multiple customers who stay is much more financially beneficial than a large increase in pricing that results in a large proportion of customers leaving.
For example, during the first two quarters of 2022, Netflix lost more than one million subscribers. It was the only streaming service to see a decline in subscribers in the second quarter of the year, and it was also, coincidentally, the only one of the big services to institute a price increase. The recommendation is to employ small, regular price updates and to use A/B testing to experiment with pricing.
By seeking to increase revenue in a way that benefits the customer rather than simply raising prices, you can simultaneously enhance your customer relationship, improve the chances of them remaining with you and recommending you to others, and minimize the risk of losing customers with unilateral price increases.
In addition to looking at individual customers and ways of increasing their monthly spend with your business, aiming to increase the ARPU is a broader approach to reviewing your business strategy and raising customer spend across the board.
There's a delicate balance to doing this and it hinges on having a deep understanding of your business, its USP and the reasons customers come to you in the first place. Plenty of businesses have sunk the proverbial ship because they have not had a thorough grasp on what makes them unique in the market. Seeking to increase ARPU needs to be done strategically, with data and careful analysis.
Two key areas to consider when looking to increase ARPU are:
Tiered pricing models are not unusual in subscription businesses, and they help businesses to market to a variety of customer segments according to needs and budgets. These need to be very carefully considered, both in terms of price point and how each package is promoted, whether it's listing key features, or adding visual signals that attract customer attention such as stickers noting that a particular offer is 'Recommended for X'.
Free or freemium subscription offers have been very popular over the years but in reality most businesses struggle to convert free users into paying customers. Research estimates the volume that do convert to be between 2-4%, depending on the market segment.
While the theory works well, free subscription options can be extremely costly, requiring all the same infrastructure, demands on server space and behind the scenes customer service as those paying, but with little or no guaranteed reward. This type of model can ultimately overwhelm resources, especially when you do have a contingent of paying customers who, for all intents and purposes, should be the main focus.
That said, it's not that free options don't have their place - they can be a fantastic way to build relationships and trust with customers, as long as you have a clear strategy for optimizing freemium options.
Key recommendations include:
The gap between customer acquisition cost (CAC) and average revenue per user, is a powerful way to play in the margins of your business and ultimately increase profits without causing detriment (and possibly improving) customer experience. This is all about minimizing waste and being as streamlined as possible in your approach to sales, finance and customer retention.
There's a lot involved in CAC, ranging from the salaries of marketers or salespeople to the marketing campaigns, social media strategies and advertising costs used to attract customers. As a result, the time it takes for a customer to convert and the number of touch points they need to go through to reach that stage can all indicate where improvements can be made.
Ways in which you can reduce CAC include:
By reviewing your sales funnel and seeing where there are blocks in customer conversion, you will gain insights into areas of potential improvement. Are there stages where customers need more information? Does pricing need to be reconsidered? Do packages need reconfiguring to personal requirements? Looking at the length of the customer journey, understanding where you can reduce the number of touch points before a customer converts and understanding any barriers to purchasing or decision making can reduce the time and cost of customer acquisition.
Understanding your customer or different customer segments and marketing to them appropriately is the foundation of customer acquisition. With the data that subscription businesses have available, the information is there to understand your customers and what they want or need. However, it only helps you achieve your business goals if this is then communicated throughout your team and manifests in your marketing messages and targeting. In short, are you targeting the right leads with the right information? In addition, you may consider investing in retargeting campaigns to stay front of mind. Research has shown that "retargeting generated the highest lift in trademark search behavior at 1,046 percent."
Understanding where you sit in the market in relation to your competitors is also fundamental to acquiring customers. While there's truth in a world of disruptors that your greatest competitor is probably not someone you're even aware exists, having an understanding of the wider world of subscription businesses as well as other business types, will help you to stay aware of customer expectations - the experiences and offers they can get elsewhere and where that places you in the market. Are there things you can improve to compete? Are there things about your business that you're not communicating effectively enough that would give you a more competitive edge in the customer's eyes?
On average, repeat customers spend 67% more in the third year of their relationship than in previous years. As already mentioned, it's also much less expensive to keep an existing customer and acquire a new one. With that in mind, to drive down CAC, subscription businesses need to focus not only on winning customers, but keeping them. This has always been at the heart of keylight's approach to subscription businesses, and it's the basis on which our platform operates - it's built to help you create long-term relationships with your customers.
Leading on from our last point, decreasing customer churn is an incredibly important part of the financial success of a subscription business. It starts from the very first interaction with a customer - possibly before you even know they're aware of you, because it begins with their expectation of you and the product or service that you're offering.
Decreasing customer churn begins by being very clear about what you can offer - it's not simply about getting a one-off sale over the line, but making sure customers are getting an experience that meets and exceeds their wants and needs. That involves clarity of marketing messages, targeting the right audiences as well as ensuring price points are commensurate with the customer's spending capacity and the value of your service to them.
Inevitably, there will always be some element of customer churn and much of that might be for reasons beyond your control - their personal circumstances may change, for example. The question is, how do you keep it to a minimum? The answer is that it's an ongoing exercise that you have to be willing to continue to investigate and invest in. However, here are three key areas of focus:
Communication is key when it comes to supporting customers and continuing to meet their wants and needs through your business. There is a balance to be had between communicating enough and being a nuisance, but subscription businesses also have the benefit of being able to observe customer usage and behaviour, using that as an additional layer of quiet understanding of a customer and how they're getting on with your service. Finding ways to check in regularly however, can show customers that you're proactively interested and invested in ensuring they have a positive experience. It can alert you to any issues early on so you can seek resolutions, retain customer satisfaction and adopt a personalized approach to customer service.
It's important to establish criteria for identifying customers who are at risk of churn and develop a pathway to help bring them back to your product without antagonising them if they still choose to leave. Data and observing customer behavior is really your friend when it comes to identifying at risk customers and creating advanced subscription cancellation flows that help to bring customers back.
In addition to checking in, asking for customer feedback is an important part of letting customers know they're being listened to. It’s also a valuable resource for driving consistent updates and improvements to the customer experience. As we have already mentioned, preventing or limiting customer churn requires businesses to be willing to continuously update and improve their offering and experience - it is not a static thing.
There are lots of different ways to ask for customer feedback in an unobtrusive manner from customer success emails to automated cancellation feedback. You can simplify them with tick box answers if needed. It's then important to evaluate that information and direct it to the appropriate team within your organization to work towards improvements.
Retaining customers for long-term relationships is what sets subscription business models apart from other organizations. The long-term perspective is essential to the sustainable financial success of subscription businesses. Therefore, while we seek to improve monthly revenue and that's important, the big number to look at is customer lifetime value (CLV).
Most subscription businesses will find that customers can be segmented into different categories - such as high value and low value customers. To increase CLV you probably need to adopt different approaches for different segments, seeking to meet their needs and ascertain who best to target and how, for the long-term success of your business.
Key areas of focus should be:
Customer segments in subscription businesses are often categorised by the subscription plan and price bracket that they're on. Observing these will give you insights into different aspects of your customers - not just their spend, but their loyalty and their usage.
Often, customers on lower-priced plans churn more and pay less, while those on higher-priced plans tend to stick around longer and generate more revenue. That doesn't necessarily mean you don't try to upgrade those on lower priced plans - perhaps by increasing their spend you can also increase their loyalty and revenue.
Use your data and understanding of customer behaviour to inform your strategy for improving customer lifetime value.
Customers with the highest lifetime value are not always those on the most costly plans. To understand customer segments with the highest CLV you need to explore all the data - from that which is trackable online to surveys that help you understand how they interact and grow with your subscription offerings. This will give you insights beyond the immediate, current financials - indicating how long they might stay with you, their level of loyalty and the likelihood of churn.
In subscription businesses, KPIs are about so much more than the numbers - they are inextricably linked with the customer experience, customer relationships and the long-term sustainability of an organization. While on the face of it they are a measure of success, the numbers can also provide excellent insights into customer satisfaction and, along with other data, can be a powerful tool to analyze and understand where improvements can be made. Increasing revenue is not simply about increasing prices or spend but also about looking to where spend can be reduced and customer lifetime value can be increased.
Running a subscription business, as with any business, is an intricate and complex undertaking, which offers enormous opportunities for individuals to create something meaningful and successful. With the tools available and the right mindset, informed decisions can be made effectively and with confidence for positive outcomes.
With so many decisions to make every day, it's essential that you have the support of predictive solid analytical tools to guide sustainable growth. Subscription businesses are integrations of multiple overlapping processes running in recurring intervals of time — finding one reliable, robust subscription engine to support this growth can help simplify complexity and place customers at the heart of business processes.
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