Financial implications of the subscription economy

Digitalization
Financial implications of the subscription economy
By Oliver Viel and translated by Sally Farrant

 

Oliver Viel, Head of Marketing at keylight, sheds light on the Subscription Economy and provides examples of how digitization is changing how we handle money.

       The digitization of the economy surreptitiously affects us all, even if only slightly. No company and no consumer can escape the phenomenon. Platform businesses based on digital subscription models are an excellent example of the progressive outcome of digitization because of their high level of digital maturity. Their business culture not only shapes our consumption habits to a high degree, but also subtly mold our attitude towards financial topics. This concept falls under the Subscription Economy, which is opening up the professional dialogue about the effects of digitization across all industries. The topic is paving the way for both technology and the economy into a new realm of financial decision-makers.

What is the Subscription Economy?

       The Subscription Economy is revolutionizing markets with the ever-growing market share that modern digital business models generate with the help of subscription contracts. This is impressively demonstrated by McKinsey in a market study from 2018 for the USA which found that the subscription e-commerce market has grown by more than 100 percent a year over the past five years. The largest such retailers generated more than $2.6 billion in sales in 2016, up from a mere $57.0 million in 2011.  

       One can easily take the common digital media subscription examples such as Netflix, DAZN, Amazon or Spotify. But delving deeper uncovers a wide array of common digital subscription examples, particularly within the world of SaaS which may not be so obvious, such as Adobe Creative Suite or Microsoft Office 365. Through such software solutions consumers subscribe to services on a digital platform and enjoy a service without any administrative burden or waiting time. Further surprise examples are automobile subscriptions such as Cluno. Even the specialized mechanical engineering company Heidelberger Druckmaschinen have long since prepared themselves for the journey towards the Subscription Economy.

       Indeed, such a form of business has significant benefits for businesses and consumers. Its continuous development has the potential to change the basic rules of the markets, on a global scale. Associated with this are changes in the financial planning of companies and the behavior of consumers. So how does this shape our market culture and our patterns of behavior in terms of financing, consumption and cash flow over the medium and long term?

       Best-selling author Tien Tzuo, CEO and founder of US-listed software provider Zuora, is the world's most popular subscription phenomenon analyst. Tzuo believes that ultimately all business models need to transform into subscriptions if they want to survive in digital markets. Even if you do not share this uncompromising belief in subscription business models, it's unequivocally clear that subscription businesses are very competitive, especially in digital markets, and that nearly all business models can be subscribed to. As a result, subscription businesses are winning a steadily growing market share at the expense of selling traditional products, as replicated in the aforementioned McKinsey study.

       To really understand the relevance of modern subscription business models, one must realize that almost all of them are accompanied by a consistent digitalization of all business processes. As a result, a digital subscription business usually has very little in common with traditional ‘analogue’ subscriptions. The development of digital subscriptions occurs through digital customer loyalty and its monetization is adapted to digital market conditions. But how does the Subscription Economy really shape how we handle our money?

The consumer perspective

       Successful digital business ideas can entice subscribers when they make a service totally convenient: they must be accessible, easy to manage and ultimately more efficient than traditional services. It is both the convenience component and the lack of purchase price cost that makes a subscription so enticing. 

       A striking example of this is the opportunity consumers now have to subscribe to a car, instead of buying one. If you subscribe to an automobile, you do not have ownership responsibilities and do not have to care about wear, winter tyres, repairs, maintenance, taxes and insurance. Instead, subscribers all their obligations fulfilled by paying the monthly fee. Even if the overall financial burden may remain the same, the way in which subscribers receive benefits and distribute their money is transformed. This kind of stabilization feels very natural to most subscribers, their earnings are clocked monthly so why shouldn’t their outgoing payments be too? Buying a pricey product such as a car may mean either have to save money which is time consuming, or borrow and pay interest. Both options are without question comparatively uncomfortable.

       In markets where consumers have become accustomed to modern subscription offerings, it is becoming harder to persuade them to make such large purchases. And the burdens of ownership such as repairs, maintenance, wear, and so on, were only once so widely accepted because there was no alternative. A car subscription is - like many other subscription services that will replace product sales in the future - unbeatably convenient and straightforward for the consumer. It is ultimately a kind of installment payment without debt and obligations, other than the smaller and steady monthly cost.

The corporate perspective

       A modern digital subscription business is first and foremost an online platform and is fully digitized. All processes are fully automated including self-service tasks, billing, sending invoices, debiting money, accounting and more. Market-leading and tech-first businesses are automated to a surprising extent. The maintenance of the systems and fewer other tasks remain, which is what the management must focus on. Ideally, almost all resources can be concentrated on the two most important digital survival techniques: attracting as many new users as possible and retaining all existing ones.

An example...

       Imagine a publisher replacing a traditionally managed portfolio of print media with a new, fully digital subscription-based access model. Where does the intriguing benefit of a subscription become apparent? Since there are significantly fewer operational tasks to perform such as printing, warehousing, delivery and administration, less investment is required when starting up the business. Initially, it is often primarily about setting up a technical system and less about pre-financing large capital goods. If there is already a subscriber network, there are even immediate revenues that ideally cover the low running costs at a very early stage.

       The example company outlined here could thus operate profitably at a very early stage and would have to service relatively small amounts of debt. The positive operating cash flow could be used more quickly for distributions and/or further investments. In particular, founders and investors attract the prospect of a business without a large investment and operating costs, but with steady income from the beginning. Not to mention the appealing scalability of subscription platforms. 

       In addition, the consistency of revenue contributes to increased planning certainty when it comes to future forecasting: subscribers are usually bound long term - so you can predict the sales of the next few months fairly comfortably. In any case, this is much more reliable than if one had to speculate one off product sales for the future.

Conclusion

       "In general, the financial side of subscription businesses offers interesting benefits for both providers and consumers and the services offered can be very well established on the market because of this.” says Erik Weibel, Managing Director of the Swiss branch of the software manufacturer, keylight. Weibel advises companies on the technical implementation of their Subscription Economy ambitions.

       "Subscription contracts create a balance between revenue and outgoings, both on the provider and consumer side, so that they are less likely to experience or mitigate peaks of unusual high-cost finance. This balance feels comfortable for both parties and reduces risk. In addition to the issue of security, the consumer quickly starts to feel comfortable. As soon as the subscribers have become accustomed to the new form of buyer/supplier relationship, a return to old product market conditions often seems less than attractive, " says Weibel.

       Consumers are likely to quickly get used to the convenience and security of subscribing, and in many areas will prefer subscription offerings over compulsory ownership of products with high maintenance costs. They will increasingly find it unreasonable to deal with long-term financing strategies such as debt or the strict renunciation of consumption, especially when many services are so easy to subscribe to. This convenience will, according to the vision of the Subscription Economy, lead to a switch of entire markets. 

       A lot of companies are already preparing for this and in many cases, providers are facing major challenges in the switch towards the Subscription Economy. Business strategists fear a high potential for disruption in the context of market change and therefore are advising companies to ensure that they do not miss the right time for their own conversion.

       For established business models, however, the shift is particularly challenging and means profound change must take place. The digital automation, which is indispensable in modern digital subscription business, is just one of many challenges.

       "It's important to develop an attractive and financially viable offer that can excite subscribers and keep them going - this is usually a similarly creative process to a startup, even for established companies. If this hurdle has been overcome, a new, customer-centered business culture and a competent use of customer data is also necessary for ongoing operations," says Erik Weibel. "If customer-centricity is the focus in digital markets, then it makes sense to have the processes and architecture in place to be able to know him/her even better and to adapt to his/her preferences as quickly as possible.”

       Perhaps this is the main message of the Subscription Economy: businesses must be able to adapt to changing markets and spoiled customers. Commerce is becoming more and more convenient for consumers, while for many well established companies it is becoming more and more challenging. For all the convenience available to consumers, suppliers in the digitized Subscription Economy must work hard in order to stay at the top of the food chain. Ultimately, an agile digital and uncompromising customer-centric business is most likely to be able to cope with the demands of volatile digital markets in order to capitalize on the interesting financial benefits of the Subscription Economy.

 

– Jan 1, 2020

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