The Subscription Based Business Model: What Is It and Is It Right for You?

Kyle Beldoch  |  

The eCommerce subscription based business model is on the rise. By 2028, subscriptions are expected to be a $2.6 trillion industry.

But why are subscriptions taking off like a rocket ship? It’s because they’re a win-win for customers and businesses. Customers love the convenience and value subscriptions offer, while businesses love recurring revenue and the increased customer loyalty subscriptions foster.

If you have a replenishable product and don’t offer a subscription business model, you’re missing out on the premier way to increase customer retention.

What is a subscription based business model?

A subscription based business model automatically charges customers on a recurring basis for a product or service. It differs from the transactional model, which charges customers for one-off purchases.

An example of a subscription based business model in action is Netflix. The streaming service is one of the most dominant subscription companies ever. Consumers have an insatiable demand for fresh entertainment content, so they’ve opted in to a monthly fee to access Netflix’s shows and movies.

While subscriptions for physical products such as magazines and newspapers pre-date digital subscriptions, it was companies like Netflix and Amazon that helped increase consumer demand for subscriptions outside the digital realm. Today, consumers can subscribe to all sorts of products, including make-up, coffee, and even paper towels.

Subscriptions are a key aspect of Relationship Commerce, a business strategy in which brands seek to develop deeper relationships with consumers — moving them from one-and-done transactions to ongoing, frictionless relationships — that results in predictable recurring revenue and higher customer lifetime value.

No discussion of the subscription based business model is complete without understanding how brands implement it. The model can take multiple forms, depending on the merchant. But for simplicity, merchants tend to either be subscription-first or subscription-second.

Subscription-first model

Subscription-first businesses generate at least 51% of their revenue from subscriptions. For instance, while pet food brand Chewy allows one-time purchases, the bulk of their revenue comes from subscriptions. Typically, subscription-first businesses use a direct-to-consumer model.

Benefits

A key benefit of the subscription-first revenue model is its high profitability. Subscribers tend to have higher lifetime value than one-off buyers since they’ve entered a longer-term relationship with your brand. They’ll provide monthly recurring revenue (MRR) as long as they find continuous value in your products or services.

Another benefit is better inventory forecasting and predictable revenue. Say you have 5,000 subscribers, an average monthly acquisition rate of 5%, and an average monthly churn rate of 1%. This data helps you predict how much inventory to have on hand to satisfy monthly orders. Excess inventory means spending more on storage. A lack of inventory means some customers won’t get what they want.

Challenges

Subscription-first models also have their share of challenges, especially if you’re a new player in a crowded field.

According to Zuora, the subscription economy grew by over 435% from 2012 to 2020, a rate five to eight times faster than transactional models. With such fierce competition, it can take longer to set up because you can’t afford to neglect any detail.

For example, say you’ve created a new brand of organic dog food. Just because dog owners need to buy healthy food each month doesn’t mean they’ll flock to you from Chewy. Can you add more value than Chewy, either through promotions or experiences?

Successful subscription-first businesses offer a thoughtful and world-class customer experience, from the initial subscription enrollment, to the ability to manage subscription orders, to the delivery of every product.

The other challenge is that subscribers often get restless. McKinsey found that 30% of subscribers churn because their subscription service lacked enough “new or fun products or experiences.” Unless you can provide value over the long term, subscribers will give their recurring payments to someone else. Chewy, after all, now offers toys and other pet products in addition to food.

Subscription-second model

Subscription-second businesses use subscriptions to drive a portion of their revenue, but they predominantly rely on one-off product sales. These businesses typically have a brick-and-mortar presence, as well as an online store. For example, a coffee brand might sell their product in stores and allow shoppers to subscribe to select flavors through their website.

Benefits

If you’re an established transaction-based business with products suitable for a subscription offering, a key benefit is the ability to ease into the subscription model.

Start with a few subscription products. Then test and iterate the experience until you get it right. Include more products and start promoting subscriptions heavily in your customer acquisition campaigns. The goal is to acquire more up-front subscribers rather than one-time buyers.

Challenges

One of the pitfalls of adding a subscription experience is thinking it can be managed with the same strategy as a transaction business. In reality, you need a strategy for each business model. For example, you’ll want to create different email welcome sequences for new subscribers and new customers who don’t subscribe.

Given the increased subscription revenue potential, you’ll want to be thorough in explaining how the subscription works, including cancellation policies and whether the subscriber can customize shipments. For non-subscribers, you might follow up with a thank-you email that highlights the benefit of subscriptions.

Another challenge is deciding how to allocate your marketing resources between subscribers and nonsubscribers. Do you use more budget trying to acquire one-off customers — who will likely be less profitable — or shift some of those customer acquisition costs to retaining subscribers? This split attention can slow the growth of your subscription experience.

Types of subscription based business models

Subscription based business models, whether first or second, take three main forms. They can be adopted by industries ranging from food to wellness, and everything in between.

Subscribe and save

Subscribe and save, also known as replenishment, provides regular, recurring delivery of the same product to consumers at a discount.

Honest sells sustainable health and wellness products for adults and kids. Their core subscription is a bundle of diapers and wipes that auto-delivers according to a schedule set by the new parents.

The Honest Company subscription based business model

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To sweeten the deal, they give subscribers a gift with every third shipment and 15% off add-ons. Subscribers can modify or cancel their subscriptions at any time.

Curation

Unlike subscribe and save, a business that uses curation varies the products in its subscription. Ideally, the subscriber chooses the products, but the business can as well.

StitchFix asks subscribers to fill out a style quiz and then ships a curated box of matching clothes and shoes. The boxes ship every 2-3 weeks, every month, every other month, or every three months.

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One of the challenges of a curated subscription is maintaining a steady stream of new products.

Membership

Memberships provide access to a company’s products or services for a recurring fee. They can encompass an entire product line or a subset of products that only subscribers can access.

Sam’s Club enhances its subscription pricing structure by offering two membership tiers.

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The more expensive Plus tier offers free shipping and savings in optical and pharmacy departments.

How to decide if a subscription based business model is right for you

With so much competition in the subscription space, you need to consider the marketplace and your own capabilities before launching your own subscription based business model.

Analyze the market

As you survey the competition prior to launching your subscription offering, make sure there is space both for your product and the experience you hope to build around it.

Take The Honest Company once again. They weren’t the first to offer a diaper subscription, and there are less expensive subscriptions available to consumers. Yet they thrive. Why? After analyzing the market, they made the following strategic decisions.

  • They believed they had a better, safer diaper because of its sustainability. As a result, with a higher price point.
  • They made their diapers fashionable. They have multiple designs from which to choose.

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  • They made their diapers flexible, both in terms of size and the children’s needs (infant, training, overnight).
  • Parents can quickly switch from one type of diaper to the next, skip shipments, and get early access to new designs.

Whichever subscription product or model you choose, it’s unlikely you’ll succeed if you compete on price alone. The subscriber experience can have as much of an impact on a subscriber as the product itself.

Audit your technology stack

If there’s friction in your subscriber experience, your technology providers might be responsible. Make sure you audit them before you launch your subscription experience.

  • Some eCommerce platforms come with a subscription solution, but the technology is often limited. If you want a flexible subscription experience, for both yourself and your subscribers, you’ll need to partner with a subscription platform.
  • Your payment provider must be able to handle automatic renewals and protect your customers’ information.
  • Real-time inventory management software is also vital. You don’t want to disappoint your customer base with out-of-stock merchandise or have too much on hand. The latter can increase your warehousing costs.
  • Subscription platforms must also integrate with your marketing automation software. This will allow you to easily update your subscribers about their order so they can easily adjust it to fit their needs.

Once you optimize your technology stack, you’ll be able to collect data about your subscribers. Use this data to improve their experience with personalized recommendations, offers, or discounts.

Subscription based business models increase customer loyalty

The convenience and value of a properly executed subscription based business model give customers valuable time back in their day to focus on what matters most. In return, they will reward you with long-term relationships and share of wallet.

If you’re interested in learning more about subscription services and the specific type that would work best for your business, check out our next article, The eCommerce Subscription Model: Understanding Its 3 Types.

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