How does a subscription business model work?
A subscription is, above all, a contract. To make money, the subscription business enters into a contract with the customer and agrees to provide the requested products or services on the agreed frequency. In return, the customer agrees to make payments, likely on the same frequency. This provides a recurring revenue stream.
For example, someone wanting to sell monthly subscriptions to a curated box may set up a payment instruction for the 15th of every month, and start the shipping process once the payment has been received.
Customers are entitled to review their subscriptions after a certain period of time or at the conclusion of the contract, making nurturing customer relationships an important component of a subscription business’s success.
Subscription based business model trends and insights
The subscription economy (products and services made available to customers through a subscription scheme) is thriving, with the total market for subscription companies projected to grow to $1.5 trillion by 2025. According to a recent report, subscription ecommerce in the US alone is expected to generate over $38 billion in 2023, up from $23 billion in 2020.
In light of current events, it makes total sense too. The pandemic fuelled the demand for subscription boxes and services, with government regulations and health fears preventing people from freely leaving their homes and making purchases from brick-and-mortar stores. Subscription box businesses were in high demand and many more have moved to a recurring revenue model.
Many traditional industries have seen the opportunities offered by the subscription model and are embracing it as part of their offering. The demand is expected to continue well into the future, with increasing digitisation and new technology providing fresh opportunities for businesses to offer membership services and other subscription services.
For some more insight on the state of the subscription box industry in 2023, check out this video from Subbly Expert Steve Krakower:
Now, let’s discover the benefits of the model.
Benefits of a subscription business model
While subscription models have grown in popularity, it’s not just global factors influencing their success. They’re a proven method of revenue generation, nurturing customer relationships, and decreasing the costs associated with a purely transactional business. When operating at an optimal standard, subscription models can be hugely profitable.
In a nutshell, with a subscription business model, you can look forward to:
- Building better customer relationships
- Being able to predict your revenue more efficiently
- Spending less on customer retention
- Lowering your acquisition costs
- Boosting your customer lifetime value
Better customer relationships
Serving the same customers repeatedly, as is the case with subscription business models, means it’s easier to foster strong customer relationships. With the customer frequently engaging with your friendly, helpful service team, their trust in your business brand grows. This relationship building exercise will play a big role in their decision to renew or cancel their subscription.
Subscription-based business models are reliable sources of recurring revenue, and make it easier to forecast monthly or quarterly revenue generation. As subscriptions are mostly contract-based, businesses have visibility into how much their next payment is and when it’s due through recurring billing.
Subscription-based revenue models equal recurring revenue, which means less stress about business finances and more time for entrepreneurs to focus on other areas of the business, like nurturing those long-term customer relationships or improving subscription products and services.
Lower spending on customer retention
With your subscribers regularly and automatically purchasing from you, there are lower marketing costs associated with retaining them. Your customers are already engaged with your business and your offering and are committed to a long-term buyer relationship. As long as you’re making them happy, they are often less likely to churn and you can invest those acquisition dollars in other areas of your subscription business. McKinsey’s survey of 500+ US subscribers to boxes and other subscription services revealed that 80% were open to keeping new subscriptions they’d signed up for during the pandemic.
Decreased customer acquisition costs
‘Traditional’ business models often involve significant customer churn, with a lot of energy spent engaging with potential customers who haven’t dealt with the business before.
A subscription business model, on the other hand, reduces customer acquisition costs by decreasing the amount of required marketing and time spent on new customer acquisition. The business is able to focus on the customer experience, maximizing value, and making it more likely to acquire customers through referrals.
Increased customer lifetime value
The customer lifetime value (CLV) is the total worth of that customer over the period of their relationship with the business. As subscription businesses are focused on delivering value and an enjoyable customer experience, the goal is for the customer lifetime to be longer and, therefore, the CLV too.
Additional benefits include a higher average customer lifetime value (ACLV) than that of nonrecurring business models, greater customer inertia and a more committed customer base as it transitions from purchase to opt-out decisions, and more potential for upselling and cross-selling other products or services.
Now, let’s move on to the challenges.
Challenges of a subscription business model
It’s important to note that despite subscription business models have skyrocketed in popularity, operating a successful subscription service is not without its challenges.
As you build your subscription business model from the ground up, the main challenges you’ll need to focus on are:
- Your pricing
- Your fulfillment strategy
- Creating sustainable recurring processes
- Creating a framework to delight customers in the long term.
Creating a pricing strategy
While customer service and the quality of your product are arguably two of the biggest differentiators for subscription-based business models, your subscription pricing strategy and subscription pricing structure remain important factors influencing customer decision-making.
Regardless of your subscription revenue model, it’s important to price your subscription box or service accurately to reflect the true value that customers are receiving. Your pricing strategy should also allow customers to make recurring payments in ways that are convenient and make sense to them. If you have multiple subscription tiers, this may involve the use of a subscription pricing table to clearly illustrate the differences. Out of the hundreds of US subscription service users McKinsey surveyed, 62% indicated that good value was the biggest magnet for them to sign up, before high quality, variety, and convenience.
Scaling your fulfillment
Fulfillment is an operational process and is a fundamental part of every online business, including ecommerce and subscription businesses. Fulfillment involves receiving the products from your suppliers, packaging them, and sending them out to your existing customers.
As your subscription business grows, outsourcing is a practical option for those seeking to scale their fulfillment. It’s essential to take the time to evaluate potential outsourcing partners and whether they are the right fit for your business.
Creating recurring processes
Subscription business models involve a lot of repetition. Each month (or set interval), a customer pays and the subscription business delivers the expected product or service. But there’s a lot of repetition that happens throughout business operations, as well.
With so many repetitive processes, it’s in your best interests as an entrepreneur to automate as many of those components as possible. Doing so reduces the number of human hours needed to perform those tasks, thus reducing labor costs. But automation also offers a number of other benefits.
- Increase customer retention with automated SMS messages
- Build loyalty within your existing customer base, such as through automatically generated rewards for high lifetime value customers
- Reduce the instance of failed payments with preconfigured same-day retry renewal, or SMS messages for customers when subscriptions are canceled due to involuntary churn
- Increase lifetime value, by setting up automatic coupons to send when a customer reaches a certain number of orders
- Automate management and operations, such as keeping customers’ user attributes organized and up to date based on their activity
- Increase your capacity to build more complex business models with sequential subscriptions or different SKUs for different plans that run with zero interference in the background after setup.
Delighting your customers on a long-term basis
It’s a truth universally acknowledged that more smiles equal more subscriptions. Subscription businesses have unique opportunities to delight their customers. They have more data to take advantage of and more customer touch points, while the very nature of subscriptions creates the framework for a long-term relationship. It’s a topic that the top subscription industry experts talk about time and time again.
To build customer relationships and drive customer retention, there’s several areas of your business you should prioritize:
- The quality of your product/service: While a customer might purchase a low-quality offering once, they are unlikely to do it again. High-quality items keep existing customers returning and more subscriptions coming in.
- The customer experience: With so many customer touchpoints, a personalized customer experience goes a long way.
- Customer care: Your customer service is part of your subscription offering. Subscribers should be able to contact you through easy-to-access channels with any questions or concerns they have about your service or the products they’ve received.
- Ongoing product value: Your offering should deliver the maximum amount of value to your customer. This means you should strive to nail the balance between the right quality and/or amount of product at the right frequency at the right price point, each and every time.
Different types of subscription business model
What makes a successful subscription product or service is easy to define, but perhaps harder to identify. A good subscription item is something that a customer is ready, willing and able to buy – on repeat.
There are several types of products that most subscription models are built on:
In a sense, subscription boxes could fit into any of the other categories, but it’s necessary to highlight them as a distinct model as on the whole, they’re the most popular type of subscription business (especially when it comes to physical products). From meal and drink deliveries to books and collectibles and more – subscription boxes normally entail some kind of weekly or monthly delivery of goods tailored to a subscribers’ preferences – and all focused around a certain niche. There may also be an element of transactional commerce in here too – as some merchants may allow subscribers to purchase one-time products too alongside their boxes.
Essential consumables and replenishment models
There are certain products we rely on having and consume consistently – think cleaning products, tea and coffee, shampoo and conditioner. Customer loyalty is a major factor in this context, as most of us have preferred brands for these products, and arriving at the supermarket to find your favorite toilet paper is out of stock can be devastating.
Having a subscription to these items is appealing because it’s a promise that you’ll never face that conundrum again. The shops may be filled with items people can purchase themselves, whereas you’re selling the perfect balance between quality and convenience – and making a neat revenue in the process.
This subscription business model is built around a proprietary base product or service (for example, an electric Oral B toothbrush) that can only be used with proprietary refills (Oral B replacement heads). It’s an opportunity to impress consumers with the quality items they need, when they’re needed, on a recurring billing system that they’re unlikely to question if your brand quickly becomes an integral part of their daily life. If a customer has purchased the base product, it’s likely they’re open to becoming a long-term subscriber.
Collectibles, passions, and hobbies
Hardcore fanbases are prolific in modern culture. You need only look at the queues for midnight launches at your local video game store, the order lists for Star Wars DVDs with limited edition metal cases, or comic conventions where people transform themselves into their favorite fictional characters.
These die-hard fans collect memorabilia and want to connect with like-minded fans. Having a subscription box that ties in with one of these fan bases is thus a great opportunity for subscription business owners. While not “essentials”, these products relate to a passion so strong that superfans will pay a recurring fee to have a consistent stream of related items.
Memberships and services
A membership-based business can be considered to be an example of a subscription business model. Memberships have all the advantages of subscription business models, but place a greater focus on customer retention using strategies such as giving access to membership privileges, premium positioning, product development, and leveraging an online community.
Membership business model subtypes
- Freemium memberships: Offering a basic level of service for free, often to funnel non-members into purchasing your paid content. Think online courses and digital subscriptions, like Medium, as well as Amazon Prime, which is projected to grow to over 180 million subscribers by 2024, up from 168.5 million in 2022.
- Tiered memberships: Structured to allow members to pay more to access additional benefits and features. This works for physical and digital products. Crunch Fitness’ gym memberships allow people to pay more to access more branches, for example, while Peloton’s digital subscription (discussed below in more detail) gives higher tier members access to more classes and device functionality.
- Loyalty and rewards programs: These normally entail some kind of points collection system redeemable for discounts and other perks. Airline memberships and grocery store membership cards are two common examples.
Often, membership products or services provide a way for people to achieve a goal, like gaining a skill, indulging in a hobby or reaping the benefits of access to exclusive content.
For example, you might have a new membership site that offers courses on digital marketing or web development. You could then offer the top-rated courses or other exclusive content to paying members of your website, while only those with free membership to gain access to regular content.
It could also be that you bundle some parts of your services for your members, while others can choose to pay for individual products. You might even create multiple membership levels to cater for people with different budgets.
These models also involve the idea of connecting with like-minded people as a key way to make the most of the offering. Your membership subscription offering might involve digital products (think streaming services like Netflix), physical products (think your Costco membership card) or could combine the two (like a scrapbooking program that has online tutorials and a community forum as well as tangible, physical subscription boxes).Start your 14-day free trial today
When and how should you add subscriptions to your business?
By now, the benefits and reasons why you should consider a subscription business model should be pretty clear. But when is the best time to make the move?
Whether your business is brand new or already established, here are a few steps to kick off your subscription strategy and start selling subscriptions:
- Understand your customers and their purchasing habits. The better you get what your target consumer is looking for, the easier you’ll find it to hone your strategy and acquire customers.
- Perform a competitor analysis. While you may believe your idea is unique, there could be other companies with the same – or a similar – offering. That doesn’t mean you shouldn’t pursue the idea, but it does mean you need to consider your differentiators.
- Develop your idea. While subscription boxes are increasingly popular, you can also consider subscription-based content or membership-only access to an ecommerce store.
💪 Top Tip:It’s important to note that the costs for memberships involving physical products are higher than for digital products. Digital exclusive content can be used and reused forever when it's evergreen — physical products need restocking (and shipping!).
- Consider logistics. How are you going to deliver your subscription product or service to your customer? If it’s a physical product, this means identifying the appropriate freight company. Don’t forget financial logistics, like having a reliable payment gateway.
- Develop your pricing strategy. Your subscription pricing strategy could involve pricing tiers for different levels of product, annual subscriptions, free trials for new customers, or bonuses for loyal subscribers.
- Make a sample box. While the idea seems solid, you need to see the product as the consumer will receive it. Your prototype should include your products and packaging so you can adjust the elements which aren’t working.
- Create a marketing plan. How are you going to let potential customers know where to find you? While many businesses use social media ads and other paid media routes, you can use low-cost or even free strategies like asking current customers to post pictures or unboxing videos of your product.
- Conduct a post-launch analysis. Your product is now (hopefully) in the hands of your customers. This is your opportunity to determine what is and isn’t working and adjust your strategy accordingly. Outside of asking your customers, you could also join a subscription industry Facebook group and ask them for feedback!
Subscription business metrics: the short version
When considering the ‘when and how’ to integrate a subscription service within your business offering, it’s important to take a few key metrics into account.
The metrics you decide to track will vary based on your business model, however most subscription-based companies will focus on customer-centric metrics.
Some of the most common metrics that are important to track when leveraging subscription business models include:
- Monthly Recurring Revenue (MRR) – The average revenue you earn per subscriber, per month, multiplied by your total number of subscribers. Your MRR shows how much revenue you can expect each month and fluctuates depending on your subscription revenue model.
- Annual Recurring Revenue (ARR) – Similar to your MRR, but is used for long-term forecasting. Your average monthly revenue per subscriber is multiplied by the total number of subscribers, which is multiplied again by 12.
- Average Revenue Per User (ARPU) – This metric is helpful for subscription businesses that offer multiple tiers. To find your ARPU, divide your MRR by the total number of customers. This is also a useful metric to see how you compare to competitors.
- Customer Acquisition Cost (CAC) – This is how much money you spend to obtain new customers, and is an important part of evaluating your subscription business’s cash flow. It’s a bit tricky to calculate, with a lot to take into account, so it’s good to have a comprehensive understanding.
- Churn rate – While subscription businesses should aim to retain every customer that comes to them, it’s inevitable that a portion will decide to cancel their subscriptions at some point. This is your churn rate. A basic churn calculation can be done by dividing the total number of cancellations by the total number of subscribers during a set period, and converting it to a percentage. Low is better – try aiming for <3%.
- Customer Lifetime Value (CLV) – The CLV is the average worth of a customer over the period of their relationship with the business. For subscription businesses, the higher this number, the more validation you have that your business is working – as users are sticking around in the long-term.
- Payback Period (PBP) – The PBP is often used as an alternative to CLV. In summary, this is the average time it takes to earn back your CAC in the form of MRR. It’s particularly important early on as when you’re acquiring customers, you’re technically not benefiting until the MRR they’re bringing in exceeds the CAC.
Real-life examples of subscription business models in action
We’ve covered what a subscription business model involves, but what do they look like in action? We’re surrounded by them – you’re probably a consumer of at least one without consciously being aware of it.
These are just a handful of examples of subscription concepts, selected across a wide range of product niches. The point is that there’s an almost unlimited amount of ideas you could apply the business model to, and all it takes is your imagination.
Now, let’s dive into these real life examples of the different types of subscription business models.
Here we go!
Example 1: Nespresso
Nespresso coffee machines need Nespresso coffee capsules. While cheaper brands have made compatible options, Nespresso has done a great job of crafting a household name and building long-term relationships with its customers. They’re a little bit of luxury the average family can afford.
Leveraging a systems subscription model, their recurring coffee plan gives consumers the ability to have their favorite coffee automatically delivered at the frequency they prefer. They drive retention with a free sleeve of coffee for every 100 capsules ordered.
Example 2: Itch
Itch delivers essentials for pet owners – a flea and worming subscription for a simple monthly fee. Their focus is evidently on subscription sales, incentivising new customers with a free trial month. Customers can enjoy tailored treatment plans and access to a members-only ‘Video Vet’ service.
The company has done a great job of offering consumables with long-term usage schedules. Working as a subscription service, the business can also pass along better pricing to the consumer. Coupled with a great customer experience, this subscription business has a recipe for ongoing profit.
For more information on Itch, check out Subbly Expert Johnny Sadler’s 360-degree analysis.
Example 3: Smugglers Crate
We mentioned Star Wars fans earlier in the article, and Smugglers Crate has been developed for the ultimate fans. Subscribers to their curated subscription boxes receive a different collection of exclusive Star Wars collectibles (think artwork, figurines, clothing, and accessories) each month.
This subscription business offers a no commitment pricing model, flexible plans and free shipping. Subscribers can choose between one-off purchases, monthly and 3-month options.
Example 4: Peloton
Peloton, an American exercise equipment and media company has taken the USA by storm in the last year. Peloton runs on a membership-based subscription model. They sell bikes and treadmills which connect to the internet, enabling their members to participate in virtual classes through a streaming service.
Their monthly subscriptions come in different tiers. Members pay a recurring subscription fee of US$39 to access these online classes and the full suite of equipment features. There is a lower membership tier at a cost of US$13 for users who only want to access content via the app or website.
Example 5: HelloFresh
HelloFresh is a great example of the curated box concept applied to a food service subscription model. Their boxes contained pre-portioned ingredients and step by-step recipes, making it easier and quicker for customers to cook meals at home. It’s a smart concept that has risen in popularity due to shifting consumer preferences towards healthier, sustainable, and convenient eating options.
The subscription model works on a weekly basis, with subscribers choosing the number of meals and servings they want every week. Subscribers can choose from a variety of meal plans, including meat and veg, vegan and vegetarian, and family-friendly options. The pricing varies depending on whether you choose standard meals or premium options. One-time purchases like bottles of wine are also available, charged separately to the recurring payments. The food is then delivered in a refrigerated box to ensure freshness.
Example 6: Smol
Smol is a household cleaning product subscription service that offers a unique and eco-friendly solution for customers. Smol’s detergent capsules are designed to be compact, lightweight, and effective, with a formula that is free from harsh chemicals and is kind to both skin and the environment.
With Smol, customers sign up for a subscription service that delivers the laundry capsules to their door every few weeks, with the quantity adjusted over time based on their self-reported usage patterns – great for Smol, who are then guaranteed a more predictable revenue stream.
Smol’s subscription model ensures that customers always have enough laundry capsules on hand, without the need to constantly purchase new products. Additionally, the company’s focus on sustainability and eco-friendliness has resonated with consumers who are looking for ways to reduce their environmental impact.
Deciding to embark on a subscription business model is an exciting journey of discovery and reward. With so many businesses finding success with the subscription revenue model, its success and popularity are expected to continue for decades to come.
In any case though, the entire process is much easier with an all-in-one subscription-first platform like Subbly by your side – try us today for 2 weeks for free and see for yourself!Start for free today
Subscription business model FAQs
What is a subscription business model?
A subscription business model is one in which customers make recurring payments on an agreed frequency in return for the business’s products or services.
How do subscription business models work?
Subscription business models work by delivering products and services to customers according to the terms and timelines defined by the contract.
What are the major advantages of subscription business models?
When optimized correctly, subscription business models allow for improved customer relationships, more predictable revenue, a reduced spend on customer retention, lower acquisition costs, and higher customer lifetime value.
What challenges are associated with subscription business models?
The most common challenges with subscription business models are creating an effective pricing strategy, building sustainable recurring processes, and delighting customers on a long-term basis.