The Subscription Business Model: Everything You Need To Know

How Does a Subscription Business Model Work?

While subscription models vary across industries, they all share a simple premise: customers make recurring payments at set intervals in exchange for products or services.

Above all, a subscription is an ongoing contract between you and your customers. 

For example, instead of offering fitness training sessions as a one-time service, you can offer a contract where your clients receive personalized workout plans every week. 

In this scenario, you commit to delivering a regular service and they agree to pay you regularly. 

This cycle repeats at predetermined intervals, such as every week or month. Once the contract nears expiry, your customers can renew or cancel their subscription. 

This sets the subscription business model apart; it relies on customer loyalty rather than creating a one-off experience. 

Have a look at the diagram below to see the contract cycle: 

Benefits of a Subscription Model

Subscription models are a proven method of revenue generation. They nurture customer relationships and decrease the costs associated with single-sale businesses. 

Subscription models can be hugely profitable. In a nutshell, you can look forward to:

1. Building better customer relationships.
2. Being able to predict your revenue more efficiently.
3. Spending less on customer retention.
4. Lowering your acquisition costs.
5. Boosting your customer lifetime value.

🚀 Better customer relationships

Serving the same customers repeatedly means it’s easier to foster strong relationships with them. 

As customers frequently engage with your friendly and helpful service team, their trust in your brand grows. 

This trust plays a significant role in their decision to renew or cancel their subscription.

🚀 Predictable revenue

Subscription-based business models are reliable sources of recurring revenue. 

Instead of worrying about the uncertainty of one-time customers, you can depend on the steady income from your existing subscribers.

This allows you to forecast your monthly or quarterly revenue, giving you the foresight to make long-term business decisions. 

As a result, there’s less stress about business finances and more time to focus on other areas, such as improving your subscription products and services.

🚀 Lower spending on customer retention

McKinsey’s survey of 500+ U.S. subscribers revealed that 80% were open to keeping new subscriptions they’d signed up for during the pandemic. 

This shows that even during difficult financial periods, subscribers are more likely to maintain their subscriptions. 

As long as you keep them happy, they will stick around. 

🚀 Decreased customer acquisition costs

Traditional business models often require a lot of energy directed toward engaging with potential customers who haven’t interacted with your business before. 

A subscription business model, on the other hand, reduces customer acquisition costs by fostering long-term relationships. 

This decreases the need for constant marketing efforts. 

Instead, you can focus on enhancing the customer experience, making it more likely to acquire new customers through referrals. 

🚀 Increased customer lifetime value

Customer lifetime value (CLV) represents the total worth of a customer throughout their relationship with your business. 

Subscription businesses naturally extend this relationship by relying on an ongoing commitment from customers, which increases their overall lifetime value to the business. 

Now, let’s move on to the challenges.

How to Start Subscription Businesses

By now, the benefits and reasons why you should consider a subscription business model should be clearer. 

Whether your business is brand new or already established, here are a few steps to kick off your subscription strategy:

✅ Understand your customers

Before you dedicate time and resources to a particular subscription model, you need to make sure that it’s the right fit for your business. 

Unfortunately, not every business is suited for the subscription model route. Here are some examples of businesses that should stick to one-off sales: 

• Car dealerships: Customers purchase vehicles as a one-time transaction rather than opting for a subscription model.
• Real estate agencies: Buying property usually involves a single transaction rather than ongoing subscription payments.
• Wedding planners: Couples usually engage wedding planners for their wedding rather than subscribing to continuous planning services.

These examples show that their respective customer bases simply wouldn’t benefit from subscribing to these businesses. 

If you discover that you have high-intent customers who are seeking ongoing services, products, or experiences, then your business may be a good subscription model fit.

✅ Perform a competitor analysis

While you may believe your idea is unique, there could be other companies with the same—or a similar—offering. 

This doesn’t mean you shouldn’t pursue your idea, but it does mean you need to ask yourself the following questions: 

• Are your competitors using a subscription model? If none of your competitors are using a subscription model, then there must be a reason for it. Finding out why they don’t have a subscription model can provide valuable insights into the challenges or limitations in your industry. 
• How can you differentiate your product from theirs? If you’re going to offer the same product or service, then customers have no reason to buy your products. You need to make sure your business is unique so that customers have a compelling reason to choose you over them.
• How much traffic does their website get? Invest in an SEO tool, such as SEMrush or Ahrefs, to analyze your competitors’ website traffic. This should help you determine how much website traffic you can expect to get and what the value of this traffic could be. 

Once you have the answers to these questions, you should use them to inform your strategy before entering the market. 

✅ Develop your subscription pricing strategy 

Setting the right price for your subscription service can be tricky. 

That’s why you need to create a realistic pricing strategy that covers all the bases, such as various pricing tiers, annual subscriptions, and free trial options. 

Here’s how to do it:

• Step 1 – Understand your market: Size up industry norms, customer expectations, product value, and what your competitors are charging to nail down a competitive price point for your subscription offering.
• Step 2 – Crunch the numbers: Calculate your product, packaging, shipping, labor, transaction fees, and marketing costs to figure out the best pricing structure for your subscription model. 
• Step 3 – Aim for profitability: Set your profit margin targets by estimating both gross and net margins against your revenue and subtracting all costs. Initially target a healthy 40-60% profit margin and aim to boost it to 50-70% as your business grows. 

For deeper insights into competitive pricing strategies, have a look at our guide to determine your ideal pricing strategy. 

✅ Consider logistics

How will you deliver your subscription product or service to your customers? This will depend on your business model: 

• If you’re managing a product subscription business, this may include shipping, warehousing, inventory management, and fulfillment services. 
• On the other hand, if you have a membership subscription business, this may include member communications and membership renewals. 

You can take care of logistics in-house or you can outsource these tasks to an external company that specializes in them. 

For example, if your business delivers specialty skincare products, you could partner with a logistics company like FedEx. 

This will help ensure that your items are delivered with care while giving you more time to focus on sourcing high-quality products and providing excellent customer service.

Have a look at this article to find out whether you should focus on your fulfillment in-house or outsource it. 

✅ Prototype your idea 

It’s one thing to have an idea and another to see what it looks like in reality. 

If it’s feasible, trial run your subscription product, service, or membership to learn what you need to prepare before you formally launch your subscription business. 

For example, let’s say you want to launch a subscription box that includes magazines for collectors. 

Before you kickstart your business, do a trial run: 

• Create a prototype box containing a selection of magazines. 
• Package it in a mock-up of your intended packaging. 
• Send it to a small group to gather customer feedback and validation. 

By doing this, you’ll gain invaluable insights into the appeal of your product, the effectiveness of your packaging, and the overall customer experience. 

✅ Create a marketing plan

You’ll need to let potential customers know that your subscription service exists and can benefit their lives. 

While many businesses use social media ads and other paid media routes, you can use low-cost or even free strategies, like sharing unboxing videos of your product.

To ensure that all your high-intent customers are aware of your subscription offering, you’ll need to create a proper marketing plan. 

Here are five ways to nail your marketing strategy: 

• Make marketing fun: Spice up your marketing with gamification to engage customers. For example, you could create an interactive quiz related to your product or industry, offering rewards or discounts for participation. 
• Try before you buy: Attract potential customers with free trials or samples of your subscription offering, giving them a taste before they commit.
• Collaborate with influencers: If it’s appropriate for your brand, partnering with influencers can help spread the word about your subscription business. 
• Start referral programs: Encourage your existing subscribers to refer friends and family by offering incentives or discounts for successful referrals. 
• Optimize your website: Make sure your website is user-friendly and optimized for conversions, with clear calls to action and compelling messaging. 

To learn more about setting up the perfect marketing strategy for your subscription business, read the complete guide here. 

✅ Conduct a post-launch analysis

The planning doesn’t end when your product reaches the customer—in fact, it often just begins.

Once your product is launched, it’s the ideal time to evaluate its performance and consider its future direction.

You can gauge its success by examining:

• Feedback from customers: Customers’ opinions matter most.
• Sales performance: Sales indicate product success.
• Social media interactions: Social media engagement reflects brand reach.
• Traffic on landing pages: Landing page traffic measures online interest.

By gathering data from these key sources, you can gain valuable insights into your product’s performance and make informed decisions for its future.  

Overview of Key Subscription Business Metrics 

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 it fluctuates depending on your subscription revenue model. 
• Annual recurring revenue (ARR) – This is similar to 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 twelve.
• Average revenue per user (ARPU) – This metric is helpful for a subscription business model that offers multiple tiers. To find your ARPU, divide your MRR by the total number of customers. Note that this is traditionally a SaaS metric rather than a retail subscription one. If you’re looking for the latter, you can swap the “U” for “C” or “S” to represent customer or subscriber, respectively.
• Customer acquisition cost (CAC) – This is how much money you spend to obtain new customers, and it’s an important part of evaluating your cash flow. It’s a bit tricky to calculate, so it’s good to gain a comprehensive understanding of it.
• 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. The lower it is, the better. 
• Customer lifetime value (CLV) – The CLV is the average worth of a customer throughout their relationship with the business. For the subscription business model, the higher this number, the more validation you have that your business is working. 
• 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 in the early stages when acquiring customers, as you won’t reap the benefits until the MRR they generate surpasses the CAC.