Is Subscription Revenue the Holy Grail for All Startups?

by Amit Jain

In the startup world, subscription revenue is sexy.  Entrepreneurs and investors love subscription revenue (also referred to as recurring revenue) because of its predictable nature.  Startups with such revenue models essentially are striving to be annuity businesses: each customer signed up is an incremental lifetime monthly cash flow (with the caveat that churn rates are zero and renewal rates are 100% in this perfect world).

David Skok’s series of blogs on SaaS economics (Software-as-a-Service companies are inherently subscription businesses) contain several analyses on the high profit potential of startups with recurring monthly revenues.  Apple/Google recently announced subscription-pricing capabilities for app developers as an alternative to ads-based or one-time transaction-based pricing models.  In our LTV class, we saw Rentjuice as an example of a startup that pivoted away from per-transaction pricing to subscription pricing.  It seems that recurring revenue models are popping up everywhere in the digital world.

So is subscription revenue really the Holy Grail for profitability? Why don’t more startups from join the party? Why aren’t all subscription startups wildly successful? A few thoughts...

Subscriptions require patience (and a leap of faith)

Imagine an iPhone app developer having the option of charging $5 for an app, or charging 50 cents per month to subscribe to the app.  The subscription approach could lead to a larger customer base which can pay off well in the long-run if customers continue to subscribe, but the developer will have to weigh that possibility against potentially reaching breakeven faster through the transaction-based model, albeit with a lower long-term revenue potential due to a smaller customer base.  This relative time delay in reaching breakeven on development costs is often the barrier for startups to jump on the subscription bandwagon.

Subscription pricing is tricky

Recurring revenue looks great in the Excel model, but the trick is determining the price for which customers are willing to subscribe for your product.  Ning, a web-based platform for building social websites, began as a traditional freemium model that let users access basic services for free and then have the option to upgrade services for $20 a month.  The freemium model was not working so Ning got rid of the free product and introduced several pricing options ranging from $3 a month to $50 per month - resulting in doubling conversation rate and tripling the base of it paying users.  Ning’s first attempt at a subscription business was not successful, but it had raised sufficient capital to survive this mistake and buy time to test different subscription price points that worked better.

Subscriptions are relationships 

When people subscribe to a product and agree to send money to a business on a recurring basis - a relationship is established (rather than just a transaction).  There is a customer service element that requires higher touch of support for paid subscription relationships.  Netflix is exemplary with its proactive approach: if there is an interruption in the Netflix feed when you stream content - customers automatically (and quickly) receive an apology email that informs them they will get a 2% credit on their next bill for the inconvenience.  However, startups often have to skimp on post-sales support, considering higher priority is usually given to the product and sales teams.

I expect an increasing percentage of startups to adopt subscription revenue models though I suspect startups with ample funding will be more successful in executing these models given the resources needed to wait out the payback period, figure out pricing, and maintain good customer support.