In a market with increasing competition and decreasing customer loyalty, companies are increasingly moving towards more flexible and predictable subscription models and searching for new ways to engage customers with subscription models over the long term. In this article, the authors present five tips to overcome the challenges of moving to a subscription model and defining a successful pricing strategy. Hong-May Cheng is a Partner at the Simon-Kucher & Partners Amsterdam office and Ruben de Lange is a Director in the Amsterdam office. They can both be reached via www.simon-kucher.com.

The Pricing Advisor, September 2018

More and more products are being offered using a subscription model. While subscriptions used to be mostly limited to magazines and newspapers, nowadays, the average household in Europe spends more than 130 euros on subscriptions monthly.

Although the usual suspects – mobile communication, Netflix, and Spotify – account for much of this amount, subscription models have been expanding to physical products as well. Think cars, groceries, flowers, and even socks.

There are two important reasons for this flight toward a “subscription economy.” First, it is in line with an increasing customer need for flexibility and convenience. Payment is postponed, but the enjoyment can be experienced right away. Second, companies adopting the subscription model are often valued higher than their competitors. The stable revenue stream is considered attractive. Moreover, basing revenue growth on the existing customer base costs less than it does to acquire new customers.

In a market with increasing competition and decreasing customer loyalty, companies are searching for new ways to engage customers with subscription models over the long term. Here are five tips to overcome the challenges and define a successful strategy:

1. Make it attractive to enter: Consider a freemium or free-trial pricing strategy. The switch from a single sale to a subscription may be a barrier to potential customers. A freemium or free trial will enable you to connect to a large audience as early as possible. Business dynamics determine which strategy is the most suitable. Freemium fits a market with many customers and low cost per (non-paying) customer. Spotify is a great example of a successful freemium strategy – they are able to convert an impressive 25 percent to a paying subscription. A free trial is effective when the expected conversion rate and cost to serve are high.
2. Follow a “land & expand” strategy: Make the entrance barrier low and then expand your business. Don’t give away the full set of features with your initial product. The product should be a decent foundation but stripped of the more premium options or services. Make sure your customers can grow by complementing your initial product with more premium variations. A good-better-best proposition suits this strategy. The best proposition has more bells and whistles aimed at customers seeking a premium solution and functions as an anchor price that renders the other propositions cheaper.
3. Innovate your pricing model: Create an automatic track to upsell. Your ideal pricing model should be scaleable to match customer use. A prime example is Dropbox. If a user needs more storage capacity, they are automatically presented with a more expensive proposition. This instrument enables you to realize organic growth from within your customer base. Furthermore, you can use your pricing model to reward loyalty, such as by reducing the charges for one- or two-year contracts.
4. Celebrate successes: Cater for the continuous development of your subscription model. Too often, companies think designing and pricing their subscriptions is a one-time exercise, even though their services and solutions are constantly being improved using agile scrum methods. Ongoing development causes the invested value to grow organically, often unnoticed. Celebrate your successes by gathering several innovations and sharing them with customers periodically in a visible way. This increases customer loyalty and creates momentum to adjust the subscription model and the accompanying pricing strategy.
5. Involve your whole organization: Establish customer lifetime value as your most important KPI. The transition to a subscription model has a major impact on your organization and cash flow. The value you deliver will be monetized over a longer timespan than the initial acquisition. As a result, revenues after switching to a subscription model tend to be lower in the short run. Also, the transition from a single transaction process to a long-term customer relationship requires commercial departments to develop a new mindset. As such, customer lifetime value becomes the most important KPI for the entire organization.

This article has first been published in Dutch in “Marketing Tribune” in May 2018.