B2B Business Model – Subscription
This is a series of posts on Business to Business (B2B) internet business models. If this is your first post, you may want to start with overview and presentation here. This post is designed to help you know how to determine your assumptions for a Subscription business and financial model.
The subscription model is definitely one of the most popular internet B2B business models for any number of reasons:
- Compared to the history of huge enterprise software installations, a monthly per-seat fee was a huge competitive advantage. I remember my first startup had an enterprise install of Onyx Software, a CRM software that cost $250k to license and install
- Recurring revenue is less lumpy than licenses sales – Computer Associates used to do a huge percentage of their annual sales in December every year (last month of the last quarter) because they trained their customers to wait to purchase
- The stock market/investors reward recurring revenue businesses, predictable recurring revenue is preferred; you just need to make sure to manage your churn
Most importantly, from the customer’s perspective, they:
- Pay for what you use
- No Hardware/Servers
- Easy setup, ready to go now!
Like all of the business models, you have some key assumptions in your hypothesis for marketing. The following key metrics represent the assumptions that will go in your financial model, as your key assumptions:
- Customer Acquisition Cost (CAC) – How much does it cost you to acquire a customer? There is a difference in the cost at the launch of your startup than at scale, but you’ll need to have a hypothesis about how much it takes to acquire a customer. FINANCIAL MODEL EXAMPLE: this will show as $1,000 in advertising spent to get 1,000 visitors, or the cost of a list purchase and the number of cold calls required to get 10 appointments/demos/
- At Launch, you, as the Founder, may be talking to every customer, though that won’t scale and you aren’t likely calculating the cost of your time. The important thing here is for you to interact with your customer to learn directly from them why they are using their product, and the value they are willing to pay.
- At <in order to> Scale, you will need to have validated your CAC assumptions. This includes validating your sales model, e.g. direct sales or web direct sales.
- Lifetime Value (LTV) – How long do you assume you will keep the customer? Again, this can be different at launch and scale, but a normal LTV period could be 20-36 months.
- Conversion Ratios
- Total traffic (1,000) to your site (regardless of channel)
- Registered for Free trial (100)
- Conversion to paid (10)
Key Metrics Subscription
- Average Revenue Per User (ARPU), sometimes called Average Revenue Per Paid User – How much will each user or seat pay per month?
- Average Revenue per Customer – Again, this post assumes B2B vs. Consumer. Though you may start selling individuals within a company (Box), you’ll eventually end up billing multiple users within a Customer. What are your seat assumptions?
- Churn – Of your monthly average users, what percentage per month stops paying for your service every month? This could easily be 5% of paid users per month. It’s part of your LTV calculation, but shows up on the spreadsheet as churn or retention.
There are other metrics you’ll want to track for non-financial measures as well. Things like:
- Time from registration to conversion – this can be an early tell-tale of MVP vs. KAP, see below.
- Frequency – how often do the users come back to use the site/app?
- Time on Site – how much time is spent on your site/app?
- Amount of Data input/shared – if your site/app builds around data, the amount of data the customer adds can be a factor which makes it harder to cancel.
The subscription model is a favorite for internet companies, but there are some challenges to keep in mind:
- Minimum Viable Product (MVP) isn’t a Kick Ass Product (KAP) – you may not be able to garner much revenue or learn much about your assumptions until you launch enough of your feature set to get customers to pay.
- Pricing the service too low – and yet, it can still be hard to sell. If your product requires a direct sales model (someone to call on customers to make a purchase decision) you will likely need a first year transaction price of >$2,500. Without that price point, you won’t be able to scale a sales force.
- The trend of Consumerization of IT is a trend in your favor, however, to achieve that level of acceptance, your product has to lower the friction required to purchase and use the product. That also means just saying your product is easy to use doesn’t make it so.
- Freemium vs. Free Trial – most of the scalable examples of B2B models offer a free trial vs a Free Version, there is a difference.
- TEST, TEST, TEST – you need to test all of your hypotheses. Don’t get too convinced of your assumptions until you actually get the data.
- Salesforce product took off for a number of reasons:
- Easy to use by the sales person and they could expense the product – be aware of your price point and take credit cards. There were other similar products launched at the same time, but SF allowed you to import your data and get started in a very easy way. Their pay wall required you to come back and add a credit card after 30 days. Consequently, the users had not only imported but had used the data and it made it harder to switch.
- MOZ, formerly SEO MOZ, is one of the few companies that has actually scaled their product sales without a scaling a sales force. One of the reasons for their success is that users are social media influencers and community managers, which encourages sharing within the user base. These influencers also take the tools with them when they change companies.
- Box and Dropbox are both products that increase sharing with users inside and outside the enterprise as part of the nature of the product. What sharing functionality can you implement for your users?