Retail

The Subscription Economy is here to stay

Archive April 2016

It is "such a good value, you'd be irresponsible not to be a member". Jeff Bezos wants you to join Amazon Prime. With 80 million members (not customers !) in the United States alone, at $99 per year, Amazon Prime is probably the best example of the emerging "subscription economy". From Netflix and beINSports to DropBox and Spotify to cite just a few, it is easy to notice the effort to "lock-in" customers for a longer period of time by transforming them into subscribers.

From a customer perspective, subscribing means choosing to be loyal to a certain provider: Amazon Prime subscribers shop 4 times more than non-subscribers, and Spotify Premium users generate 13 times more sales than free-of-charge users. But the subscription model is tough for companies to implement because of significantly higher than average cost of acquisition. It is not surprizing to see that the players who invested in the subscription economy still struggle to reach profitability. Today, the majority of new subscription models are subsidized  – so why are so many companies betting on it?

All that glitters is not gold

subscription models

All subscription models are not created equal, and their specificities are attached to different business goals and development stages. Pure digital companies that sell intangible assets (i.e. Spotify, Netflix or DropBox for example) leverage on subscription models to build a subscribers base that can be monetized with time. Subscription models allow for those kind of companies to show, at least on paper, a recurring stream of revenues over a longer period of time. And that is exactly what investors and creditors need to appreciate: the lifetime value of a customer has to exceed its cost of acquisition. For this kind of company, a subscription model is probably the best option to rapidly grow its market share and get investors' attention. Current technology allows for companies to "lease" rather than "sell" intangible assets: the cost of distributing an intangible asset becomes marginal when selling it once for all or leasing it over time. This very same advantage becomes a threat when we look at it from a subscriber point of view. 

For a subscriber, it is actually rather easy to unsubscribe from these services, thus managing/containing "churn" becomes key for any of the providers. Netflix is believed to lose around 1% of its existing customers per month, music streaming services as well as food delivery firms could lose from 5 to 10% of subscribers per month. 

The longer the relationship is, the wider the scope, the more data insights are captured and crunched, the more the products and services are tailored to a customer's unique profile.

Pure digital companies that sell tangible and intangible assets (Google, Apple, Amazon, etc.) mainly leverage subscription models to hook customers into ecosystems that are difficult to escape from. Being able to provide a range of services and products, from entertainment to mobile devices and/or grocery delivery, creates a superlative barrier to entry against competitors. The longer the relationship is, the wider the scope, the more data insights are captured and crunched, the more the products and services are tailored to a customer's unique profile. This creates a great customer experience, which is extremely valuable, but it also raises the cost of switching. A user would never want to lose his/her playlists on Spotify, giving the provider room to adjust pricing over time: this year Amazon Prime increased its monthly price in the United States by 18%, going from $10.99 to $12.99, and raised its yearly price from $99 to $119. As most of those models are subsidized, you can certainly expect prices to go up as time passes.

digital companies and their subscription models

Shutterstock - Credits: Shutterstock

Traditional companies accustomed to one-off purchases (big immediate tickets and less hurdles) have less incentives to turn them into recurring revenue. This approach will last until customers demand, market practices and lack of challengers on pricing models don't get hit by technological change.

From ownership to subscription: a passenger economy

$5,000

A YEAR

what autonomous cars could on average save an household driving 10,000 miles

Let's have a look at the automotive industry as an example. Up to now, most people purchased cars by paying a nice lump-sum to the dealer, or borrowing from a financial institution in order to spread-out the required lump sum into monthly installments. On top of that they can add an annual insurance premium and a maintenance plan to sustain. Today, a private owned car sits unused for 95% of the time and costs its owner about $1.20 per mile, while ride-hailing costs on average $2.50 per mile. A closer look at the car-hailing business models shows that 60% of the $2.50 per mile goes to driver compensation. Things are changing for the automotive industry. It's estimated that automatization (AVS) and electrification (EV) will reduce the cost of ride hailing by almost 70%, bringing it to $0.70. As the autonomous vehicles scale the cost of opportunity for car ownership will be undermined. It's estimated that on average, an autonomous vehicle could save an household driving 10,000 miles around $5,000 per year.


Shutterstock - Credits: Shutterstock
Shutterstock

It is not surprising to read forecasts such as the one from UBS Automotive Industry stating that by 2050, individuals car ownership will fall by 70%. As of today, car makers sell around 80 million vehicles to individuals worldwide, shaping a market of around $2 trillion. Their profitability is already an issue: Volkswagen sells around 10 million vehicles per year but relies on 2 million Audi and Porsche high-end models to build up 65% of its profit. In a not-too-far future there will be different models of cars (i.e. AVS + EV) that are more difficult and more expensive to produce, creating more costs. As people will switch from car ownership to ride services it is not too difficult to predict that private sales will dramatically fall, generating less revenue.

We are moving to a world where people are no longer willing to compromise with the time and hassle it takes to look after a car

Toby Kernon

Pricing models are also changing for the customers. Independent Brokers are leveraging the spiking consumer demand of mobility as a service by providing ever more flexible lease plans for different models of cars and brands. Toby Kernon, CEO of Wagonex, a mobility broker in the UK, is convinced that "we are moving towards the world where people are no longer willing to compromise with the time and hassle it takes to look after a car".

Mobility as a Service

Uber is testing a monthly subscription model in several US cities, with a fixed price for a set number of miles. Lyft started to offer a similar service based on a monthly payment. To survive, car makers will probably be forced to supply fleet operators as hardware providers – Uber like companies and cars lease brokers – or will try to reinvent themselves as mobility service providers. Today, the worldwide mobility services market (i.e. ride hailing based) is worth around $10 trillion. A recent study estimates that autonomous driving technology will enable a passenger economy worth $7 trillion by 2050, and car makers see different ways out. On April 2nd this year, a BMW dealership in Nashville will offer a monthly subscription membership to its customers enabling them to switch BMW models during the lifetime of the contract. BMW is the last among few others that already launched this kind of offer: Ford, Porsche and Volvo are testing subscription models as well.

As technology makes it easier for intangible assets to be leased rather than owned, I dare say that ownership is now of the past. As days pass, we indeed see technology percolating into tangible assets, generating the same above mentioned effect. And the automotive industry transitioning into mobility services industry could be the first example of it.

By Alessandro PROMUTICO
CEO de L'Atelier BNP Paribas North America