Last modified: 29. March 2019
Determining the right way to position your product for subscription billing can be a challenging task when trying to make a profit. Understanding how your service or product will best translate into a recurring revenue model is the first step in making the transition to selling software as a subscription. You have to balance strategies for new customer acquisition, increasing AOV, and long-term retention. Understanding the tradeoffs for each can guide your pricing strategy to achieve optimal profitability.
For software companies traditionally selling perpetual licenses, it can be a difficult transition to switch from higher immediate revenue per customer. However, if done right, the lower upfront cost offered through subscriptions can attract more customers and drive greater long-term revenue. Subscriptions will transform your business, creating new growth potential and allowing you to adapt to market trends and provide an agile framework to shift your sales strategies as needed.
Customers want immediate, ongoing value with frictionless experiences, and they prefer to choose how they pay for and access a product. The music industry provides a perfect example of creative monetization in response to the shift in cloud-based buyer preferences. Digital downloads and subscription services like Pandora and Spotify have altered the way we access and consume music so significantly that the industry has been forced to completely transform. Consumers and businesses today prefer access over ownership. Adobe has experienced a significant increase in profitability since embracing a recurring revenue model. And with their new subscription model, Autodesk has successfully linked their traditional products (desktop applications), with cloud-based support elements and updates leveraged within a subscription pricing model.1
There are many pricing models you can offer as a single strategy or in combination:
- Single price subscription is the simplest model, offering unlimited access to your product for a specific period of time (e.g. one year). It’s straightforward for your customers and simple for you, requiring minimal product setup.
- Tiered subscription pricing levels allows you to appeal to a broader customer base with different budgets. This approach provides options for the consumer based on different levels, such as duration of time or product usage, with discounts applied to the higher price levels to incentivize higher order value purchasing.
- Free-trial gives a low-risk option to test out your product before purchase for a defined period of time. This is a great way to acquire new customers and often the customer’s billing information is captured during the signup progress and yields a high sales conversion.2
- Freemium is another popular acquisition tool. Offer a basic level of your product—such as limited access or advertising sponsors—and incentivize upgrades to a premium level that unlocks additional features, removes advertising or other benefits.
Subscriptions can be excellent drivers of business evolution that deliver top performance and leave customers more satisfied with your brand experience than before. Savvy business leaders are paying close attention to subscription commerce, and learning how to turn this business model into a compelling competitive advantage. Understanding the psychology and motivations of this trend will help to create a seamless transition.
Areas to focus on to make a subscription strategy work for your business and achieve optimal profitability:
- Research the market.
How does your product compare with your competitors? You don’t have to be the least or most expensive, but you do need to offer something of greater value that differentiates you from your competitors. It’s crucial to know how your product/service compares against your competition to get a clear picture of which elements of your offering are superior and how to appropriately price your product, based on value.
- Find the right value.
Calculate direct costs per user to understand the price point you need to start making a profit. Then consider which of the previously mentioned pricing models is best for your product. The longer a customer is willing to pay for your product and/or services, the greater their lifetime value (CLV) will be to you and, if priced appropriates, the more profitable you will become with each customer over time. To keep your customers satisfied, renewing and upgrading, you have to find the right balance of price and value. You’ll do well as long as you can deliver ongoing value and nurture the relationship between your customers and brand. Many companies offer product upgrades, upsells and cross-sell merchandising to increase order value and extend CLV.
- Trial, test and analyze.
The only way to find out the right pricing and subscription model for your business is to take some calculated risks and try out new approaches. Market testing different price points and access models will yield the insights needed to know if you have achieved the right market strategy and how price points are resonating with buyers. After measuring sales and testing pricing for a few months, you should analyze the results and assess your product price. You may find that your product is undervalued or overpriced. Since the market is constantly changing, product pricing and monetization modeling should be a continuous assessment against the competition and overall market.
- Manage subscriber churn.
While subscriptions are an excellent tool for new customer acquisition, achieving profitability in a subscription business is dependent upon customer retention through renewals. The greatest opportunity to influence long-term revenue growth lies within your ability to properly manage involuntary churn—when renewals fail due to reasons beyond the customer’s choosing. According to a study conducted by Forrester Research, 34% of all subscriber churn is involuntary. That number can even reach 50% or more for high-tech software companies with a high percentage of auto renewals. That’s a significant amount of leaky profits. On the flip side, increasing your retention rate by only 5% can lift profits by 25-95%.3, 4
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- Digital River customer data on file.
- “The Art and Science of Reducing Involuntary Subscriber Churn” by Forrester Research.
- “Customer Retention Should Outweigh Customer Acquisition” by Jerry Jao, Retention Science.