The Subscription Advantage
The tech industry has been enamoured with the subscription business model since the late 1990’s as Netsuite and Salesforce first began offering applications as a service over the Internet. The “Great Recession” of 2007-2009 accelerated the adoption of software as a service (SaaS) across a variety of businesses as capital investment dried up and companies that wanted to be competitive moved software acquisition to SaaS and subscription (and their operating budget versus capital budget). Since 2009 SaaS and cloud computing has rapidly expanded to include all types of technology from infrastructure (IaaS) to hardware and is the default business model for most tech companies. Over the past 10 years that expansion of the model has moved into a rapidly growing list of industries including consumer goods, automotive, manufacturing, media, entertainment, and many others. Offering subscription based products and services provides several business benefits, including:
Recurring revenue that increases the businesses’ ability to forecast revenue more accurately
Ongoing customer relationships that create future opportunity for revenue expansion from additional units of current product or service, add-ons to the product or service and future product and services offerings (upsell and cross-sell)
The revenue predictability and opportunity for expansion is seen favorably with investors, which can increase valuations and access to capital
Reduced customer acquisition costs
Reduced cost of customer retention
Depending on the specific product or service, better capability to manage inventory and / or manage resources
The past three years have been very difficult for many businesses and forced many businesses to deploy new technology to enable changing business processes required to survive. Have the business benefits of a subscription business model given these companies an advantage through the economic pressures of the pandemic?
Zuora’s Subscription Economy Index™
To answer this question let’s examine some data from subscription management software provider Zuora taken from the latest Subscription Economy Index™(SEI), released this past week. The SEI is a bi-annual report based on benchmarks collected from over 500 Zuora Billing customers across a variety of industries and focused on Q1 and Q2 2022. Based on the SEI, the simple answer to my question is the companies in the index grew 9% more than the S&P 500 for the first half of 2022, and looking at Q2 alone, the SEI companies grew 24% more than the S&P 500 (which reported a revenue decline in Q2). Over the long term the difference is even more pronounced. Comparing the combined annual growth rate (CAGR) over the 10 year period of 2012 to 2021 the SEI companies grew revenue 17.5% versus 3.8% for the S&P 500. Other highlights from the SEI include:
Subscriber retention: Quarterly churn rate, or subscriber non-renewal rate is a critical business health metric, and in the SEI is lower than it was in 2019 (pre-pandemic) at 6.13% instead of the 2019 average of 6.5%.
Subscriber acquisition: Subscriber growth rate average nearly doubled in the 1st half of 2022 at 2.35% over the 2021 quarterly average of 0.86%. Considering the current macroeconomic conditions versus 2021, that number is even more revealing on the power of the subscription model.
Subscription revenue expansion: Average revenue per account (ARPA), which is another critical business metric for subscription businesses, dropped in Q1 to 0.94% versus a very strong Q4 2021 average of 2.78%. In Q2 though, ARPA recovered to 1.89%, beating the 3 year (2019-2021) average of 1.81%.
Gaining the Advantage
The data shows some real business advantages playing out for companies that have already moved to a subscription business model both during the troubled economic times of the pandemic and also over the past 10+ years. If you look at just SaaS companies, which are by far the largest segment of subscription based companies in the SEI, the revenue growth in Q1 was 2.63%, and jumped to 4.08% in Q2. Subscriber growth was also strong for the SaaS companies, with 2.16% in Q1 and 2.03% in Q2. The strong growth rates are the highest since Q2 2019, and have trended up since Q4 2020.
Subscription, or recurring revenue business models continue to prove that they are resilient and a solid foundation for business success. It’s a simple decision for startups, especially those with some type of software offering, the subscription business model is now the default. Moving to subscription for an established business, either by launching a new product or by moving a legacy product to the model can seem daunting. It is both a cultural shift and a business model shift, which can complicate the process. The necessary ongoing relationship of the subscription model changes the way traditional product companies think and function. It’s much more important for business success to nurture the customer relationship and demonstrate true business value in the offering. If you’re considering launching a subscription business and/or product line, Arion Research can help.
