For ecommerce merchants, predictable revenue can often be elusive as customers purchase items one-off, and inevitably move on. Enabling subscriptions for your brand can turn one-time transactions into long-term relationships, ultimately reducing churn and increasing customer lifetime value (LTV).
Subscription revenue models have continued to gain popularity, due to the potential for exponential growth as more subscribers are acquired. With increased average order value (AOV) and extended lifetime value (LTV) per subscriber, the revenue for a subscription company continues to compound over time. On the flip side, ecommerce brands who focus on one-time purchase opportunities tend to see flat growth year-over-year or slight, incremental growth as new customers come onboard.
What is a subscription revenue business model?
A subscription revenue model creates a predictable recurring revenue stream—whether in terms of a streaming service, memberships, subscription boxes, or auto renewals (replenishment) of commonly used items.
In the ecommerce industry, subscription revenue businesses differ from regular revenue businesses in that there’s a much heavier emphasis on retaining existing customers versus attracting brand new ones. In fact, we know that in any ecommerce business, the customer acquisition costs are significantly higher than retaining customers. A subscription business model allows for the focus to be on the customer base—amplifying the customer experience over a longer period of time and continuing to create compounded value that prevents them from churning.
The forecasting process within a subscription-based business model allows you to predict a few key elements:
- New subscribers
- ARPU: Average revenue per user (subscriber)
- Lifetime value (LTV)
- Churn rate
- Monthly recurring revenue (MRR)
- Annual recurring revenue (ARR)
Types of subscription revenue business models
Subscription businesses are more common than ever, and as a result, fall into a few main categories. Some of these categories of subscription businesses are:
- Streaming services: The most widely-used subscription business model is streaming services, such as Netflix and Spotify. These services allow members to pay a monthly recurring fee to access thousands of titles. Many of these customers have actually opted out of traditional cable and music services and have obtained a large number of streaming services instead.
- Ecommerce subscriptions: These subscription business models are almost exclusively product-based, providing customers with tangible goods for a recurring fee.
- Curation: Curated subscription boxes are the most popular business model for ecommerce subscriptions. In this model, customers receive a monthly box of curated items, typically around a specific theme like beauty brands, or regional snacks.
- Replenishment: Replenishment boxes are gaining popularity as a subscription business model. These subscriptions are specific to products that require refills on a regular basis, such as laundry detergent, deodorant, or even toilet paper.
- Access: An access subscription model focuses in on memberships. Customers buy in to the program, and in return, receive special deals or early access to products.
- Software as a service (SaaS): Software as a service subscription businesses offer applications to consumers or other businesses for a recurring fee. Often priced monthly, but billed annually, SaaS companies are able to maintain the product for their customers as updates are available as a result of their recurring subscription. The recurring revenue for SaaS companies is fairly straightforward, in that tangible products are rarely shipped and distributed. Instead, SaaS companies provide the service to customers using their software on a monthly or annual basis.
The benefits of a subscription revenue model
Offering subscriptions for your customers can result in a slew of benefits for your brand. Leveraging analytics to forecast important metrics can help you optimize and plan for future launches or strategies. Some of the main benefits of a subscription revenue model are:
Predictable revenue & better forecasting
As subscribers enter the funnel, your brand can utilize your average revenue per user (ARPU) to determine what each customer’s overall contribution to the pipeline will be. Let’s say a customer signs on for a subscription, and you know they will spend about $40 a month with you. By understanding how long most subscribers stay with your brand, you can estimate how much that individual will spend with you, and often about how long it will be before they potentially churn. Having that opportunity to calculate recurring revenue can allow for more investment opportunities in the future.
Focus on customer relationships
Due to the predictability and automation of subscription based business models, the focus on individual transactions can migrate to building strong customer relationships. A customer who subscribes to your brand is in it for more than just a one-time transaction. They are looking for the value in that subscription relationship—beyond your product offerings. This in turn increases their lifetime value.
How does subscription revenue benefit your customers?
Subscription services have become wildly popular in the last few years. In fact, it is estimated that the subscription economy will hit almost $478 billion by 2025. For your customers, paying a subscription fee is not out of the question, as long as the value is there.
Today, the subscriptions industry is seeing monumental levels of growth across verticals.
Many customers subscribe to brands due to the convenience. Especially in 2020, during the lockdowns from COVID-19, consumers were looking for ways to obtain products they would normally shop at brick-and-mortar stores for. As a result, many consumers were exposed to the possibilities of subscription-based products for their homes and personal lives that they normally shopped in traditional retail stores for.
Customers have also become familiar with various subscription plans, whether they are billed monthly, semi-annually, or annually. In the State of Subscription Commerce report, we saw many merchants provide their customers with options for greater flexibility and customization.
Another important aspect of subscription flexibility is the opportunity for customers to easily add on products to their monthly box from a merchant. Leaning into convenience, these add-ons not only serve as a benefit for customers, but also for subscription brands, increasing their cross-sell and upsell opportunities. As long as the value is there for customers, the chance that they’ll purchase more products stays high, ultimately increasing their AOV.
How to calculate your subscription revenue
Subscription revenue calculations are straightforward, in that they are the sum of all successful subscription transactions over a given period of time.
Slicing that data even further, you can measure the average revenue a subscriber brings in (ARPU) by dividing subscription revenue/average subscribers. For example, if you brought in $100,000 in subscription revenue in a given month, and had 10,000 subscribers, your average revenue per subscriber is $10.
To project your monthly recurring revenue (MRR), you take your annual recurring revenue (ARR), and divide it by 12 months. However, with the cumulative growth of subscription revenue, a monthly recurring revenue typically does not average out equally throughout the year.
Other KPIs to track to measure the health of your subscription brand
Having a subscription business model not only allows for you to have a predictable revenue stream, but also a slew of other benefits that you can track to measure the health of your brand.
- Average order value (AOV): Average order value measures the amount of revenue brought in per subscriber for every order. With increased focus on relationships and the ability to cross-sell and upsell more seamlessly, subscription merchants tend to see higher average order values. And in 2020, we found that almost every vertical saw increases in AOV throughout the course of the year.
- Lifetime value (LTV): Customer lifetime value is calculated by dividing the ARPU/ churn. Your goal is to keep your subscribers for as long as their lifecycle with you allows, so having a strong lifetime value metric helps quickly see the results of your efforts around subscriptions.
- Churn rate: Your churn rate is the rate at which your subscribers are canceling subscriptions with your brand. If you notice your churn rate start to increase, you can work to identify the source of the churn and allow for a specialized focus on why customers are churning.
Leveraging a subscription revenue model for your brand
You may wonder if offering subscriptions is right for your brand. Consumers are being more widely exposed to subscription pricing tiers and a recurring product offering which means the pool is growing for potential new customers. With the opportunity to forecast your recurring revenue and subscriber growth, the benefits of offering subscriptions are substantial.
Subscription management doesn’t have to be complicated. Using a subscription payments solution like Recharge for your subscription management allows for you to enable subscriptions seamlessly, so you can focus on building strong relationships with your customers.