So, you’re considering the move to a subscription-based commerce model. You’re in good company. Businesses and brands across the industry spectrum are transitioning to subscription or automated payment models to meet consumer preferences.
Now the question is: How will you implement it? As with other critical business decisions, there are choices to be made. At a high level, there are three basic models for implementing subscription-based payments. Determining the right one for your business depends on a range of factors—from the type of product or service you offer to your financial and marketing strategies.
Let’s review these three subscription models and discuss some key considerations and best practices for each.
Prepaid Subscription Model
This model is based on a prepaid monthly or annual subscription, with no long term commitment; if the consumer stops paying, they stop receiving the service. Think Netflix. This is the simplest model and, for most businesses, the easiest to implement. It’s also the model consumers are most familiar and comfortable with. And it works with the broadest range of products and services—everything from software-as-a-service (SaaS) to consumable replenishments or “of-the-month” clubs.
For new products that involve a replenishment, it’s important to consider the re-fill cycle. Will the consumer receive your product every month, every three months, or some other interval that makes sense for the product category? Ideally, the billing cycle will map to the replenishment cycle, so the consumer isn’t getting billed in a period when they aren’t receiving product.
In some cases, businesses with existing subscriptions may consider moving from an annual to a monthly payment in order to reduce the barrier to adoption for consumers. This poses a challenge: Going from a single annual billing transaction to 12 transactions dramatically increases the costs associated with credit card processing fees. If you’re paying a $0.30 transaction fee on top of a percentage, going from an annual to a monthly subscription will cost an additional $3.30 per customer plus a percentage for every one of those 12 transactions over the year.
There’s also the added infrastructure cost to consider. If a business has one million customers, moving to a monthly subscription will potentially increase their workload from one million per year to 12 million per year—or even more, assuming you attract more customers. More transactions mean more administrative overhead, more storage, more bandwidth, more of everything that supports each billing cycle.
Another issue to consider when moving to a monthly subscription is that the consumer now has more opportunities to opt out during the year. This means your product or service must deliver value every month—not just on a 12-month or 18-month product upgrade cycle. In fact, consumers may churn throughout the year for reasons as simple as changing credit cards and failing to update their billing information. Monthly subscriptions lower the barrier to entry, but they also lower the barrier to cancel.
Despite these potential downsides, going to a monthly model can be an effective strategy for attracting new, more budget-conscious consumers, potentially making the added cost and churn risk a worthwhile investment.
One other consideration with prepaid subscriptions is what billing schedule to use. Should you bill everyone on a particular calendar date or on the date they purchased? In other words, do you do all your billing at once or spread it out? The answer will depend on a range of factors specific to your business, including your billing infrastructure capacity and, for physical products, your supply chain and logistics realities.
Term-based Contract Subscription
With this model, the consumer is committing to a specific term, such as a year or multiple years, but they are billed on a different cycle, often monthly. If the consumer breaks their commitment prior to the term ending, a penalty of some kind is assessed. Satellite TV contracts operate on this model, for example. In some cases, a term-based contract option may be offered alongside a prepaid subscription option, with the consumer receiving a discounted price in return for the term commitment.
This model offers businesses a higher degree of financial predictability. However, in order to entice consumers to sign up for longer term commitments, companies typically bill less than they might for a regular prepaid monthly subscription. So it’s important to analyze the financial implications of this trade-off up front. Is it worth getting $20 a month rather than $30 a month in exchange for the predictability of a long-term commitment?
Term-based contract subscriptions also introduce accounting considerations. What about penalties assessed when a customer bows out before the contract term is ended? This increased accounting complexity may translate into higher administrative costs.
If you decide to go with this model, make sure the infrastructure tools you use to handle payments offer the flexibility to determine how you define contracts, with the ability to quickly and easily modify that in the future if your needs change.
As the name suggests, this model involves billing the consumer only for what they use, after the fact—like a utility bill. This offers consumers the advantage of never having to worry about paying for a service they won’t use while on vacation, for example. However, usage-based billing also offers less predictability, for both consumers and for businesses. Think back when text messaging was handled this way and consumers complained about getting $600 bills when their kids abused their texting privileges.
In part because of this lack of predictability, many businesses today employ usage-based billing only for things like overages or special services on a regular prepaid or term-based subscription. An example might be metering on-demand movie services on top of a regular, monthly cable or satellite TV subscription, where the consumer pays an additional fee for every on-demand movie streamed. Or a service where the consumer pays based on how many people have access, such as a telephone or video conferencing service.
In addition to the lack of predictable revenue, companies implementing this model also face challenges around bad debt and collections. Because the usage is billed after the fact, consumers may dispute charges or simply refuse to pay, leading to collection costs and lost revenue.
Businesses pursuing this model need a system that can handle a highly fluid billing volume and monitor a wide variety of usage variables (time, participants, downloads, etc.). For some services, such as internet radio, this may require logging usage information to drive personalization of the service to each customer.
The Value of Flexibility
There are many factors that play into determining which subscription approach is right for your business. Moreover, what works well in one market or demographic may not work well in another, leading some companies to pursue multiple, targeted approaches. So it’s important to build out a subscription payment infrastructure that offers the flexibility to support whichever model or models makes sense today—with the ability to change in the future if required.
Carefully consider the often overlooked cost of infrastructure and seek out solutions that don’t add to administrative complexity. Leveraging SaaS platforms built to support the peaks and valleys of subscription models, while providing the scalability to support rapid growth, make a lot of sense. And make sure you have the flexibility to determine which payment methods you accept for different types or levels of subscriptions, helping minimize the impact of transaction fees on micro transactions.
Ready for a subscription model? Great move. Just make sure to take a good look at your consumer, your product and your business model before locking in your approach.
James Gagliardi is vice president of strategy and innovation at Digital River