A long time ago, in a galaxy far away, most consumer enterprises were in the business of selling physical items that could be held, consumed, and bought again. Whether it was a cheeseburger at McDonalds, a quart of milk at the grocery store, or a stamping machine from an industrial supplier, the pricing model was simple: Take the cost to produce, add profit (plus padding for high market demand), and you’re done. Ship one unit, charge for one unit. Simple.
However, companies started changing the game in a bid to squeeze more juice from the berry. Companies like General Electric pioneered the concept of service contracts—added on to unit sales to help increase recurring income. In its model, GE would, for example, sell a jet engine for a fixed price, and along with the engine, sell a lifetime service contract – “power by the hour.” It worked for both the customer and the supplier – the customer got rid of the maintenance cost and headaches, and GE found a way to add additional revenue and profit.
Then, with the dawn of the computer age, software companies took this a step further. True, software originally started out as a “by-the-unit” purchase. You bought Microsoft Office for a fixed price, installed it on your hard drive, and eventually bought another one for a fixed price some years later when the software was updated with new features and speed. Eventually, however, software companies started offering subscriptions – for the “convenience” of paying a certain amount per year, you will be rewarded with the benefit of always having the most current version. The advent of the cloud hyper-accelerated subscriptions, since software maintenance and updates were now quick and effortless.
Today, subscription services are expanding into unexpected areas. A local car wash is offering an unlimited $12.99 per month subscription – stop in any time. The idea is to create a “habit” of getting your car washed, and, of course, once there, upsell other services (would you like a hand wax to make your car even shinier?). And, of course, most people today get their cell phones on a subscription.
With such a dizzying array of pricing options, it can be hard for a company to settle on what’s right for its business model. Are you “old style” unit pricing, “new style” subscription pricing, or a little bit of both? Here are four tests to help you figure out what is best for your business:
- What is your purchase cycle? If you are an industrial parts maker selling components that are purchased during the 8-10 year depreciable life of a machine, unit pricing probably works best for you. Certainly, there might be a service contract opportunity, or a bundling opportunity with other equipment, but the enormity of the individual sales price, along with the long service life, would likely mitigate against subscription pricing in this case.
- Do you have the ability to upsell? Some companies use subscription pricing as a marketing tool to drive traffic, like the car wash example. Clearly, if a consumer gets a wash every day -- 30 car washes per month, the car wash operator isn’t going to make any money by charging $12.99/month (that equates to 43 cents per wash)! But if the standard wash included in the subscription is $4, and the optional add-on wax option is $3, and the optional undercarriage cleaner $3, suddenly a $4 transaction is now a $10 transaction. In a business with low incremental cost (you are running the car wash machinery all day anyway) this can work for everyone. The customer gets a deal for their loyalty, the car wash gets more revenue and profit.
- Do you know the lifetime value of your customer? Creating a habit with a subscription model—which equates to a sort of financial annuity for a company—makes sense for both the customer and the company if the company understands what the lifetime value of that customer’s business is, and the customer also sees the lifetime value. This particularly is true if your service has a low incremental cost like most software, which, once written and paid for, essentially has a production cost of zero. If you are Microsoft, enticing a customer to use Office forever has a tremendous value. The same can be said from the standpoint of the customer – they benefit from a familiar product, their software is always up to date, and they have ready access from any device.
- Can a subscription make your product accessible to a larger market? Cell phones are a great example. An iPhone, on a unit basis costs between $600 and $1,200—way too high for most people. But break that up into monthly payments over a three-year contract, and it opens up a much wider and deeper market. And for the bleeding edge tech aficionados, there’s even a plan whereby a consumer can pay a monthly fee and always be guaranteed the latest and greatest iPhone with all the bells and whistles every two years.
Not all is perfect with subscription pricing. Some cautions:
- Multiplier effect: While an annual subscription can make both business and personal budgets more predictable, adding a number of subscription plans can add to overhead cost, particularly for those recurring tools that don’t get used. Think of a newsletter that you don’t really read any more, but every year your Visa card gets charged the annual fee.
- Visibility: It’s too easy for the customer or the business to lose price sensitivity. Drivers with the EZ Pass automated tolling device know that replenishment operates, automatically, in the background. Though the consumer has a general idea of how much they are spending when whizzing through toll booths, they don’t typically pay the monthly bill much notice. This makes it very easy for toll authorities to increase prices. If the bridge toll goes from $5 to $10, that normally would cause an outcry that would serve to limit the amount of increases. But a 200 percent increase—when spread over a subscription—is far less visible. The same is true for business purchases.
Subscription pricing is here to stay, and in many cases, has big benefits for both the customer and the supplier. The key is to understand your market, how people use your product or service, and what other products or services might be related. But a smart consumer will ensure they evaluate subscriptions periodically or even “sunset” them so they can truly understand whether the price/value scales are still tipping in their favor. Understanding all this, and executing smartly, can result in better business for you, and a better experience for your customer.