Ecommerce merchants recently discovered the subscription business model and, since then, it has exploded in popularity among a diverse range of stores. From the razors of Dollar Shave Club to Japanese Candy, Dutch Waffles and even a guitar delivery service, creative entrepreneurs are applying this model with growing ingenuity.

Not surprisingly, many of our customers at Compass are joining the bandwagon, and this got us thinking: are there particular types of companies for which this model is more suitable than others? How can businesses take advantage of it to increase profits? How do subscription customers compare to transactional customers in terms of long-term profitability?

Of course, there’s nothing new about a subscription-based model. We have been subscribing to newspapers, magazines, TV channels, sales clubs, fitness clubs, mobile companies, and so forth for many years. But as a wider range of products becomes available in this convenient model, both users and businesses seem to be benefitting from it.

Users get convenience and an increasingly longer tail of product choices. For a one-time entry of their credit card information, users are regularly greeted with their favorite goods and services in the comfort of their homes. When prices get lower, and life gets busier, it’s no surprise that this affordable convenience has started to gain traction.

However, the subscription model is not only good for consumers. John Warrilow went so far to say that “It’s the perfect business model because it provides the greatest value to both the entrepreneur and the customer.”

Figure 1 depicts the ratio of subscription customers’ LTV (customer lifetime value) to transactional customers’ LTV among online merchants who work with the two models. A value above the green line indicates that these businesses’ subscription models have a higher LTV (a measure of profitability) than their transactional counterparts.

The increase in LTV, as indicated by the green line, is significant. Merchants working with an average transaction value below $25 have customer lifetime values 1.78X higher for subscriptions than for non-subscription customers (LTV ratio).

The benefits of subscriptions are also clear for merchants with average transaction values between $25 and $75. For merchants with an average transaction value over $75, the LTV ratio is below 1.0, with only 34% of merchants recording a higher LTV for subscriptions customers than for non-subscription ones.

In particular, Food & Drink and Health & Beauty product categories benefit the most from subscriptions (Figure 2). This is more than any other vertical we’ve come across so far.

The benefits of subscription models

1. It is easier to obtain a higher Customer Lifetime Value (LTV)

In a transactional ecommerce model, a customer’s first purchase is only the first step in a company’s marketing efforts. To leverage a high LTV, they need to do much work to bring that customer back to buy more and drive more value for the business.

LTV is very unpredictable and difficult to calculate because some users come back while others don’t. It is not simple to predict what type of customer is worth spending more to acquire as opposed to another.

However, in a subscription model you have a much clearer picture of the value of each customer. All you need to do is calculate the average time they stay as a subscriber to know their LTV and, subsequently, how much you can spend to acquire them.

As importantly, even though each customer is paying every month, they only need to make a purchase decision once. That takes off a huge burden from your client’s decision-making process. They don’t need to do anything to keep buying. This differs from transactional customers who, with each purchase, must engage in a new cycle of decision making.

2. More predictable monthly revenue and growth

With a higher retention rate and a clear idea of how long the average customer will be buying from you, it becomes easier to predict monthly revenues in the near future. You will know with higher certainty how much can be spent on the acquisition of each customer to generate revenue and growth.

3. Easy Shipping Procedures

Most subscription-based ecommerce businesses have only one product, with maybe a few different subscription levels. That limits the number of packages that need to be assembled and shipped each month. The shipping process becomes smoother and predictable, which makes the ability to forecast shipping costs and profits much easier.

4. Choices Kept to a Minimum

Another advantage of having a limited amount of options is that, for most buyers, too many choices end up having a paralyzing effect on them. Buyers even subscribe tosurprise boxes, where they don’t need to exercise any purchase decision at all. It’s convenient for the consumer, who needs to exert less effort, and it’s great for business.

5. Easily Identified Buyers

Most subscription services can easily identify their core buyer personas. Since they often specialize in niche segments, each subscription service knows what they hope to accomplish for each and every buyer. Knowing a lot about a customer segment and focusing on them is the best way to deliver to their needs.

 

Case Studies

 

Death Wish Coffee Grows Revenue with Bold

Death Wish Coffee needed to overcome two big challenges along the way: scaling their business and finding ways to keep customers coming back over and over again. Their sales started to increase when they started using Bold’s Recurring Orders app to offer their coffee on subscription. In their own words, the main way they scaled their subscription business and drove customer loyalty through the roof was “honestly, by adopting Bold”.

They soon achieved a 20% increase in revenue thanks to a constant rise in repeat purchases from loyal customers. When asked how this has improved the relationship with their customers, they put it best when they said, “People committing to a subscription are implying they can’t go without your product.”

5-hour ENERGY Increases Profitability with ReCharge

5-Hour ENERGY sells liquid energy shots that can help you feel energized and alert for hours. They wanted to increase the profitability of their sales and did so by adding a subscription model to their online store, using the app ReCharge to do so. This allowed their customers to easily subscribe to products and manage their subscriptions while retaining their existing payment processor and promotion strategies.

5-Hour ENERGY adopted subscription selling as an additional option to their pre-existing one-time purchase options. Recurring billing now represents 45% of 5-Hour ENERGY’s online Shopify sales. In the months following their launch with ReCharge they reported that their subscription base grew approximately 10% per week.

Jimmy Club Creates Striving Businesses with PayWhirl

Jimmy Club, a condom subscription service, was created by a few Arizona State University friends for a business pitch competition in 2015. They started using PayWhirl to manage their subscriptions in September 2015 and quickly scaled to thousands of monthly subscribers. In total, they spent $11,512 on Facebook marketing (pointed directly at a landing page with a PayWhirl recurring payment widget) and netted $39,929 in their first few months.

In fact, they did so well that they started another subscription business called BuddaBox that blew the Jimmy Club’s sales out of the water. BuddaBox, which offers monthly “420 essentials” now has tens of thousands of subscribers billing monthly. It’s quickly become a multi-million dollar subscription business that was launched entirely on PayWhirl technology in a few months. BuddaBox’s average customer LTV is still climbing and has more than doubled in the last three months as they’ve added more and more subscriptions offerings.

 

Subscription Model – Best Practices

1. Create buyer personas for your subscription service

Creating buyer personas is already standard practice among the most successful startups in Silicon Valley. While they are significant in any marketing and product efforts, buyer personas are critical to a subscription business. Your clients are going to stay with you for a very long time (that is the objective regardless), receiving content, services or products on a regular basis, sometimes for years. It is crucial that you learn a lot about them—as much as a book or a script writer would know about their main characters. If you need help building your personas, this template from Hubspot will certainly help.

2. Use a separate marketing strategy for your subscription service

Your subscription service deserves its own marketing strategy. This may include social media accounts, loyalty programs, packaging, email marketing, and so forth. Make sure your marketing is making a very positive impact on your customer in each delivery.

3. Content-led ecommerce

Perhaps the most remarkable example of this was Dollar Shave Club, with their hilarious introductory video that went viral. Now it has become somewhat of a trend to have editorial content on the cover of subscription-based ecommerce sites instead of products. Treat your blog and social media outlets with care and dedication, build up your voice, and start engaging with your customers.

4. Focus on what makes you unique

Some products are so innovative that they do the job of standing out in their uniqueness. However, practical, functional products often don’t have this edge, even if they have great quality. In which case, like the Dollar Shave Club razors mentioned above, unique content can go a long way in making your company seem exciting.

5. Give fewer and clearer options

Transactional ecommerce is all about choices. Amazon, Zappos, Wal-Mart, Staples—they all grew exponentially by offering a long tail of options. Subscription ecommerce has more to do with fewer curated choices that users can very quickly decide on.

6. Your first shipments are critical

Give everything you can to “wow” your first customers and gather the testimonials you need to reach out to more clients. Transform your first buyers into evangelists and you are on the right track for exponential growth.

7. Customer relationship management is amplified in a subscription model

Relationships matter. Because your time with each client is increased in a subscription model, you need to make sure to understand and care for their needs. Introduce a CRM strategy from the start and invest in customer care and support.

 

The Different Types of Subscription Businesses

There are several types of subscription models you can choose from. Below are the main ones adopted by ecommerce merchants. See Marty Zwilling’s article in the Huffington Post for the description of additional types of subscription.

Consumables: If your ecommerce sells products that need to be re-purchased regularly, then a subscription model can go a long way in providing convenience for your customers and higher LTV for your business.

Surprise box: A model that started with wine boxes and is now used in virtually any type of product you can imagine. Consumers love the idea of receiving a curated box of goodies on their doorstep every month.

Private clubs offer their customers a higher status by providing them with exclusive access to products, content, and services.

Front-of-the-line: Some businesses are charging subscriptions for customers that are not price sensitive and do not want to wait in line. It is popular with companies that provide customer service, as well as airlines, hotels, and clubs.

Conclusion

The subscription business model works remarkably well for merchants working with an average transaction value lower than $75, though works less well for an average transaction value above that.

Even though our data seems to correlate subscription success with the categories of ‘Food & Drink’ and ‘Health & Beauty’, our hypothesis is that products in any category can be successfully sold via recurring billing. Success seems to depend on the intimate knowledge of the target customer, rather than anything else (even transaction value). As we saw above, if applied correctly, the subscription model has proven to increase profitability dramatically, and it is well worth considering.