The growth of a subscription business has a natural tendency to plateau. This article examines why that is and what you can do to prevent it happening to your business.
There are three key ways in a subscription business that you can increase revenue these are:
- Increase the rate of Acquisition of new customers
- Increase the Average Revenue Per Customer (APRC)
- Reduce the rate of Churn
Of the three churn rate is special because its affect is naturally compounding over time, let me explain. When we model churn, we obviously don’t know which customers will actually leave but instead, based on averaging the behavior of customers, we observe that there is a probability that any given customer has a probability of, say 1%, to leave each month. So, the actually number of customers that churn per month depends on the total size of the customer base. With a customer base of 1000 customers we expect to loose 10 per month, if we have 10,000 customers we expect to loose per month 100.
Compare this with rate of acquisition. It is tempting to also represent the rate of acquisition as a percentage of the existing customer base but to do so can be deceptive. The number of acquired customers is not automatically linked to the size of the customer base. It is more usually a function of things like advertising spend, the size and effectiveness of the sales team, etc. Likewise, increasing ARPC is tied to sales and marketing efforts and is limited by the availability of additional (or higher priced) products.
The subscription business model can be thought of as being like a leaky bucket. Acquired customers pour in the top, churned customers pour out of the holes. The volume of water lost through the holes is directly related to the amount of water in the bucket. The volume of water coming in at the top is not.
This is one of the reasons that a lot of subscription businesses plateau. Initially the acquisitions significantly exceed the losses through churn. However, if the acquisition rate and churn rate stay constant eventually the number of losses that occur through churn will balance it out and the business will stagnate.
Because of the compounding affect of churn this can happen surprisingly fast even with fairly low churn rates. Remember those charts that your financial adviser showed you about the way your pension fund grows over time? Well its the same thing except its working against you. Consider the chart below. It shows the Monthly Recurring Revenue (MRR) for two businesses over 5 years. Both have the same acquisition rate (100 customers per month, and ARPC ($100 per month). But they have different churn rates. The red line shows a churn rate of 2.5%, the blue line shows a churn rate of 5%. Notice that both businesses are starting plateau but the 5% business gets there much faster and plateaus at a much lower MRR.
Monthly Recurring Revenue Over 5 Years
Fortunately there are things that you can do to help prevent this:
- Reduce your churn rate
- Up-sell or cross-sell your customers to increase your ARPC
- Scale your rate of acquisitions as you grow
Reduce your churn rate – The key to reducing churn is to understand customers behaviors, why do they leave, when do they leave and why do they stay. Talk to some of the customers who have canceled. Find out why they left. Look for patterns. Engagement metrics can be a great tool to help with churn, if you can predict when customers are about to cancel, you may be able to contact them before they do and save them. You should understand what are the sticky features in your product that keep customers around. Its the customers who are not using those features that are most at rick of churning.
Up-sell your existing customers – You can continue to sell to your existing customer base. Either help them to see the value of upgrading to a better version of the product or sell them other, related products. Better still, if you can build your up-sells and cross-sells into the product then they will start to scale as the customer base scales and they will compound against your churn.
Scale your rate of acquisitions – The example model that we use here is somewhat artificial since businesses will scale their sales and marketing effort as their revenue grows. As you increase sales and marketing spend it is very important to watch the customer acquisition cost (CAC), that is the cost of acquiring each new customer. If the CAC exceeds the customer lifetime value then your business will quickly run into the ground. If you can do it, having your customers sell your product for you is the best approach. You can provide incentives (e.g. discounts or credits) for every friend that a customer gets to join.Dropbox does this. They give customers additional free storage for each friend introduced (500Mb for free users and 1Gb for paid). The beauty of a referal program like this is that it leverages your existing customer base and so, like churn, compounds over time.
In summary, we discussed how the subscription business model is like a leaky bucket and why that, in turn leads to plateauing. we investigated the compounding effects of churn and we talked about ways to mitigate that effect by reducing churn or boosting up-sell/cross-sell and acquisitions.