Profits, success and subscription models

By September 8, 2009Business models, Exits

Last week I posted that success equals profits and got an email response from William Reeve, saying very true, and good post, but don’t forget about businesses with subscription models.  Many of these have highly predictable revenues and profits and can therefore be said to be successful before they have reached profitability, but once it has become highly likely that substantial profits will be generated.

This is an important nuance to the success = profits argument.  To make the argument more general, a business is only truly worth a lot of money when there is a high likelihood of significant future profits.  A business is therefore not successful (in this sense) if it has a single great year but cannot sustain its profitability.

To go into more detail on subscription models Will’s put it like this:

where you are building subscription businesses and you can see strongly positive lifetime values, and are investing accordingly in customer growth. Early in such a cycle you will report an accounting loss, even as your shareholder value is rising under anybody’s metrics (dependent on lean/mean overheads too, but this is a nuance). Amazon, Orange, Sky, are three prominent tech-related businesses that have all exhibited this growth and proven it works

We have two businesses in our portfolio, both of which Will is involved with, that are following this model.  Lovefilm is now mature and profitable and can be said to have made the subscription model work and graze has a ton of positive momentum, but is at an earlier stage and is still learning about the lifetime value of its customers.

Note also that some subscription businesses get it wrong, typically by mis-calculating (or over-estimating) the lifetime value of their customers and over-spending on marketing and customer acquisition.  Vonage springs to mind as an egregious example of a company making this mistake.

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  • brewsterbarclay

    Another nuance that I would add includes the ability to create more services, apps etc. over time to increase the overall lifetime value. This same principle of looking at multiple time periods and products which build upon the research and marketing of previous products is standard strategy analysis in the off-line world. Look at Facebook, Google etc. that build up more and more products to sell to the same base.

    Knowing that you will succeed with product and service extensions is much more difficult!

  • Nic… great post.

    When we work with SaaS vendors who are hanging their hat on the subscription revenue model there are two key elements we bring up:

    1) the subscription revenue stream is only one of 8 revenue streams available to a SaaS vendor, and within that revenue stream, you must ensure the metrics (user, per month, transactions, etc.) are properly aligned with the customers or you will not get the traction you want/need

    2) it is critical to not only keep a customer for a long time, but to actively seek to increase customer lifetime value. This ties directly to the other 7 revenue streams for upsell opportunities, but also monetizing your existing clients in non-direct ways. In SaaS, the ability to generate revenue beyond the core application and outside of your main subscriber base is due to the network-centric and ecosystem support of Software-as-a-Service.

    The interesting thing we run into are gross margin profitable companies that kill all net with high customer acquisition costs as they try to grow, while forgetting all about the captive audience they have in their existing customers. But this problem goes far beyond not understanding how to create an environment for upselling existing customers, at the core, it speaks to the fact that many SaaS vendors simply don't understand all aspects of their chosen Business Architecture.

    Too many SaaS vendors don't understand all of the potential revenue options available to them and far too many focus only on charging a low monthly fee, per user. They end up leaving a lot of money on the table and are ultimately doing a disservice to their investors and other stakeholders.

    – Lincoln Murphy
    Sixteen Ventures

  • Great comment. Thanks Lincoln.

  • Great comment. Thanks Lincoln.

  • Muffalotto

    if you want to take a look at the way Vonage spends money, just look at who they chose recently for a billing vendor