Edited excerpts from 10 Factors To Consider When Evaluating Consumer Subscriptions by Nikhil Basu Trivedi:
Great consumer subscription businesses have these 10 characteristics:
1. “Must Have” service. To be a must have, the product or service solves a real need for the customers, and delivers a solution with higher convenience, better cost, or higher quality than other options, and often with a combination of those elements.
2. Taps into existing recurring behavior. It’s much easier to build a subscription business that draws on an existing recurring consumer behavior, instead of trying to create a new recurring behavior.
3. High conversion rate from free tier or trial to paid subscriber. The higher the conversion rate, and the faster the duration of conversion, the more effective the free tier or trial.
4. Annual gross profit per subscriber is high. To calculate the annual subscription gross profit, take the annual revenue per subscriber and subtract the cost of goods sold (COGS).
5. Strong customer, revenue and usage retention. Retention should be measured for cohorts. Revenue retention should be higher than customer retention, because subscribers that stick around are able to spend more on the subscription over time. Usage retention is a leading indicator for customer retention.
6. Rapid payback on customer acquisition costs. The best subscription businesses have very quick payback on customer acquisition costs, perhaps even instant payback. A payback period of over a year is challenging.
7. Large total addressable market for the initial subscription offering. It should be able to support $50 million in annual subscription gross profit, creating the potential for a $1 billion valuation.
8. Attachment and bundling potential for Act II, III, and beyond. Most great subscription companies have an Act I that gets them to tens or hundreds of millions, or even billions, of dollars in revenue. But they follow that up with more products and services that lead to secondary and tertiary subscription offerings (Act IIs and Act IIIs) that expand the size of the business and the total addressable market.
9. Win-back potential. Can the company turn previously churned subscribers into paid subscribers again? For example, a free tier enables ex-customers to continue to see value out of the service, and to be engaged to convert back to being a paid subscriber over time.
10. Network effects. The best consumer subscription businesses leverage network effects to increase the value of the subscription offering, to boost many of the factors listed above, and to provide a moat against competition.
1. On rapid payback on customer acquisition costs, see Why capital efficiency is critical for SaaS and subscription businesses.
2. On network effects, see Building a moat – barriers to entry for SaaS companies.