Strengths and weaknesses of the subscription business model

Half the battle in growing a subscription product is figuring out the strengths and weaknesses of the business model.

Part of the reason I started writing about this topic was to try to contextualize the “generic” advice for growing a startup and filter out what I think works for subscription products.

I've seen many subscription companies go out of business when they try to take a growth playbook from another model (usually e-commerce) and apply it to consumer subscriptions.

Just like the coach of a new team, if you want to win the championship, you have to figure out what your strengths and weaknesses are before committing to any plan.

Most subscription products, whether B2B or B2C, make money through a self-service enrollment flow. This means that people can find the product and buy it without needing to speak to a salesperson.

The good thing about all this is that you, as the business operator, do not need to find, hire and train teams of salespeople before you start selling your product.

This (could) mean you have to spend less money on salaries and can get to market faster without the delay of staffing a team.

This also means you can offer lower prices because you don't have to factor in salespeople's high salaries into your customer acquisition costs. This, in turn, will reduce some of your other costs (like office space), which increase when you have a larger team.

The initial team also doesn't have to spend as much time hiring and managing people, time that you can spend on product development.

In addition to not having a sales team to manage, you also don't have a sales team that can relay customer feedback to the product team and adjust messaging on the fly to see what works with different customers.

You'll see users come to your site and then leave without purchasing, and it will be very, very difficult to figure out why.

This probably means hiring other expensive employees (engineers, designers, product managers, growth marketers, etc.) who can help you master selling the product through self-service.

I would say that in the last 5 years it has been more difficult to fill these positions than salesperson positions, because there are fewer of them and the big technology companies will pay them a lot if they have experience.

Arguably the best part of subscriptions is the recurring revenue. You can continue earning money from your customers as long as they continue using the product.

Perhaps the best part of a subscription business is that it has recurring cash flows that make the business easier to manage and predict.

This puts less pressure on acquiring each month to bring in more revenue and keep the lights on. You don't need to reacquire customers to earn enough to survive.

If you can keep users for a long time and find effective acquisition channels, you can trigger compound growth, allowing you to build a large user base and a valuable business.

Subscription companies have historically received high valuations relative to their revenue, which is great for employees and investors when buying.

Amazon bought Pillpack for $753M in 2018, reportedly making around $100M in revenue the year before, earning a 7-8x multiple.

Codecademy made around $50M annually in 2021 and was bought for 525M that same year, earning around a 10x multiple.

When you are in your growth stage as a company, you are still changing core aspects of your model, such as pricing, feature set, acquisition channels, etc.

All of this will have an impact on the LTV of your user base, but these changes cannot be “known” until that group of users reaches the end of their life cycle. This means that it is very difficult to forecast revenue and budget how much money to spend on acquisition costs.

In addition, depending on the use case of the product, there is a “natural” limit of user permanence.

All products are built to solve problems, and it will be very, very difficult to keep your users longer than the problem you are solving for them.

If you sell a product that helps me lose weight on a diet, after 4 months, most of your users will have lost weight or given up. There's not much you can do to prolong them beyond that.

Fundamentally, humans only perform a few behaviors for more than a year, and there are already gigantic companies in those spaces (mobile phone contracts, utility companies, rentals, insurance, etc.).

Common use cases for Internet products, such as dating, exercise, weight loss, education, and dating, are all things that users will end or abandon over time.

Subscription companies are classically durable, meaning they can withstand both good and bad market pressures.

Since your revenue base is made up of many small transactions, this makes the business more durable in the long run.

This differs from B2B companies, which may earn 40% of their revenue from 3 big customers. If these customers leave for any reason, the company is in big trouble.

Therefore, subscription companies can weather bad times relatively well. Its revenue base is diversified across millions of small transactions.

The biggest “billion dollar” startup failures are always B2B companies. This is because even though a company may be making $10 million, if its average customer pays it $250,000 to use the service, it only has 40 customers.

If their margins are 30%, it would be enough for 12 clients to abandon them for them to start losing money. This can happen, especially in a bad economic situation, and if there are cheaper alternatives.

Subscription products take longer to grow revenue than other business models for two key reasons:

1: Average contract value is much, much lower than B2B products. If you are currently launching an AI copilot tool for mechanical engineers, and the average contract value is 20,000 per month, then you are only 5 customers away from $100,000 ARR.

If you're selling a $9.99/month product, you'd need just over 10,000 customers to reach the same revenue numbers.

This just takes more time.

2: It is more difficult to use paid acquisition to increase revenue. It's not impossible, but it's more difficult.

The money you get from users is spread over their lifecycle, so it will take you longer to recover the acquisition cost and reinvest it in acquiring more users.

Unlike e-commerce, where the LTV of “most” of your users is captured in a single order, allowing those companies to recycle that money into acquisition more quickly.

Additionally, the total lifetime value of subscription products tends to be lower than other products, so you have to spend less to compete in those channels.

If your user is worth $115 in LTV, you will have a hard time competing for audiences with other products whose users may be worth thousands of dollars and, therefore, can spend 5 times the budget on the same advertising channels.

99% of great subscription products were created by systematically improving the core product and acquisition channels. You live in the land of accumulating small victories.

It is very, very unlikely that you will find a silver bullet that will accelerate your growth and profitability.

Lean on your strengths and try to mitigate some of the weaknesses of the subscription model.

You won't (nor should you) eliminate these weaknesses, but you might improve them slightly.