What’s Fueling the Subscription Economy? Hint: MRR
Why are businesses hot on subscription business models?The answer: recurring billing and recurring payments.
The entire subscription economy is built on the frame of subscribers getting billed periodically for a product or service. In return, the subscription business gets timely payments. Since everything is recurring, automated, and convenient for both businesses and subscribers, it’s a win-win.
How is recurring revenue different from a repeat revenue?Repeat revenue is when customers come back and buy again. Recurring revenue, on the other hand, comes from people who pay up each payment cycle, usually each month or annually.
A great example is a local coffee shop. Repeat revenue comes from the regulars who buy a daily cup of coffee. Even though they frequent the coffee shop, they are paying each time for the coffee. Recurring revenue comes from the customers who subscribe for a bean-of-the-week club, where subscribers get sent a pound of coffee at the beginning of each week. Since they’re paying one time each month, we consider that recurring income.
Check out our top 10 examples of brilliant subscription businesses.
What are the pros and cons of recurring bills?Pros:
- Predictable money: Subscribers pay every month, and that data can accurately forecast future operations
- Increased LTV: People don’t need to remember to buy a product or choose between two brands. They get billed regularly for what they want/need—no hassle or choices
- Smaller long-term marketing/sales costs: It’s easier and more convenient to just stick to a service, once subscribed. Sales and marketing costs both drop steeply once you get a subscriber signed up
- Quality customer data: You can’t beat subscriber data. Recurring revenue is regular and gives you a good picture of customer sentiment
- Very difficult set up: Billing subscribers each month sounds easy in theory. But a lot goes into getting the pricing model right, getting the right billing systems in place, reporting and monitoring customer payments, managing disputes, etc.
MRR and ARR formulas
Forecasting recurring revenue is easy and accurateThe beauty of recurring revenue is anybody can accurately forecast profits. There are two ways people do this: Monthly recurring revenue (MRR) and annual recurring revenue (ARR). Since the same amount of revenue is earned every period and for each subscriber, forecasting is done by using a trend. Businesses look at past monthly growth and use a trend line to forecast out the next months or years of expected revenue growth.
How do I choose between MRR and ARR?Fusebill breaks it down nicely: MRR gives you a granular view of the month-to-month revenue trends. ARR gives a blown out look of the entire year, making it great for showcasing data to stakeholders. To find the best metric, look at your subscription length, business model complexity, business size, and data intention. If you’re a young business trying to get a handle on growth, choose MRR. If you're trying to show bigger picture trends, choose ARR.
5 popular billing models for subscription businesses
- Fixed pricing (or a flat rate): With fixed pricing you get what you pay for, nothing more or nothing less. Think of Netflix and Apple Music; subscribers pay the same amount every month and get the same agreed on product or service
- Fixed Pricing is great for: A product that has limited features and one type of buyer
- Tiered billing: This is when you offer different packages or versions to subscribers at different price points. Most successful SaaS products follow this model. Slack, for example, allows organizations pay based on features, size, and the complexity of an organization’s need
- Tiered billing is great for: Subscription businesses with a diverse spread of customers. When subscribers have different budgets, uses, and needs, tiered billing can help provide a more flexible solution. The option to downgrade to a lower tier can also help increase LTV, as leaving for a different product/service is a hassle
- Usage-based billing: Subscribers pay for what they use with this model. Phone and data providers tend to opt for this payment setup
- Usage-based billing is great for: Companies that have many customers, all with different usage needs. It can work well at bringing in new customers because initial costs are significantly lower, and payments are flexible
- Hybrid billing: Either subscribe and pay recurring bills or pay for one time. Amazon is a great example for this billing model: you can pay a one-time fee for a product, or you can pay for Amazon Prime and get free one-day shipping
- Hybrid billing is great for: Giving customers superior flexibility to pay for what they truly want. Pay less for a product that you use frequently or pay a higher onetime fee
- Freemium: Get free (but limited) access to a product or service. Subscribe for full access as needed. A freemium example is Dropbox that allots a certain amount of space for free and charges for anything more
- Freemium is great for: Getting people in the door and using your product or service. As users get more invested in your brand, you will see a nice increase in subscribers
Recurring revenue stokes the subscription economyOnce a month or year, a subscriber gets billed for a product and service. In return, the subscription business receives income in the form of recurring revenue. Subscription businesses see many perks from running this type of business, from increased LTV to cheaper sales costs. But don’t let the simple model fool you. Getting started and managing payments is a unique skillset honed over time.
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