The Evolution of The Subscription Business Model
Exploring the world of in-app payments, usage-based pricing (UBP), and decentralized finance as it pertains to subscriptions
This piece was originally published on Substack by Ben Futiriansky on June 8th, click here to read the original version.
Subscriptions are everywhere. On the consumer side, we subscribe to content applications such as Calm, Netflix, and Spotify, and purchase physical items such as beauty, healthcare, and pet products through eCommerce channels. As new technologies, along with changes in consumer preferences, have contributed to the rise of digital services monetized via subscription or consumption approaches, managing the mobile payments ecosystem has become a key challenge. On the business side, most companies historically were hosted on-premise and vendors would charge up-front license fees with recurring maintenance fees before evolving to per-seat subscriptions paid on an annual or monthly basis. As software matured, end-users began controlling purchasing decisions and new pricing models emerged (Slack via feature-based pricing, Salesforce via monthly or yearly per-seat pricing, and AWS for usage-based pricing). Now, companies must provide the appropriate billing infrastructure to manage modern pricing and invoicing. The potential for the subscription model grows even further when Decentralized Finance (DeFi) enables payments to be “streamed” in real-time.
In-App Payments Meet the Subscription Economy
Consumers are relying more and more on mobile apps as critical tools in their everyday lives. At the end of 2021, the Google App store had 70k apps added every month while the Apple App store had 32k apps added every month. Reliance on mobile apps will only increase with time as business models evolve from one-off purchases to ongoing subscriptions. In fact, the total spent on in-app purchases in 2021 has increased 19% YoY from $112B to $133B, with top 100 non-game subscription revenue increasing 41% YoY while the other section increased 16% YoY. The gaming sector accounted for 67% of the 2021 TAM, with entertainment and social apps accounting for 11% and other categories at 22%.
Reliance on mobile apps and subscription spend has created a complex mobile payments ecosystem for app developers to manage multiple platforms and users. To do in-app subscriptions, developers need servers, databases, APIs, and frontend code. RevenueCat is one example of a mobile subscription toolkit designed to assist in application development and manage in-app purchases and subscriptions. It enables applications developers to build a mobile business — without having to set up or maintain any purchase infrastructure — along with a robust dashboard to track key metrics across customers, conversions, revenue and more. Chargebee, Adapty and ChartMogul are other companies tackling mobile subscription for in-app payments.
From License to Subscription to Usage-Based Pricing
The SaaS world is undergoing a shift where speed and flexibility of pricing iterations needs to match the velocity of product iteration. Success is now tied to the value of what a customer is getting out of the product, largely accelerated by market examples of the likes of Twilio, Snowflake, and AWS. Traditional billing systems are not good at handling new pricing structures like consumption-based pricing, coupled with handling refunds, credits, and chargebacks to expired payment methods. Billing can shift from an accounting problem to a payment problem to a product problem. Zuora, the incumbent in the subscription management space, has long implementation times that usually need an external consultant like Accenture to implement, with a product that hasn’t kept up with modern needs.
One of the most critical elements to get right is selecting the right price metric. One that customers understand, will pay for, and likely to grow in usage. Some examples include user/seats (licensed users, concurrents, time logged), usage (API calls, data stored, page views, sessions, downloads), outcome based (% rev share, % profit share, % cost reduction), technical (instances/hosts, CPU cores, total devices) and others. A common misconception of UBP is that it is only on-demand pricing and must be charged after the usage has occurred (think of a pay-as-you-go cellphone plan). In a downturn, this would be a large area for concern where consumption is more prone to short term volatility. However, there are three levels of flexibility via prepaid (fixed amount that doesn’t vary on usage), prepaid + overage (hybrid), and postpaid (pay-as-you-go model), helping UBP companies avoid significant exposure in difficult macroeconomic times. Aligning sales and post-sales efforts closer to customer value (product usage) tends to foster much deeper customer relationships, as customers are paying for software according to the resources actually used.
Today, sales teams want flexibility to structure custom-tailored up-sell and cross-sell opportunities, and ramp deals that provide increasing discounts as usage grows. Usage-based billings impact everything via product, CRM, ERP and the customer. In fact, 45% of SaaS companies say they have usage-based pricing, up from 34% last year, while 24% of companies with usage-based pricing have implemented it in the last 12 months. Among the software companies that do not have usage-based pricing today, 61% expect to test or introduce it in the future, with 20% in the next 6–12 months. The fastest growing companies are especially likely to leverage UBP, coinciding with best-in-class CAC payback and Net Dollar Retention. On the other hand, founders are building software designed to specifically handle the complex needs of modern SaaS pricing. What’s interesting about these companies is that their founders experienced these issues first-hand at their former employers; Subskribe (Zuora), Metronome (Dropbox), Aqueduct (Stripe), Orb (Asana), and M3ter (AWS) all provide products to service needs across UBP. Ultimately, companies deploying UBP have increasingly outperformed the general SaaS public indices, while others are looking to index this growth by building the underlying infrastructure.
How Does Decentralized Finance Play a Role in Enabling the Evolution of Subscriptions?
DeFi is one of the greatest opportunities for innovation and growth within crypto. Global crypto users have reached 295M as of Dec-2021, growing 178% since Jan-2021. Simultaneously, unique addresses that have used DeFi protocols reached ~4M as of Dec-21, growing 243% in the same time frame. Today, there are ~4.8M unique addresses resulting in 1.6% of DeFi adoption to total crypto users (up from 1.1% in Jan-21). At the center of DeFi is the concept of “programmable money”. Participating in more complex transactions, such as future or recurring payments, buy/sell limit orders based on on-chain events, remains difficult for lay-users to participate in at this time. A core tenet of crypto is self-custody as every transaction needs to be signed and approved with private keys associated with public addresses. In addition, gas prices (similar to transaction fees, but for processing on-chain transactions) tend to disincentivize higher frequency transactions required for recurring/subscription payments in many cases. Businesses will eventually migrate much of their payment and transaction processing to on-chain solutions, which provide unique benefits to them and their customers. These will include constant, recurring flows of income that can be programmatically allocated to various DeFi tools. Streaming payments — from one account to another, then to others, concurrently, in real time — has long been the holy grail of DeFi.
While there are an abundance of infrastructure and payment solutions to support fiat subscription payments, a few players have begun to emerge in the Web3 space. Superfluid aims to optimize and automate revenue streams according to a user’s preferences. This can include automating savings and investing plans for salaries, subscriptions, rewards, and any composable stream of value with continuous settlement and per-second netting. Superfluid differentiates itself by allowing revenue streams to build on other streams (for example, receiving hourly wages while simultaneously paying back a loan, streaming money into a savings account and buying the remainder in ETH), whereby increasing capital efficiency, reducing gas consumption and reducing number of unique transactions. Superfluid’s mission is to enable an ecosystem of Web3 apps that can leverage blockchain technology building the new financial primitive of asset streaming by the second, helping unlock frictionless capital flows across the economy.
One such example is Diagonal, a non-custodial protocol for accepting and managing subscriptions natively on Ethereum, that is built on top of Superfluid. Specifically, it helps DAOs, Web3 businesses and developers monetize crypto-native applications with ongoing subscriptions by providing audited smart contracts via “ongoing streams of money”. Another example is OAK Network that’s building a Web3 hub for DeFi and payment automation through easy-to-use event driven transaction model built on Polkadot. OAK enables users and developers to schedule future and recurring payments, engage in auto-trading and place decentralized limit and stop-loss orders on DEXs.
DeFi tools such as Superfluid and Diagonal will revolutionize the subscription economy. Use cases include automated DeFi investment strategies with salaries streamed directly into investments, yield farming with automated harvesting every second, DAOs that direct all incoming streams to pay rewards to members, risk management as collateral management can become programmable in real time, working capital costs due to delayed cashflows can be alleviated (potential to unlock Buy-Now-Pay-Later) and users can dollar-cost-average into positions with only a single on-chain transaction. Going one step further, NFT’s can disrupt this even more. For example, what if a typical subscription was an NFT on the blockchain that you can trade in the open market, rent it out when not using it, earn royalties from each trade of the NFT and be composable across different applications. Software providers would be incentivized to launch this as they can capture value beyond price points offered, with ability to earn revenue on add-ons and each time a person shares an account or trades the subscription.
From sales/marketing-led growth to product-led growth, and now to protocol-led growth, I’m looking forward to continue to explore the world of subscriptions and how it evolves as new consumer and business behaviors increase demand and as new technologies enable more use cases!
