If you’re a subscription business, the most dramatic effects of trends like cloud computing and mobile won’t be felt in your company’s product line. The real disruption will be to your revenue model. Customers will not pay to own your products. Instead, they expect to pay for the value they receive by using your products. Revenue management is the common approach to solving the challenge of optimizing the revenue model. Unfortunately, the rules of subscription models render traditional revenue management ineffective. To manage revenue and profits in this case, companies need a new revenue management process to optimize the revenue model.
What is revenue management?
Revenue management is common practice in the distribution-centric Transaction Economy. The goal is to maximize revenue and profits by pricing products to match customer demand. Revenue management is pervasive in such industries as airlines, hotel rooms, surgery, advertising, retail, media and rental cars. For example, airlines offer a passenger a seat between two cities defined by departure time, legroom, seat width, and associated service. Because the product, in this case, a seat, is both standardized in terms of customer fulfilment and limited in inventory, the airline can forecast demand at specific prices from different customer segments and manage seat availability to optimize revenue. The airline can forecast demand for higher-priced seats from business travellers that value last-minute bookings and sell the remaining inventory at a lower price to early purchasing leisure travellers who value cheap travel. While the business traveller and the leisure traveller sitting next to each other expected the exact same product, each valued the trip differently and consequently paid a different price. By selling the right standardized, inventory-constrained product to the right customer at the right price, the airline maximizes revenue and profit.
Why can’t traditional revenue management be used in the Subscription Economy?
Unfortunately, distribution-centric revenue management doesn’t work for the consumption-centric subscription business model. For example, imagine if your cellular provider informed you that all the minutes of data transfer were sold out for the day and you could not buy anymore regardless of the price?! Or imagine if you wanted to sign up for a subscription and the provider said they were sold out?! These are principles of the distribution-centric revenue management process.
The revenue management process is different from subscription business models for two reasons as shown in the figure. The first difference is that customer fulfilment is variable. While each customer receives a standard subscription agreement, each of them will use the product differently. Unlike the airline example where the airline defined customer fulfilment (i.e., a seat), in the Subscription Economy, customers define fulfilment based on their individual usage (e.g., amount of texting consumed in a cellular plan). Customer demand can no longer be determined from purchase data alone. Customer demand must be measured by usage data and purchase data together.
Second, for subscription business models, there is no limitation in inventory. In other words, the differentiated value between customer segments cannot be derived simply from product availability (i.e., inventory management). Unlike airlines that create differentiated value and revenue based on managing inventory of a particular product package (i.e., a seat), in the Subscription Economy, differentiated value and revenue opportunities have to be created by providing differentiated product packaging (e.g., different combinations of minutes, text, and data in a cellular plan). Rate plan management replaces inventory management for revenue optimization.
These differences highlight why revenue management for subscription business models requires a new approach which the “use it or lose it” dynamic highlights the most. The “use it or lose it” dynamics states if the customer does not use your product at a level that matches the subscription agreement, the customer will cancel the subscription, and you’ll lose the revenue (A complete description of “use it or lose it” can be found here ). So in the Subscription Economy, managing recurring revenue (i.e., the ability to proactively manage the subscription revenue model) boils down to matching the right rate plan to the right customer usage at the right price.
Why is recurring revenue management required?
Just as revenue management is a well-chronicled competitive advantage in Transaction Economy industries such as airlines, revenue management will be a requirement for competitive advantage for subscription businesses. Managing recurring revenue is rapidly becoming a necessity rather than a nicety. Companies that currently manage recurring revenue are able to increase topline revenue by 10-15% compared to their competition. That statistic by itself makes managing recurring revenue a required discipline for survival in the Subscription Economy.