Industry Blogs

How to Choose the Right Payments Model for Your Subscriptions Business

 If you’re business is considering a move to a subscription-based commerce model, you’re certainly not alone. The growing need to conform to consumer preferences has made subscriptions the new model of choice across countless industries from baby diapers to snowboards and luxury cars. So how do you get started? Unfortunately, subscription models are not all created equal, so companies first need to determine which one is the right fit for their product offering, customer base and future of their business. 


Let’s take a look at three basic subscriptions business models. Understanding which one is right for your business will ultimately dictate how you restructure your operations and online payments processing, especially if your company plans to scale globally. 


Prepaid Subscription Service 

Think Netflix. This is a subscription model with a prepaid monthly or annual subscription, but no long-term commitment: if a subscriber stops paying, he stops receiving the service.  


A key consideration for the business, however, will be the cadence of customer transactions and how this affects billing. For instance, a company may introduce a monthly subscription versus an annual subscription to help lower the barrier to entry for consumers. This strategy also dramatically increases the volume of transactions the business must process in a year to 12 payments instead of just one – increasing transaction fees, creating new billing cycles and more.  


And as a business scales, this increase in transaction volume only becomes more complicated from a back-office infrastructure and operations perspective. Twelve transactions a year versus one doesn’t sound complex, but when you apply that to a million customers, you’re now turning one million transactions a year into twelve million. More billing cycles requires more infrastructure, more overhead, storage and bandwidth. More transactions also means dramatically higher payment costs for the business since the per transaction fee charged by card providers will be applied to 12 transactions a year rather than just one. These all are things a business needs to take into consideration.  


As you can see, moving to a monthly subscription service sounds simpler than it really is beneath the surface. Not to mention that introducing more billing cycles also introduces more opportunities for a customer to opt out entirely. Churn is a major issue for subscription providers and challenges them to continually create new value for their subscribers or risk losing them entirely.  


Term-Based Contract Subscription 

Think DirecTV. In this model, a subscriber agrees to a specific contract length or term, typically a year or multiple years, but is billed on a more frequent cycle, often monthly. Usually when subscribers commit to a longer term – say 24 months rather than just 12 – companies often discount the monthly fee, which is a better value for customers.­­ While this model increases financial predictability for companies by locking in subscribers for longer terms, it also brings into play a tradeoff that companies must reconcile. And that is whether or not it’s worth it to take in less money in exchange for the security of a longer term contract.  


This model also comes with some accounting challenges. Businesses must be sure their back-office infrastructure is flexible enough to handle not only the variety of payments they will see from the different contracts they strike, but also unexpected charges and penalties they must assess when contracts aren’t honored. At the end of the day, the ultimate value this model offers businesses is the financial predictability of long-term deals. And depending on the service they are offering, it might be the best subscription model for their company. 


Usage-Based Subscription Billing              

Think of your electric bill. In this model, consumers pay for what they use after they’ve used it. This gives consumers flexibility and ties payment directly to their behavior. But it also limits financial predictability for both consumers and the business. We saw this years ago when text messaging was billed this way and parents got saddled with $500 bills when their children abused their texting privileges. Today, usage-based models are more often seen as an add-on to regular prepaid or term-based subscriptions. For example, you might pay a monthly fee for cable or satellite TV, but incur additional charges for ordering a movie on-demand.  


This model brings about variability in revenue as companies never know how much their customers will use the service. Another issue is the fact that payment occurs after a consumer has received the goods or services. This can lead to lost revenue from nonpayment or disputed charges. For this reason, businesses pursuing this model need to have the infrastructure and payments tools to handle a highly fluid billing volume and monitor a wide variety of usage variables (e.g., length of use, number of users, downloads, etc.).  


Choosing the Right Model 

As you can see, there are a variety of moving pieces that companies need to consider when deciding on the type of subscription model they select. It is important to acknowledge that flexibility should be a priority in any implementation. Given how quickly consumer preferences can change, and how much those preferences influence sales, it is important that companies build out a subscription payment infrastructure that supports the model(s) they choose today, and can shift in the future to a new model if necessary. It is essential that businesses are able to pivot without enduring unnecessary administrative complexity. The sooner a business can understand how their operations and payments processing will differ depending on the subscriptions model they decide is right for their business, the sooner they can reap the benefits that subscriptions promise.  

Content Provided By: James Gagliardi, Vice President – Strategy & Innovation at Digital River

Search Perspectives

View All