How to Choose the Right Payments Model for Your Subscriptions Business

by James Gagliardi 0

If you’re businessis considering a move to a subscription-based commerce model, you’re certainlynot alone. The growing need to conform to consumer preferences has madesubscriptions 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 firstneed to determine which one is the right fit for their product offering,customer base and future of their business.

Let’s take alook at three basic subscriptions business models. Understanding which one isright for your business will ultimately dictate how you restructure youroperations and online payments processing, especially if your company plans to scaleglobally.

Prepaid Subscription Service

Think Netflix.This is a subscription model with a prepaid monthly or annual subscription, butno long-term commitment: if a subscriber stops paying, he stops receiving theservice.

A key considerationfor the business, however, will be the cadence of customer transactions and howthis affects billing. For instance, a company may introduce a monthlysubscription versus an annual subscription to help lower the barrier to entryfor consumers. This strategy also dramatically increases the volume oftransactions the business must process in a year to 12 payments instead of justone – increasing transaction fees, creating new billing cycles and more.

And as abusiness scales, this increase in transaction volume only becomes morecomplicated from a back-office infrastructure and operations perspective.Twelve transactions a year versus one doesn’t sound complex, but when you applythat to a million customers, you’re now turning one million transactions a yearinto twelve million. More billing cycles requires more infrastructure, moreoverhead, storage and bandwidth. More transactions also means dramaticallyhigher payment costs for the business since the per transaction fee charged bycard 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 cansee, moving to a monthly subscription service sounds simpler than it really isbeneath the surface. Not to mention that introducing more billing cycles alsointroduces more opportunities for a customer to opt out entirely. Churn is amajor issue for subscription providers and challenges them to continuallycreate new value for their subscribers or risk losing them entirely.

Term-Based Contract Subscription

ThinkDirecTV. In this model, a subscriber agrees to a specific contract length orterm, typically a year or multiple years, but is billed on a more frequentcycle, often monthly. Usually when subscribers commit to a longer term – say 24months rather than just 12 – companies often discount the monthly fee, which isa better value for customers.­­ While this model increases financialpredictability for companies by locking in subscribers for longer terms, italso brings into play a tradeoff that companies must reconcile. And that iswhether or not it’s worth it to take in less money in exchange for the securityof a longer term contract.

This modelalso comes with some accounting challenges. Businesses must be sure their back-officeinfrastructure is flexible enough to handle not only the variety of payments theywill see from the different contracts they strike, but also unexpected chargesand penalties they must assess when contracts aren’t honored. At the end of theday, the ultimate value this model offers businesses is the financialpredictability of long-term deals. And depending on the service they areoffering, it might be the best subscription model for their company.

Usage-Based Subscription Billing

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

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

Choosing the Right Model

As you cansee, there are a variety of moving pieces that companies need to consider whendeciding on the type of subscription model they select. It is important toacknowledge that flexibility should be a priority in any implementation. Givenhow quickly consumer preferences can change, and how much those preferencesinfluence sales, it is important that companies build out a subscriptionpayment infrastructure that supports the model(s) they choose today, and canshift in the future to a new model if necessary. It is essential that businessesare able to pivot without enduring unnecessary administrative complexity. Thesooner a business can understand how their operations and payments processingwill differ depending on the subscriptions model they decide is right for theirbusiness, the sooner they can reap the benefits that subscriptions promise.

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