At 37signals we sell our web-based products using the monthly subscription model. We also give people a 30-day free trial up front before we bill them for their first month.
We think this model works best all the time, but we believe it works especially well in tough times. When times get tough people obviousy look to spend less, but understanding how they spend less has a lot to do with which business models work better than others.
There are lots of business models for software. Here are a few of the most popular:
- Freeware
- Freeware, ad supported
- One-off pay up front, get upgrades free
- One-off pay up front, pay for upgrades
- Subscription (recurring annual)
- Subscription (recurring monthly)
Cutting new before cutting old
Typically people look to cut new spending before they cut current spending. They’ll often put a freeze on anything they aren’t already paying for. Eliminating new costs is easier than eliminating existing costs.
For example, if they’ve been evaluating something new, they’ll put that evaluation on hold. If they’ve been able to get by without it they can likely continue to get by without it. Or if there’s a big upgrading coming up they’ll stall or just consider it unnecessary.
But if they’re already paying for a service they use, they’ll likely continue using that service. They may downgrade to a cheaper plan, or try to negotiate price, but if it’s still useful there’s a fair chance they’ll continue using it.
The problem with one-off selling
The problem with one-off selling is that once the customer pays you once, that revenue stream runs dry. In tough times, when people freeze new spending, less new customers means less new revenue. And in extreme cases, you may see no new customers at all. That means no new revenue at all. So if you have no new customers for three months, you have no new revenue for three months. If you don’t have reserves, going dry for three months could sink you.
The semi-benefit of annual subcriptions
Annual subscriptions are better because you still have the potential to generate revenue on a regular basis without picking up new customers. However, since annual renewals are initially more expensive than month-to-month renewals, companies may think twice about re-upping. If they do re-up, they’ll likely negotiate harder and threaten to leave all together if their price isn’t met. They may be bluffing, but in tough times it’s especially hard to risk losing a customer.
The benefit of monthly subscriptions
Since new spending is often cut before current spending, you may not see any new customers for a while, but with a monthly subscription business model you’ll still be earning regular monthly income from your existing customers.
If you have 5000 paying customers at $10/month, you’re sill seeing $50,000/month in revenue even though no new customers are signing up. And while some existing customers may start to cancel to save on their current costs, you will still have money coming in every month. Cash flows from monthly subscriptions are among the most predictable flows you can find.
The other benefit of monthly subscriptions is that the entry cost is lower for new customers. An annual subscription may ultimately be cheaper than a monthly subscription, but the initial outlay on an annual subscription will scare a lot of folks away in a tough economy. People are looking to save money, and annuals can do that, but they’re thinking short term not long term. Short term savers reign in tough times which is why monthly subscriptions are safer for all involved.
How about a combo?
Some companies offer a combination of plans. Monthly, annual, or big up front “lifetime” subscriptions. As long as monthly is an option I think they’ll be alright. At 37signals we don’t have an advertised annual option, but you can make a lump sum deposit into your account once you’re signed up. This way you can put in $500 and not have to worry about seeing a credit card charge on your bill every month. Some people like this because they can spend whatever remains in their annual budget this year and get to use the product “for free” next year.
Just a reminder
The ideas above aren’t rocket surgery, but they are a reminder that the type of model you offer can have a significant effect on your company’s viability when the bad times roll.
Scott Brooks
on 18 Dec 08True that.
My customers have been happy with the service and have been actually signing up more in what I think is a result of the downturn.
Many companies actually see this web-based services as the way to go … especially if they have had to lighten the payroll they are looking for tools to make them more productive.
I think if you have the right service at the right price …. this could be lucrative times for SAS.
My only worry is if you had a advertising supported service … are the ad rates still going to be able to support the service? I know in speaking with ad centric companies that they have noticed a sharp decline in the rates and the willingness of advertisers to place.
Cheers
Scott
keith bohanna
on 18 Dec 08Good, simple reminder of the benefits of this model. Interested in yours (or readers) thoughts and links on how this model will fare with consumer facings services where the decision making process is slightly different.
keith
nico
on 18 Dec 08As a customer, I don’t like to be locked in. Personally I do not use services that try to lock me in for whatever reason if there’s an alternative without lock-in.
So yes, a monthly payment is the best. It’s the best compromise between being locked in even for a short period and the annoyance of having too many payment processes.
Raymond T. Hightower
on 18 Dec 08“The Cathedral and the Bazaar” also gives a strong argument for subscription-based software models. Through subscriptions, software companies create a direct correspondence between the value received by the customer and the money paid to the developer. What a great way to promote customer/developer partnership. Win/win. Thanks for a great post.
Scott Brooks
on 18 Dec 08Annual payments make sense for people who work for companies that have to do reimbursements every month …. it is just an added headache for them.
Generally if you are signing up for an annual you know what you are getting and why you are getting it. We have found that people usually switch to annual once they have had used the monthly for a while and don’t want the headache of having to worry about submitting.
Annuals also make sense incase there is an expired card, card gets lost …etc. Last think you want is your service to go down because of one of these snafus …..those always seem to happen when the card holder is on vacation…. slams the entire company and their clients.
Corey H Maass
on 18 Dec 08I’ve kept this model in my own apps, offering one extra feature – maintaining information for the fair weather customer. Netflix put the idea in my head. When I’m broke, I’ll unsubscribe for a month or two from Netflix. “I can live without those movies.” Then a couple months later I’ll resubscribe, picking up where I left off because they maintain all my information. So a simple promise to not delete a users account and the option to come back anytime is a great feature really on available with a monthly subscription.
Ric
on 18 Dec 08At Swirrl, we’ve gone for the monthly subscription too, for pretty much the reasons you cited above.
During a downturn, having a low initial outlay is essential if you want to attract new customers.
Saas offerings may not give the full functionality of a bespoke designed/developed app, but they offer perhaps 80% of the features at 1% of the price, so the current economic climate might not be such a bad thing after all… for our kinds of apps!
Brett
on 18 Dec 08I’ve been working towards a SaaS based version of my product for awhile now. Only problem is it’s size – it’s huge and I need to pare it down for the web subscription model. My product is large and expensive and typically takes about 6 months to introduce and sell to a corporate client. In the current financial market, they’ve all put a moratorium on capital expenditure. No sales!!! Your post is spot on, just wish my situation wasn’t the example of what doesn’t work.
Daniel Massicotte
on 18 Dec 08Selling information you research, into well constructed content rich PDF files for $6 is a great way of getting the contacts you need to set up one of the above listed strategies going.
Derek
on 18 Dec 08“Rocket Surgery” I love it when people mix cliches. This was obviously a mix of Brain Surgery and Rocket Science.
The thing is I’m never sure if people are doing it on purpose. My favorite I have heard. “Does the pope ** in the woods?” Classic!
Lee
on 18 Dec 08Recurring revenue models work for software, but it’s not as clean if you’re in a service business.
Cameron
on 18 Dec 08What if you are offering something that you download, as well as a service?
For example MP3’s that you can download, but also a website that has features that you might think would work best with a subscription.
Would you charge one off for the MP3’s and give the service free, or have a subscription that includes the downloads free. As they have already got the product on their hard drive, is it worth them keeping a subscription up?
Just curious to any thoughts.
Kevin Milden
on 18 Dec 08I am still pretty skeptical. 37signals is very lucky to have a strong customer base due to being very early to the SaaS game. Now that the market is over saturated with subscription based services (customers have to rent their invoice app, project app and so on). I am hear that most companies are looking for a less expensive longer-term solution. As for the developers, I have yet to meet anyone making a killing off subscription fees. They make some money but not hundreds of thousands a month.
Sarat Pediredla
on 18 Dec 08Jason is right on many counts and there is no denying that as a SaaS supplier, you cannot deny the benefits of a recurring subscription model.
As someone who sells on the “one-off” pay-once, then upgrade model, my views are mixed.
I agree with @Kevin Milden that 37signals is lucky to be at a scale where the downturn will not really affect it. However, how many web-based project management, invoicing, CRM, apps can you sustain in the ecology (most of them doing similar things in functionality for very little price difference and service differentiation) before the saturation levels make it unsustainable for new entrants? Critical mass is valuable in this sense.
My personal experience is also that when I think of cost-cutting, they immediately look to cancel subscriptions and recurring costs and be able to look at something that has fixed costs.
For us, the downturn has meant more queries and increased sales than we used to have before (although we just started on the cusp of the downturn), and precisely from people who were tired of being locked into never ending subscriptions.
There are people who will argue for both ends but just my 2 pence (or cents!) as a person on the “dark side” of software delivery.
Jim
on 18 Dec 08The other benefit of recurring monthly payments: people forget about their accounts and keep paying.
I haven’t used Backpack for months. But I kept paying for it, just out of inertia. I had a bunch of notes in there I wanted to keep but didn’t feel like moving. A few nights ago I used the “Email me this” link at the bottom of each of my 25 pages and shut it down. http://twitter.com/jimbrayton/status/1057904942
When I was using the service regularly, it was worth $5/month. Kudos to 37signals for making it relatively easy to leave.
JF
on 18 Dec 08However, how many web-based project management, invoicing, CRM , apps can you sustain in the ecology (most of them doing similar things in functionality for very little price difference and service differentiation) before the saturation levels make it unsustainable for new entrants? Critical mass is valuable in this sense.
A ton.
“Critical mass” in the consumer software world has been achieved by very few products. Office, Photoshop, Quickbooks, Windows? Maybe a few others. To suggest that any other category or product has attained critical mass is giving up 10 years early. And to suggest that other people can’t make good money building accounting software or image retouching software is just simply not true.
There’s so much room for so many products from so many companies. And today a bunch of companies can do well all competing against one another. The market has never been more accessible.
We’re doing great and business is good, but we haven’t even cracked the market. Unless you’re Microsoft or Apple or Adobe or Intuit or a few others, far more people don’t know about you than those who do.
Jose Maria
on 18 Dec 08I think that monthly recurring revenue model is the best for internet companies. However, there are some voices out there that seem to be a bit envious of the seccess of this model http://www.businessweek.com/technology/content/jul2008/tc20080723_506811.htm?chan=top+news_top+news+index_technology
Out of the Topic:
You can become fan of 37 Signals in Facebook
http://www.facebook.com/home.php#/pages/37-Signals/43645765903?ref=share
Sarat Pediredla
on 18 Dec 08Jason,
As I said, I do not disagree with you. I just have my reservations about a major share of the current crop of SaaS applications coming out.
I also concede that maybe “Critical” mass was a bit of an exaggeration but the question most competing SaaS vendors can’t offer me (unless they are 37signals ;) ) is, “How is your product different from x, y, or z?”. If the answer is “we are cheaper” or “we have feature X”, then that IMHO isn’t good enough.
That being said, I agree that there is a long way to go before we consider the market saturated but I want to see some compelling applications that cover the breadth of the market. I am sure there is more to come.
Michael (Nozbe)
on 18 Dec 08Couldn’t agree more with Jason here. I’d add one additional benefit of recurring payments:
- not JUST ONE KEY customer. Everyone’s an important customer and you care about everyone, but if some of them leave, it doesn’t hurt you all that much, because new are coming. You don’t have customers who your business depends on…. because it depends on hundreds or even thousands of customers.
Many businesses unfortunately rely on KEY customers and especially in the crisis times, when these stop paying, the businesses have to close the doors. I saw it many times.
When you pay for my Nozbe or for any SaaS just a few bucks a month, it’s not that much of a cost and the benefit of a web-based service is really great.
David from PopupChinese.com
on 18 Dec 08Cameron,
We’re a business like you describe (we teach mandarin), and give away downloadable materials (free mp3s) while charging for premium subscription features (annotated texts, tests, etc.).
The model works for us because the free products are helpful on their own, but work even better if people pay a little bit of money. So people feel good about you (and you feel good about them) and sometimes that even translates into sales on its own: I’m certain we’ve got a few users who don’t use our premium features but pay anyway.
That being said, I don’t think it’s a viable business model unless you can make it work at low volume, since it takes time to build up a base of paying users and get to the point where people start recommending your service to others.
—david
Dave B
on 18 Dec 08I started my entire business 4 years ago when leaving college solely on the thought of: How can I get 100 people to pay me $100 a month for along time.
Now I have a aprox 230 customers paying $135. My overhead is next to nothing. I am not the next Google. I don’t want to be. I focus on a niche industry and built a nice “web based” business. I am my only full time employee. I sub out when I get busy. I’ve made a point to make sure I am “not the product” as much as possible. I follow blogs and typically “keep to myself” in the tech world and focus on my business. I do manage to take a month a year off (not all at once – but it wasn’t always this way). Though I have a very loyal customer base, I am nervous about the economy.
I am 26. I’ve never taken a single computer/web/programing class. I went to college to become a pilot and I guess I am one. I wasn’t thrilled with prospect of making $17k a year so now I am here. I see so many people trying to come up with the next cool trend. I don’t understand what’s so wrong with building a small company that provides a quality service to an industry and charging for it to just make the proverbial 100 grand.
Sarat Pediredla
on 18 Dec 08I am not the next Google. I don’t want to be. I focus on a niche industry and built a nice “web based” business.
I see so many people trying to come up with the next cool trend. I don’t understand what’s so wrong with building a small company that provides a quality service to an industry and charging for it to just make the proverbial 100 grand.
None of that equates to why a monthly recurring revenue model is a good one? Would you consider it equal if I was a 1-person company selling “one-off” software and made $31050 in an annual year? Isn’t that the same?
Bjørk
on 18 Dec 08I’m not an expert on financing, but if I could make the assumption of ‘other things being equal’, I would definitely opt for the models with the highest up-front payment possible.
I’ve always stuck to the fact that money come at a price and if you are able to allow your customers to postpone their payments you are in reality becoming a bank.
All companies fail when they are not able to pay their bills – that’s a fact of business life. So having a close eye on the cash flow is critical. Hence, in this perspective getting 3.000 upfront is better than waiting ten months getting 300 in payment per month. You have to pay a lot of bills throughout those ten months!
One of the things that I truly admire about 37signals is, that you seem to have been able to break away from this basic premise, with high recurring monthly revenues and a low cost base.
But for the average start-up that still have significant investments to do before they have a solid base for their business, a high-level of positive cash flow is everything.
A monthly recurring revenue model might be the only viable option for entering a market, but if not, I would opt for as big a chunk of the money as early as possible.
Bjørk
Dave B
on 18 Dec 08None of that equates to why a monthly recurring revenue model is a good one? It’s a simple model and works well. It’s a great monthly “base” income. In my case, I have a simple business. 230ish customers paying $135 a month. I spend, on average, 6 hours a week on direct customer support. If I lose 1. Thats a bummer. But it’s not the end of the world – I know I have 229 bottles of beer on the wall. I’d really have to screw up or economy to absolutely not exist to lose all 230. (In 4 years I’ve only lost a total of 8-9 customers)
Nothing wrong with 1 off software. I am very guilty of buying it. But, I couldn’t sleep at night under the notion that past performance is a prediction of future revenues selling one offs in this market.
There are ALOT of niche industries out there. Real businesses in need of simple specific solutions and the monthly recurring revenue model fits them really well. It’s a shame so many extremely talented developers put so much effort into contrived applications with flakey revenue models or one off projects with the hopes of making it big by being featured on a blog. No thanks. I’ll sleep well with the monthly revenue model.
steven Wagner
on 18 Dec 08Jason:
Any suggestions or insight into how you determined the different levels?
What is your percent of customers are each level for say basecamp or highrise?
BTW: we just canceled a provider that was not on-demand/subscription based because it was too much of fixed cost rather then variable.
Sarat Pediredla
on 18 Dec 08Dave B,
It’s great that a web-based model is working for you. Pleasenote I am not saying this is bad or not a good idea.
The point I am making is that how does it matter if the end result is the same? The only thing I can see is that you feel “comfortable” (personally) with the idea that a recurring revenue model.
But, I couldn’t sleep at night under the notion that past performance is a prediction of future revenues selling one offs in this market.
Again, how is this unique to one-off models? How sure can you be that you are “only” going to lose x number of customers in the next year? You also assume that historical retention of customers equals future retention.
It’s a shame so many extremely talented developers put so much effort into contrived applications with flakey revenue models or one off projects with the hopes of making it big by being featured on a blog
Doesn’t this apply to web-based models too? Techcrunch anyone?
Sorry if it feels like I am being argumentative or difficult. I just want to say that almost all the arguments (nearly) apply for every revenue model. Winning and retaining customers is important whether you are a SaaS or installed software provider. Value and great customer support are not unique to hosted models.
Chris Carpenter
on 18 Dec 08We just launched a new app – doculicious and chose the monthly subscription model with a free signup level. Because this is a new service, there’s not much regular income. Times like these require extra work if you want to keep the customers coming in. This might mean getting out and marketing to business in your area, people you can talk to and meet, instead of relying solely on web marketing.
JJ
on 18 Dec 08DaveB: I think there are a lot of people out there who enjoy the middle road, but it’s not so easy to find the kind of idea you’re talking about. I’d be hard-pressed to think of a web-based business that has some sort of annual subscription rate of $100.
Scott M
on 18 Dec 08another good reason to go with a recurring revenue model is company valuation. a company that has highly predictable recurring revenue is far more valuable to an acquirer than one that has “lumpy” revenue streams. in a lot of cases, the entrepreneur can’t envision the day when he/she will want to exit the business. but when that day comes, the entrepreneur with a recurring revenue model will receive a much higher purchase price.
Sammy
on 18 Dec 08New to this forum – great to find some good topics and comments here.
DaveB: I’m interested to know what your software is given your monthly subscription rate is $100/month. I presume it’s not a consumer product?
Also, has anyone experimented with bundling? 37 Signals for example have a family of applications. Are there benefits for bundling the products from a pricing perspective to provide value to the customer? Eg, if I’m a Basecamp customer and a Highrise customer – will you reward me for loyalty and offer me a bundled price? Ideally the products also talk to each other which demonstrates that the bundling goes beyond price.
We’re trying to finalise a pricing structure at the moment and so this has been a great post to come across. We’re considering both bundling and a “credits” system (ie buy the credits you need, use credits to buy stuff). Would very much appreciate if anyone who has insights or experiences to share in either areas.
Dave B
on 19 Dec 08I’m interested to know what your software is given your monthly subscription rate is $100/month. I presume it’s not a consumer product?
Def B2B for the rates. My company works primarily with heating oil companies (also offer scaled down packages for propane, some HVAC, etc. but they are not “the” customer).
We make it easy for Mr. & Mrs. Homeowner to purchase heating oil online.
We also toss in some easy simple website templates and now and then some SEM, Mailbuild template here and there. But there are 1,000,000 others doing that stuff so its not really a core focus. Its a niche industry, it took awhile to really learn all the “industry” concerns, issues… lingo, speak their language, etc. Suddenly one day, you become a “specialist”! How exciting. < / sarcasm >
Since becoming involved with this, I’ve been wildly intrigued by how many other industries are in real need of modern solutions. And a solution that fits the monthly recurring model.
I’m convinced if you pick any “main street business” in your town… you’ll discover opportunities.
Again, this is one of many many examples of a small business built around the recurring model. I only wanted to contribute and say, hey – it’s working OK here… I’m nervous about the economy but… the scheduled daily credit card batches are comforting for the time being.
Time for another scotch & water. G’nite!
JF
on 19 Dec 08Since becoming involved with this, I’ve been wildly intrigued by how many other industries are in real need of modern solutions. And a solution that fits the monthly recurring model. I’m convinced if you pick any “main street business” in your town… you’ll discover opportunities.
Dave, you’re a smart man. There is so much opportunity to modernize so many obtuse industries. It’s still the stone age. There are plenty of areas in need of new thinking and breakthrough simple solutions.
Brian D
on 20 Dec 08Great post, and price perceptions are very true in my experience. Just this year my company suddenly got billed $600.00 for an annual subscription using our credit card on file. When I saw that on pop my statement, I yelled a few choice words because I was not ready for it, and it looked like a big number to me. However, we pay $100/month for several other apps and I never feel shocked when those hit my account, even though they cost twice as much on an annual basis.
Car dealers were hip to this long before personal computers existed. That’s why they don’t want you to focus on the sticker price, but rather what monthly payment you would like to have.
So invite the local radio station over, serve up some hot dogs and pie, and quote your prices on a monthly basis!
twojarandka
on 20 Dec 08What if you are offering something that you download, as well as a service?
Joshua Clanton
on 21 Dec 08The point I am making is that how does it matter if the end result is the same? The only thing I can see is that you feel “comfortable” (personally) with the idea that a recurring revenue model.
@Sarat: I think the main difference is in customer perception. Many potential customers would turn you down if you asked for a lump sum of $250, but are perfectly happy to pay $21/month. The difference is in the immediate pain felt. Lower the pain threshold and you’ll get more customers.
Brian Jones
on 22 Dec 08I know it’s probably covered under freeware, but what about the open source model? If some creates an open source version of your service, releases the code so that it does not have to be hosted on their infrastructure, could not this model compete with a monthly subscription based model?
This discussion is closed.