You can now buy a subscription for everything from dog treats to razor blades. Music subscription services are booming as our appetite to buy tracks is replaced by our willingness to rent access to them. Starbucks now even offers coffee on subscription.
Why are so many companies leveraging the subscription business model? The obvious reason is that recurring revenue boosts your company’s value, but there are some hidden benefits to augmenting your business with a subscription offering.
Finding out what your customers want is expensive. By the time you pay attendees, rent a room with a one-way mirror and buy the little sandwiches with the crusts cut off, a focus group can cost you upwards of $6,000. A statistically significant piece of quantitative research, done by a reputable polling company, might approach six figures.
With a subscription company, you get instant market research for free. Netflix knows which shows to produce based on the viewing behaviour of its subscribers. No need to ask viewers what they like, Netflix can see what they watch and rate.
For you, a subscription offering can allow you to test new ideas and gives you a direct relationship with your customers so you can see what they like first hand.
Subscription companies are often criticized for being hungry for cash. Many charge by the month and then have to wait months—sometimes years—to recover the costs of winning a subscriber.
That assumes, however, that you’re charging for your subscription by the month. If you’re selling your subscription to businesses, you may get away with charging for a year’s worth of your subscription up front. That’s what the analyst firm Gartner does, and it means they get an entire year’s worth of cash from their subscriber on day one. Costco charges its annual membership up front, which means it has billions of dollars of subscription revenue to float its retail operations.
Customers can be promiscuous. You may have a perfectly satisfied customer but if they see an offer from one of your competitors, they might jump ship to save a few bucks. However, if you lock your customers into a subscription, they may be less tempted to try a competitor since they have already made an investment with you.
One of the reasons Amazon Prime is so profitable is that Prime subscribers buy more and are stickier than non-Prime subscribers. Prime subscribers want to get their money’s worth, so they buy a wider swath of products from Amazon and are less tempted by competitive offers.
The obvious reason to launch a subscription offering of your own is that the predictable recurring revenue will boost the value of your company. And while that’s certainly true, the hidden benefits may even be more important.
Have you ever wondered what determines the value of your business?
Perhaps you’ve heard an industry rule of thumb and assumed that your company will be worth about the same as a similar size company in your industry. However, when we take a look at the data provided by The Value Builder System™, we’ve found there are eight factors that drive the value of your business, and they are all potentially more important than the industry you’re in.
Not convinced? Let’s look at Jill Nelson, who recently sold a majority interest in her $11 million telephone answering service, Ruby Receptionists, for $38.8 million.
That’s a lot of money for answering the phone on behalf of independent lawyers, contractors and plumbers across America.
To give you a sense of how high that valuation is, let’s look at some comparison data. At Value Builder, we’ve worked with more than 30,000 businesses in the last five years. Our clients start by completing their Value Builder questionnaire, which covers 35 questions that allow us to place an estimate of value on a company. The average value for companies starting with us is 3.6 times pre-tax profit and those who graduate our program with a Value Builder Score of 80+ (out of a possible 100) are getting an average of 6.3 times pre-tax profit.
When we isolate the administrative support industry that Ruby Receptionists operates in, the average multiple offered for these companies over the last five years is just 1.8 times pre-tax profit.
Nelson, by contrast, sold the majority interest in Ruby Receptionists for more than 3 times revenue.
There were three factors that made Nelson’s business much more valuable than her industry peers, and they are the same things you can focus on to drive up the value of your company:
Acquirers do not buy what they could easily build themselves. If your main competitive advantage is price, an acquirer will rightly conclude they can simply set up shop as a competitor and win most of your price sensitive customers away by offering a temporary discount.
In the case of Ruby Receptionists, Nelson invested heavily in a technology that ensured that no matter when a client received a phone call, her technology would route that call to an available receptionist. Nelson’s competitors were mostly low-tech mom and pop businesses who often missed calls when there was a sudden surge of callers. Nelson’s technology could handle client surges because of the unique routing technology she had built that transferred calls efficiently across her network of receptionists.
Nelson’s acquirer, a private equity company called Updata Partners, saw the potential of applying Nelson’s call-routing technology to other businesses they owned and were considering investing in.
Acquirers want to know how your business will perform after they buy it. Nothing gives them more confidence that your business will continue to thrive post sale than recurring revenue from subscriptions or service contracts.
In Nelson’s case, Ruby Receptionists billed its customers through recurring contracts— perfect for making a buyer confident that her company has staying power.
In addition to having customers pay on recurring contracts, the most valuable businesses have lots of little customers rather than one or two biggies. Most acquirers will balk if any one of your customers represents more than 15% of your revenue.
At the time of the acquisition, Ruby Receptionists had 6,000 customers paying an average of just a few hundred dollars per month. Nelson could lose a client or two each month without skipping a beat, which is ideal for reassuring a hesitant buyer that your company’s revenue stream is bulletproof.
Nelson built a valuable company in a relatively unexciting, low-tech industry, proving that how you run your business is more important than the industry you’re in.
If you were to draw a picture that visually represents your role in your business, what would it look like? Are you at the top of a traditional Christmas-tree-like organizational chart, or are you stuck in the middle of your business, like a hub in a bicycle wheel?
As anyone who has tried to fly United when O’Hare has been hit by a snowstorm knows, a hub-and-spoke model is only as strong as the hub. The moment the hub is overwhelmed, the entire system fails. Acquirers generally avoid hub-and-spoke managed businesses because they understand the dangers of buying a company too dependent on the owner. Here’s a list of nine warning signs you’re a hub-and-spoke owner and some suggestions for pulling yourself out of the middle of your business:
Most business owners sign the checks, but what happens if you’re away for a couple of days and an important supplier needs to be paid? Consider giving an employee signing authority for checks up to an amount you’re comfortable with, and then change the mailing address on your bank statements so they are mailed to your home (not the office). That way, you can review all signed checks and make sure the privilege isn’t being abused.
If your employees are out of their depth a lot, it will show up in your mobile phone bill because staff will be calling you to coach them through problems. Ask yourself if you’re hiring too many junior employees. Sometimes people with a couple of years of industry experience will be a lot more self-sufficient and only slightly more expensive than the greenhorns. Also consider getting a virtual assistant (VA), who can act as a first line of defense in protecting your time. You can find a VA by filling out the request for proposal at http://www.ivaa.org/.
Flat revenue from one year to the next can be a sign you are a hub in a hub-and-spoke model. Like forcing water through a hose, you have only so much capacity. No matter how efficient you are, every business dependent on its owner reaches capacity at some point. Consider narrowing your product and service line by eliminating technically complex offers that require your personal involvement, and instead focus on selling fewer things to more people.
