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Subscription Economy – An Entirely New Success Model

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Subscription Economy – An Entirely New Success Model

More and more companies do not want to sell clients a product only once. Instead, subscription models are becoming more popular. They strengthen client relationships, offering companies recurring, predictable sales, and hence also higher profit margins in most cases.

“Battle of the streaming services”

 

At the moment, the “battle of the streaming services” is attracting a lot of attention worldwide. Netflix started with DVD rental by mail. Now the video-on-demand provider has worked its way up to become number one in the field of online streaming services. The company has not only turned the entire movie industry upside down. It has also completely changed the way that people consume audiovisual content. Movies, series, or documentaries are now viewed less and less often at prescribed times. What is known as linear TV watching is on the wane. Instead, people are consuming content via the internet, anywhere, at any time, and on any internet-ready device. Well-known corporations such as Amazon, Walt Disney, and Apple do not intend to leave the field to Netflix alone.

 

In the past, Netflix has primarily been challenged by Amazon and its Prime services. Since November 2019, Disney has had its own Disney+ streaming service on the market in the USA and Canada. It is set to be launched in Germany and other important markets at the end of March 2020. Well-known brands such as “Star Wars”, “Pixar” animated movies, or the “Marvel” superhero series are set to give victory to this US media corporation. Apple is also joining the fight with its own streaming service, Apple TV+. This is astonishing when you consider that the corporation with the apple logo was for a long time primarily successful with the sale of hardware products such as the iPhone, iPad, iPod, Mac PCs, or the Apple Smartwatch. Now Apple seems to have seen the signs of the times and is switching increasingly to subscription models.

 

More and more companies do not want to sell clients a product only once. Instead, subscription models are becoming more popular. They strengthen client relationships, offering companies recurring, predictable sales, and hence also higher profit margins in most cases. After all, subscription models also deliver better products in the long term because they have to be constantly adapted to consumer requirements in order to remain attractive to them.

 

Apple is having to reinvent itself

 

The smartphone market has been approaching saturation in recent years. Apple fans are dragging their feet more and more when it comes to replacing their old smartphones with new models. On the one hand, this is due to the high price, and on the other hand the latest smartphones are so sophisticated that switching to an even newer model brings only a few advantages, which often makes the high costs not worth it. Consequently, Apple is investing heavily in growing various service offerings. An Apple Music subscription already offers users 60 million songs. With Apple TV+, movie and series fans get in-house Apple content for EUR 4.99 per month after a free 7-day trial subscription. Apple Arcade wants to benefit from the growing popularity of online video games, while Apple News+ is supposed to offer users access to a wide variety of newspapers and magazines. A credit card is also set to offer Apple new revenue options.

 

The success of this new subscription-based strategy already became clear in the 2018/2019 fiscal year, which ended in September. While revenue from sales of the iPhone fell by almost 14 per cent compared with the previous year, down to USD 142.4 billion, the services business grew by more than 16 per cent to USD 46.3 billion. Apple was primarily dependent on iPhone sales for many years. In the last fiscal year, however, the share of sales from its services business rose. So, this turnaround is not only delivering greater predictability at Apple, but also commercial success. The effect of this increased concentration on service offerings is not only apparent in the form of strong growth, but also in the form of increasing profit margins.

 

In the last fiscal year, Apple achieved a gross profit margin of 63.7 per cent in the services segment. Group-wide this only amounted to 37.8 per cent. The margin in the field of service offerings is not only considerably higher than in other segments; it has also grown strongly in recent years. This high gross margin for Apple is thanks to the rise in recurring sales, among other things. Recurring sales mean lower follow-up sales costs and hence as a rule higher profit margins, leading to a rise in the value of the shares for companies. In the case of Apple, a share price performance of more than 70 per cent in the 2019 trading year speaks volumes.

 

Apple is far from the only corporation that has recognized the advantages of the subscription model. The subscription economy is on the way. In fact it has reached the point where some fundamental theories that were established over decades about the production economy or marketing are having to be rethought.

 

The customer’s wishes are taking priority

 

One of the loudest voices heralding the arrival of the subscription age is that of Tien Tzuo. He was the chief marketing officer and chief strategy officer at the cloud computing specialist Salesforce.com. He is also the co-founder and CEO of Zuora. This software firm helps companies switch their business to a subscription model. In his book “The Subscription Economy,” he outlines his view of the transition from a production economy to a subscription economy.

 

However, in addition to the opportunities, he also shows the risks that lie in wait for companies that no longer offer their products and offers exclusively for one-time consumption, but as a service for a subscription. On the one hand, companies are tempted by predictable sales, but at the same time the start of the changeover is often also associated with some major sales losses. And not every company is prepared to undertake radical change. As a positive example, he cites the software company Adobe, which switched to a subscription model for its graphics software in 2013 and which is currently enjoying major business successes thanks to this bold step. While recurring sales accounted for virtually 0 per cent of total sales at Adobe in 2011, this figure has recently risen to around 90 per cent.

 

Other companies that implemented subscription models have also enjoyed strong growth. Zuora has published the Subscription Economy Index™ (SEI) since 2012. This illustrates the strong growth in the area of the subscription economy. The average annual growth rate for sales of products or services that were distributed with the aid of a subscription model between January 2012 and June 2019 was +18.2 per cent. This means that growth in this period was around five times higher than that of the companies in the S&P 500® (+3.6 per cent) or US retail sales (+3.7 per cent). For a company to successfully implement a subscription model, Tien Tzuo maintains that its business model, marketing, sales, accounting, and even its corporate culture have to be modified. After all, with a subscription model, the focus is shifted from a static product onto the client. Companies have to find out what service clients want. While this shifts the focus onto the client, Tien Tzuo cites the fact that all products can be transferred to a subscription model as another advantage of the subscription economy.

 

The composition of the index

 

The index comprises 25 companies. These are made up as follows: The five companies with the highest scores from the IaaS segment are included in the Solactive Subscription Economy Performance Index. The SaaS segment provides eight representatives, while the index is completed by two companies from the subscription management sector and ten XaaS companies. Regular index adjustments take place every six months, and unscheduled index adjustments may become necessary if measures are taken by a company (e.g. dividend payments, equity splits, reverse splits, capital increases, share buybacks, spin-offs, takeovers, share sales, delistings, transition to a state-owned company, insolvency) which have a significant effect on the price of the index, its weighting, or the overall integrity of the index components. The members of the Solactive Subscription Economy Performance Index include the following:

 

 

Disney

 

The video-on-demand provider Netflix turned the movie industry upside down. Disney could no longer sit back and watch. Disney as the “Micky Mouse” group is engaging more actively in the “battle of the streaming services” with its own streaming service Disney+, as well as popular brands such as “Star Wars.”

 

Zuora

 

This software company somewhat takes center stage when companies need to switch their businesses to a subscription model. For example, Zuora automates payment transactions and subscription management for its clients in the cloud.

 

ServiceNow

 

With its cloud-based platform, ServiceNow ensures that employees in companies can work more efficiently. For example, this happens with the assistance of digitized, automated work processes. In addition to automating routine tasks, this also means improved cooperation between various departments.

 

Adobe

 

Adobe is a graphics software specialist and is seen as one of the pioneers in the subscription economy. While the changeover initially cost Adobe some sales, the company is now achieving impressive growth rates and its business is largely based on recurring and predictable sales.

 

SAP

 

Like other software companies, SAP increasingly relies on cloud computing. This company is based in the German town of Walldorf and has also grown in recent years with the aid of some billion-dollar takeovers. This strong growth contributed to the fact that SAP has become Germany’s most valuable listed company.

 

Summary

 

Vontobel has now also made it possible for private investors to invest in the Solactive Subscription Economy Performance Index. With the aid of one single tracker certificate on the index, investors can easily invest in 25 promising securities from the subscription economy segment and participate fully in the development of the Solactive Subscription Economy Performance Index.

 

Please note: There is a risk of loss in the event of payment default of the issuer of the tracker certificate or of the guarantor (issuer risk), and there is no capital protection. In the worst case, there may be a total loss of the invested capital.

Disclaimer

 

This publication is deemed to be marketing material within the meaning of Article 68 of the Swiss Financial Services Act and is provided for informational purposes only. We will be happy to provide you with additional information about the specified financial products, such as the prospectus or the basic information sheet, free of charge, at any time.