In a series of articles, we will go through the most important concepts for measuring and analyzing a subscription based business. In this part, we look at general concepts and their relationships, as well as the concept of Volume. In the coming articles, will go through Revenue and Costs, and how to work using a data driven workflow.
One of the fantastic characteristics of any subscription business is that almost everything about it can be measured. Measuring is the first step in optimizing and growing your business. However, this is hardly the last step, which is why we must constantly understand why we measure our business, what insights we draw and how we should act on the information.
For any subscription business, there are a number of generic measurements which are basically the same for all businesses. These measurements are the ones that affects the volume of subscribers, how much they pay, how long they stay and what costs we have. This article series will mainly focus on these. Apart from these, there are also industry and product specific measurements, which we will cover at a later time.
As an overview, we summarized in three simple concepts: 1. Volume of subscribers 2. Revenue per subscriber and 3. Costs. Concept # 1, in turn, is a function of New sales and Churn. The first and the second forms the Total revenue (i.e. volume multiplied by revenue), which can then be compared with Costs to understand the contribution.
The basic concepts can be summarized as
Volume = Opening balance + New sales – Churn
Revenue = Volume * Average revenue
Profitability = Revenue – Cost
Here it is good to point out that Volume is always measured at a give moment in time – while sales, churn, revenue and costs are always measured over a certain period of time (like days or months).
It can also be mentioned that in addition to these more basic concepts, there are a number of advanced analyzes and concepts to work with to grow their business. Examples of these are lifetime value, cohort analysis, scenario analysis, chain-event analysis and forecasting. However, these concepts will have to wait for future articles.
To measure Volume
The first step to successfully measuring volume is to determine what volume we actually mean. You need to decide whether to measure subscribers or subscriptions. A subscriber (i.e. a customer) buys one or more subscriptions, either simultaneously or over a period of time. In the long term, it may be important to understand how a customer buys multiple subscriptions. However, I would recommend to start out by measuring subscriptions. It is generally easiest one to find out, although this in turn depends on the technical platform you work with and the quality of your data.
The next question is whether we should include all subscriptions in the volume. For example, should we include non-paying? Should we include those in a (free) trial period? My recommendation is to count everything and everyone, but segment so that it becomes clear what different volumes we are talking about. For example, it may be misleading to calculate non-paying if we want to be able to quickly calculate correct average revenue.
As we noted earlier, the volume consists of an opening balance, which in turn is changed by (mainly) sales and churn. Sales are simply how many new subscriptions are added during a certain period of time, i.e. the inflow of the stock.
Churn is what we have lost over a period of time and is measured in absolute numbers and also in percent. Traditionally, churn percentage is defined as: The number of cancelled subscriptions / The number that had the option to cancel. If you run a monthly subscription business, you can say that Churn % = Cancellation during the month / Opening balance for the month. This is because all monthly subscriptions (theoretically) can be canceled. If you run a non-monthly business, however, you need to understand how many were actually up for renewal.
Here is a good rule of thumb regarding life time value. By lifetime in this case is mean the number of months (or other time periods) a subscription “lives” on average. For example: “5.3 months”. It should be interpreted as: If we get a new subscriber, it stays on average for X months. By then calculating how much a subscriber on average pays per month during their lifetime, we can calculate the total “lifetime value” for a subscriber. This is an estimate of how much money we are expected to receive from a subscriber during its lifetime. A very powerful concept that can, for example, be used to consider the profitability of different segments.
The rule of thumb goes: If the churn is X % per time period, the life time is 1 / X time periods. You can convince yourself that this is the case by studying geometric sums, or simply accept it as a rule of thumb. Example: If the monthly churn is 10 %, the life time is on average 10 months (1 / 0.1 = 10). If the churn is 5 %, the life is 20 months (1 / 0.05 = 20), the 20 % is the life 5 months (1 / 0.20 = 5). Note, however, that this is a rule of thumb and it can be shown that it often indicates a too short lifetime. This is because in practice the churn is rarely constant X %, the churn often decreases gradually over time (which is good!). In practice, it is this “long-term retention” that creates long-term profitability in many subscription businesses.
Another factor which affect the volume is conversions between products. Although such changes generally do not affect the overall volume, it is important to understand these moves when looking at the volume for more specific segments, such as a specific product or customer group.
In summary, the following basic concepts are a good start for understanding Volumes:
= Initial balance at time A
+ New sales
– Cancellations (churn)
± Conversions between products
= Closing balance at time B
This article was an introduction to how to measure and think about Volume in your subscription business. In future articles we will go through analysis of Revenue and Costs, and more.