Last editedMar 20235 min read
If you run a business then one of the most important decisions you’ll ever make is the revenue model you opt for. In simple terms, this means choosing how your customers are going to pay for the goods or services you supply. Getting the choice right means maximising sales, bringing in more revenue and keeping your cash flow as healthy as possible. There are various options available, but in this piece we’ll be looking at two of the most popular – the subscription model and the transaction model. We’ll explain how each revenue model works and set out some of the pros and cons of each, making it easier for you to decide which is best suited to your business.
What is a subscription model?
The rise of digital technology and the fact that items which once had to be purchased in physical form can now be downloaded onto laptops, tablets or smartphones has fuelled an increase in the number of businesses opting for a subscription model. According to statistics published in Forbes magazine, the global market for e-commerce subscriptions was worth $72.91 billion in 2021 but increased to $120.04 billion in 2022 and is tipped to reach $904.2 billion by 2026. Think of the things you purchased yourself- such as music, films and software – which have switched from being one off purchases of hardware, usually in the form of a disc of some kind, to being based around a monthly subscription service such as Spotify or Netflix. The changing nature of many products means that a subscription model – in which customers receive goods or services in return for regular set payments – has become the logical choice for many businesses.
The pros and cons of a subscription model
There are benefits and risks to a subscription model from the point of view of businesses and customers alike. In this article we’ll mainly be looking at how subscription or transaction based revenue models can impact on businesses, but it’s worth considering the point of view of the customer, since this will often dictate whether a subscription model is suited to a particular product.
One of the advantages of a subscription model from the customer’s point of view is that the initial payment is much lower than it would need to be to purchase the product or products outright. Software such as the Adobe products could seem prohibitively expensive when presented as a one-off purchase, but more affordable in the form of on-going monthly payments, for example. The main risk of a subscription model from a customer point of view is that they end up making regular payments for a product which they no longer actually use. The prototypical example of this would be a customer who signs up for gym membership in January, visits a few times in the first months of the year and then stops going as their post-Christmas good intentions wane, but still have the monthly membership fees leaving their bank account.
From a business point of view this phenomenon – generally referred to as the inertia effect – is one of the pros of a subscription model, and here are a few of the others:
The benefits of a subscription model
Regular income – a subscription model which attracts multiple customers will generate strong, reliable and regular income streams, making it easier for the business in question to plan for the future and seek investment.
Customer appeal – as stated above, one of the main benefits of a subscription model for your business is that you’ll initially be asking your customers for a much smaller payment. Over time, the amount of income generated per customer will equal if not exceed the amount generated by a one-off transaction, but the smaller individual payments will often be much more psychologically appealing.
Consumption – the fact that customers are making regular payments for your goods or services often encourages them to consume more of those goods and services in order to enjoy the full benefit of their investment. In turn, this will help to build customer loyalty and encourage them to explore the full range of what your business offers.
Free trial – offering a free monthly trial in return for a customer providing their payment details is far simpler when a business uses a subscription model. It is an effective means of persuading interested customers to take the leap and sample your goods or services.
Customer loyalty – offering goods or services on a subscription basis makes it far less likely that customers will switch to competitors for the same products. As long as the goods and services you provide are of the requisite quality, the effort of seeking out a rival subscription service is likely to be more than most customers can be bothered with.
The risks of a subscription model
Customer reluctance - from the customer’s point of view, the need to sign up for yet another subscription when they want to purchase another product may discourage them from spending money with your business. As subscription models have become more prevalent, consumers have become more aware of issues such as the inertia effect, and may think more carefully about signing up to a subscription.
The need to innovate – once you’ve persuaded customers to sign up to your subscription service you might feel pressured to constantly innovate in terms of the goods and services on offer. A streaming service such as Disney+ needs to add new programmes and films constantly in order to maintain customer engagement, for example. Without the business and financial power of Disney, your business may find this pressure difficult to cope with.
Admin costs – by its very nature, a subscription model will involve more admin work on the part of your business. Some of this will revolve around ensuring that payments are being collected on a regular basis, unless you partner with GoCardless. Businesses which utilise our services can quickly and simply set up regular recurring payments via the Direct Debit system.
The pros and cons of a transaction model
The transaction model represents the tried and tested means by which businesses have always made money. Income is generated each time an item or service is sold to a customer, with the price per purchase being based on the cost of production plus any profit margin built in. The higher the profit margin is, the greater the income generated by each individual transaction will be.
The benefits of a transaction model
Control – the simplicity of a transaction model makes it easy to maintain full control over the prices you charge for your goods or services. One sale will always generate a specific profit, so the overall profit margin can be calculated by multiplying an individual sale by the overall number of sales. As a business grows you can cut production costs through economies of scale and efficiencies, and either pass the savings on to your customers or keep the same price and boost your profit margins.
Maximising profits – the control offered by a transaction model is such that it becomes simpler to maximise the profits generated by each sale. The price charged each time can be tailored to meet the specific circumstances, including factors such as the specific customer, the number of items being purchased and even variables such as the time of year.
Simplicity – compared to the potential admin involved in a subscription model, a transaction model is simplicity itself. Money is paid and the goods or services provided, and that tends to mark the end of the customer/business relationship.
The disadvantages of a transaction model
Pressure – a transaction model places huge pressure on your business in terms of more sales having to be constantly generated. Unlike a subscription model, which guarantees a certain income each month, a transaction model means that a month in which no sales are made is a month in which no income is generated.
Lack of data – the one-off nature of the customer interactions involved in a transaction model makes it more difficult to gather the kind of customer data that can be so useful for a modern business. Details such as customer spending habits and the demographics of your customer base can be extremely useful when making decisions about product offerings and pricing levels, and these details are harder to track via one-off payments.
Customer loyalty – it can be more difficult to build customer loyalty – and repeat custom – when customers only make one-off purchases. The pressure can be on businesses to drive loyalty through tactics such as discounts or loyalty programmes, another expense on top of the increased marketing and sales effort involved.
We can help
GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.