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From fighting fires to fire insurance


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Slide from the first-ever workshop on subscription-based pricing with Ron Baker and Ed Kless.

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From fighting fires to fire insurance

  1. 1. From Fighting Fires to Fire Insurance Transforming to a subscription-based business model
  2. 2. Exercise • Why would you subscribe to: A. Roofs B. Refrigerators C. Drills D. Guitars E. Cars F. Birthday Parties G. Shoes • What are the advantages and disadvantages to the customer? • What are the advantages and disadvantages to the provider? • Tease out the value proposition.
  3. 3. Why subscription? Why now?
  4. 4. Hotel California Columbia House
  5. 5. “In five years, you won’t buy anything, but subscribe to everything.” Tien Tzuo, CEO of Zuora
  6. 6. “In five years, you’ll have the option of subscribing to everything—and every business will have to accommodate that fact.” Anne Janzer, Subscription Marketing
  7. 7. Four trends ushering in the subscription model Reduction of transaction costs Light-switch reliability Delicious Data The Long Tail
  8. 8. McKinsey Says Subscription ecommerce market has grown by more than 100% a year for past 5 years Subscription-based companies growing 8x faster than S&P 500 (17.6% vs. 2.2%, and 5x than US retail sales (17.6% vs. 3.6%)
  9. 9. Smile Curve for implementations Determine Cost/Benefit Develop Project Plan Implementation Go Live Access Level Agreement ValuetoCustomer Duration
  10. 10. Design Build Solutions Deliverables Ideation Execution MAGIC LOGIC Low-value Low-marginHigh-value High-margin
  11. 11. MAGIC LOGIC Low-value Low-marginHigh-value High-margin “The easier it is to quantify, the less it’s worth.” Seth Godin Marketing and Business Author “There is margin in mystery.” Tim Williams Marketing and Business Author #SageSummitUS - @edkless Be Sage. Build On. MAGIC LOGIC Low-value Low-marginHigh-value High-margin “ The easier it is to quantify, the less it’s worth.” Seth Godin Marketing and Business Author “ There is margin in mystery.” Tim Williams Marketing and Business Author
  12. 12. Implementation – Magic v Logic Step Magic Work Logic Work Determine Value to Solve Requires providing insight into the data gathered and assimilated and developing tangible goals Is mostly about just gathering and assimilating data from the customer Develop Project Plan Requires a focus on tight objectives, resource and quality requirements Is mostly about just describing the deliverables and functional requirements Implementation Requires a high level of collaboration with the customer including a well executed communications plan and adherence to the scope or change request process Is mostly executed by the Partner by using a checklist. (Usually in someone’s head, but nonetheless.) System Commencement Requires a detailed understanding and use of the change and transition model Is mostly about getting the data right and can the customer personnel function Access Level Agreement Requires a deep understanding of the on-going knowledge requirement of the customer Is mostly about fixing problems the crop up in a timely manner
  13. 13. Transaction Costs • Triangulation—Matching buyer with seller, agreeing terms • Transfer—Of product/service and payment terms • Trust—Honesty, performance (ratings and brands) “In the past 20 years entrepreneurs have for the first time been able to specialize in selling not more stuff, but reductions in transaction costs for access to existing stuff.” –Michael Munger
  14. 14. Advantages of the subscription model – 1 Predictable revenue Customer lock-in and switching costs Not selling services, but creating annuities with a lifetime value that far exceeds whatever you paid to acquire them Collective knowledge of your customers is a competitive advantage that can’t be duplicated 1:1 Marketing: Changes the 4 Ps of marketing. We’re not pricing a service, we’re pricing an transformation, insurance (peace of mind), and the portfolio
  15. 15. Advantages of the subscription model – 2 Shift to a long-term relationship focus rather than delivering tasks—the very definition of a professional Attract new customers (rather than just selling more to current customers) You can plan cash flow and capacity more effectively Moving beyond efficiencies and into possibilities Breaks down silos, and molds the firm around the needs of customer Truly a “one-firm” model: Portfolio approach to analyzing profit, rather than silo P&Ls, and realization rates
  16. 16. Advantages of the subscription model – 3 Dynamic cycle customer interaction: renew, suspend, upgrade, downgrade, etc. They increase the value of your largest asset (Amazon Prime carved out of Amazon would be worth billions; the New York Times would be a Unicorn) Get paid automatically, less financing, collections costs Increases customer loyalty Recession-proofs your business
  17. 17. Nine Subscription Models The Automatic Customer by John Warrillow
  18. 18. Web-site membership
  19. 19. All-you-can-consume content
  20. 20. Private club
  21. 21. Front-of-the-line
  22. 22. Consumables
  23. 23. Surprise box
  24. 24. Simplifier
  25. 25. Network
  26. 26. Peace-of-mind
  27. 27. Hybrid Examples
  28. 28. Fender Guitar
  29. 29. Amazon Prime 1 x 7 ≠ 7 x 1
  30. 30. Ascend HR Corp • Four reasons why contingency recruitment is not good for most companies • Acts too much like self- insurance • Increases unpredictable budgeting • Misaligns incentives – take on lesser qualified candidates • Doesn’t promote effectiveness toward more hires
  31. 31. Exercise 2 • Which of the models apply to your firm? • Give an example of at least three. • Report out. 1. Web-site membership 2. All-you-can-consume content 3. Private club 4. Front-of-the-line 5. Consumables 6. Surprise box 7. Simplifier 8. Network 9. Peace-of-mind
  32. 32. You are what we charge for • If you charge for stuff, you are in the commodity business (fungible). • If you charge for tangible things, you are in the goods business (tangible). • If you charge for the activities you execute, you are the service business (intangible). • If you charge for the time customers spend with you, you are in the experience business (memorable). • If you charge for outcomes the customer achieves, then you are in the transformation business (effectual, personalized).
  33. 33. If a member retains membership and engagement for a year = 90% chance member for life
  34. 34. AICPA: Cost 11x more to acquire a new customer than retain one
  35. 35. Customer success management An integration of the functions and activities of marketing, sales, professional services, education, and support into a new profession to meet the needs of recurring revenue model companies. Marketing after the sale!
  36. 36. Adoption models The subscription trial—low risk, low reward, lack of commitment may doom transition The segmented approach—offer only selected services, or only to selected customers The all-in pivot—Adobe Systems most visible example, in 2011, “won’t this lower our margins? How will sales sell this stuff?” By 2016 revenue $5.85B, 78% from subscriptions
  37. 37. Three Macro Pricing Strategies Penetration: Wal-Mart, Southwest, Costco, Dell, Timex Neutral: Toyota, Sony, Casio, UPS Skim: Apple, BMW, FedEx, Nordstrom, Disney
  38. 38. Three actuarial axioms • If what you sell entails risk, you are not a commodity. • There is not such thing as a bad risk, just a bad premium. • There is no model for pricing risk by the hour.
  39. 39. What is Systems Thinking? A system is a whole that cannot be divided into independent parts. Its properties and behavior derive from the interactions of its parts, not their actions considered separately. A disassembled auto cannot carry people. –Russell L. Ackoff, Creating the Corporate Future, 1981
  40. 40. Ultimate Car, or…
  41. 41. The 11 Laws of Systems Thinking
  42. 42. #1 Today’s problems come from yesterday’s solutions. (e.g., dozens of disparate spreadsheets). There are no solutions, only tradeoffs.
  43. 43. #2 The harder you push, the harder the system pushes back. Known as compensating feedback, best illustrated by the story of Boxer the horse in George Orwell’s Animal Firm.
  44. 44. #3 Behavior grows better before it grows worse. Treating the symptom, not the cure? The “old” system always appears to have been better in retrospect and people will question the change, even if they had complained about the old system previously.
  45. 45. #4 The easy way out usually leads back in. Drunk looking for his keys under a streetlamp. Comfort zone challenge: Satisficing (satisfy + suffice).
  46. 46. #5 The cure can be worse than the disease. Iatrogenic illnesses are caused by the doctor. First, do no harm. The cure can become addictive (opioids).
  47. 47. #6 Faster is slower. A fast fix can equal a slow cure. Tortoise and the hare. Every system has an optimal speed.
  48. 48. #7 Cause and effect are not closely related in time and space. Pushing the elevator button; adjusting the cold water in the shower; ROI; and Homer Simpson.
  49. 49. #8 Small changes can produce big results— but the areas of highest leverage are often the least obvious. Understand dynamic complexity, not detail complexity (e.g., the 4 Ps of marketing are a dynamic system). To control insects in greenhouses, wasps were introduced—brilliant, effective, and counterintuitive.
  50. 50. #9 You can have your cake and eat it too—but not at once. Tradeoffs are key. You cannot increase the quality of a product AND simultaneously decrease the cost. Over time, though, higher quality CAN lead to decreasing costs. Either/or thinking vs. both/and thinking.
  51. 51. #10 Dividing an elephant in half does not produce two small elephants. It produces an ugly, bloody mess. Nine pregnant women can’t produce a baby in a month.
  52. 52. #11 There is no blame. Dr. W. Edwards Deming looked to the system, not people, for the blame.
  53. 53. Measurements v. Metrics Measurements Metrics Net Income Using Average LIFO FIFO 2018 $16,080 $18,980 $11,940 2019 $17,980 $20,800 $14,020 2020 $19,920 $24,890 $17,050
  54. 54. All result in different amounts Standard costing Total absorption costing Average costing Lean costing Marginal costing Activity-based costing
  55. 55. The F-16 had a unit cost of US$18.8 million (1998). Operational cost per flight hour has been estimated at $7,000 to $22,470 or $24,000, depending on calculation method.
  56. 56. Gedankenexperiment #1 1. Do we pay $25 when we make one more? 2. Do we save $25 when we make one less? 3. Apple made 4 billion to get unit cost down to $25. 4. But what if demand is only 1 billion? 5. A higher gross margin will be calculated, but total cash costs will be higher (see GM). 6. When you produce more units with same capacity, you’re being more efficient, not saving cash. 7. Are there are any costs not adding value to the customer? Cost per Pencil = $25 What does that tell you?
  57. 57. Gedankenexperiment #2 1. 10,000 books costs $10,000, or $1/book 2. $14 Gross margin 3. Digital print option cost 5,000 books for $8,000, $1.60/book 4. But what if demand is only for 5,000 books 5. Option 1: Revenue = $75,000 - $10,000 = $65,000 6. Option 2: Revenue = $75,000 - $8,000 = $67,000 7. Lesson 1: Don’t let calculated unit cost influence operations 8. Lesson 2: Model cash flow, not accounting calculations Sales price = $15 What does that tell you?
  58. 58. Traditional vs Subscription P&L Traditional Net sales $ 100 Cost of goods sold (40) Gross income 60 Sale and marketing (20) Reasearch and development (20) General and administrative (10) Net income $ 10 Subscription economy Annual recurring revenue $ 100 Churn (10) Net annual recurring revenue 90 Recurring costs Cost of goods sold (20) General and administrative (10) Research and development (20) Total recurring costs (50) Recurring profit 40 Sales and marketing (30) Net operating income 10 New annual recurring revenue 30 Ending annual recurring revenue $ 120
  59. 59. Subscription metrics MRR – Monthly Recurring Revenue ACV – Annual Contract Value CAC – Customer Acquisition Costs Churn rate = MRR beginning of month divided by amount of lost MRR in the month Recency (last visit), Frequency (how often do they visit), and Volume (how many articles read) LTV > 3 x CAC (3:1 ratio of lifetime value must be 3 times greater than cost to acquire. Most successful sub business have 8:1 ratios)
  60. 60. Calculating Customer Lifetime Value Where GC is yearly gross contribution per customer, M is the (relevant) retention costs per customer per year, n is the horizon (in years), r is the yearly retention rate, d is the yearly discount rate.
  61. 61. Calculating Simplified Customer Lifetime Value – (No really!) Where GC is yearly gross contribution per customer, r is the yearly retention rate, d is the yearly discount rate.
  62. 62. Calculating Simplified Customer Lifetime Value – Example Example: If the gross contribution (profit) of a customer is $500 per year, your retention rate is 95 percent, assume a discount rate of 2 percent (using interest rate as a proxy), this would yield a CLV of $6,786. So what and who cares?
  63. 63. How Retention Rate Affects CLV $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 80% 90% 95% 98% $1,818 $3,750 $6,785 $12,250 Customer Lifetime Value
  64. 64. Three reason cost accounting is a bad practice • To get a cost, you have to create and force math and relationships that do not exist. • By doing this, you lose touch with your operations. • You create meaningless numbers that people consider as gospel (a single representation of an artificial reality).
  65. 65. Dr. Reginal Tomas Lee “Costs and profits are not absolute; they change based on the model you use to calculate them. The largest expenditure for most companies is capacity; space, labor, materials, equipment, and technology. Unless you model and manage capacity effectively, you will not achieve the cash flow results you seek.”
  66. 66. Business domain management Operations and Cash Domain > Accounting Domain
  67. 67. Dr. Reginal Tomas Lee “There is too much focus on accounting data and not enough on understanding the factors that influence the data. The idea that you can calculate different costs from the same data and information should suggest that costs do not represent cash. Cost accounting confuses measurement with metrics. Companies spend millions to manage costs that have nothing to do with money.”
  69. 69. Resources Subscribed, Tien Tzuo, founder of Zuora The Automatic Customer: Creating a Subscription Business in Any Industry, John Warillow, 2015 Subscription Marketing, Anne Janzer, 2017 Retention Point: The Single Biggest Secret to Membership and Subscription Growth, Robert Skrob, 2018 Subscription Economy Index: Tomorrow 3.0, Michael C. Munger