The subscription model
With the current outlook for many corporates increasingly challenged, we expect business-model resilience to be put sternly to the test. During such periods, we look to assess the quality of business models and how these might evolve. From our analysis, we expect the subscription model to continue growing as its benefits apply in both good and bad times.
As more companies look to address the accelerated move towards remote working, there are also important considerations around the ever-changing technology landscape, proliferation of data and the evolving workforce demographic. These require businesses to be more agile and adaptable to client demands, and in some instances this means a sizeable shift in business strategy. A model where customers pay a subscription fee for usage is becoming increasingly prevalent across multiple industries. While it has not always found success, its financial benefits are becoming more prominent.
Streaming apps such as Spotify and Netflix have operated this model for some time. Disney has more recently been successful with its direct-to-consumer launch. Video game developers Electronic Arts and Ubisoft have achieved further monetisation of their back catalogues through monthly subscriptions. Meal-kit services like Pasta Evangelists and HelloFresh have also boomed in recent months.
Why is this model becoming increasingly important?
For companies, the subscription model offers greater visibility on growth and cash flow from a recurring revenue stream. This works best for products that have low churn as it offers a better way to monetise content or a service. Importantly, it provides a higher total lifetime value. From the customer’s viewpoint, there are the benefits of greater accessibility, flexibility, simplicity in pricing and value. For example, the average person will probably pay more for Spotify than they would have done on CDs over a 10-year period. However, Spotify’s wealth of choice and access is unparalleled and we believe it offers tremendous value for money.
We can see this model on the rise in UK tech too. For example, industrial software provider Aveva is currently driving the digital transformation of process industries. The subscription element of the business now represents 62% of total revenue, and the company’s new products like Aveva Flex have found early success, including contract wins with two blue-chip North American food and beverage companies.
Aveva believes the move to subscription improves the quality of its earnings and drives a more sustainable future. It helps the company trial and utilise new products, improve lifetime value and allows for further investment in innovation. Crucially, securing these multi-year deals has a positive impact on both revenues and free cash flow. For a customer, it offers a low-risk way of trying new products that can pay for themselves in efficiency savings. It also allows for flexibility in challenging economic times.
Specialist retail is another industry where subscription models are being adopted in the move towards digital services. One example in a fast growth category is Pets at Home. Subscriptions bring additional incremental opportunities from online customisation, in addition to the potential for 100% lifetime order capture for each household pet. In doing so, it can also be used to drive footfall traffic to stores through cross-selling and other offers.
These versatile business models offer significant economic value, in our view. Subscription brings scale and agility, delivers a steady stream of income and helps manage operating costs. We expect to see further attractive growth rates from subscription services, as they offer both defensiveness and earnings quality to a business, particularly during times of economic turbulence.
All references to specific stocks and securities are for illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.