Does subscription economy still have a future part 3
Counter-examples that invalidate the Zuora thesis
Cemeteries are full of companies that didn’t understand the power game.
To understand the economics of subscription, there is nothing like studying its opposite, the economics of non-subscription. Many companies have succeeded in breaking through and dominate with a classic transactional business model. We can mention Google, Facebook, Amazon, etc. Part 1 and Part 2 have shown that the conditions for a subscription offer to work are very specific:
create abundance with a scarce resource (no subscription for Ferrari)
identify a utility function that is as differentiating as possible amidst the abundance created, since the scarcity of the resource has been destroyed
guarantee this utility function at a reasonable cost: subscription is a guarantee
A subscription is first of all a reciprocal insurance: subscribers insure themselves against the risk of shortages. Abundance is addictive and if you perceive a risk that it will stop, you are ready to subscribe (this is the principle of the freemium model). Meanwhile, a company promotes subscription to protect itself against the risk of flops (in case of high upfront cost). In the Netflix example, the subscription finances good and less good films and limits the unit risk that the company could take. For a subscription offer to thrive, a scarce resource is required, involving high upfront cost, on the business side (films, software) transformed into abundance on the customer side.
The examples of Google and Facebook will help to better understand why some successful businesses do not offer subscriptions. Facebook and Google are data factories, turning a worthless raw material (individual users data ) into valuable data for users and advertisers. Ben Thompson in his Stratechery site dissects this mechanism:
Facebook quite clearly isn’t an industrial site (although it operates multiple data centers with lots of buildings and machinery), but it most certainly processes data from its raw form to something uniquely valuable both to Facebook’s products (and by extension its users and content suppliers) and also advertisers (and again, all of this analysis applies to Google as well):
Users are better able to connect with others, find content they are interested in, form groups and manage events, etc., thanks to Facebook’s data.
Content providers are able to reach far more readers than they would on their own, most of whom would not even be aware those content providers exist, much less visit of their own volition.
Advertisers are able to maximize the return on their advertising dollar by only showing ads to individuals they believe are predisposed to like their product, making it more viable than ever before to target niches (to the benefit of their customers as well).
And then, in exchange for these benefits that derive from data, Facebook sucks in data from all three entities:
Users provide Facebook with data directly, both through information and media they upload, and also through their actions on Facebook properties.
Content is not simply data in its own right, but also a catalyst for generating user action data.
Advertisers, like content providers, not only provide data in its own right, which acts as a catalyst for generating user action data, but also upload huge amounts of data directly in order to better target prospective customers.
Facebook and Google charge their customers who are the advertisers. They do not sell them subscriptions but instead sell spaces by auction. This does not prevent these two companies from being in a situation of duopoly over digital advertising.
Facebook and Google are transforming an abundant asset (users data) into an exclusive asset: data about users. This allows these two aggregators to sell exclusive locations to advertisers. This is the opposite of the favourable context for subscription. According to the law of exclusivity seen in Part 1, the more exclusive the property, the more desirable it is to own it:
Advertisers want an exclusive location (without the presence of competitors) and are willing to pay a high price for it. Auctions are a well-known strategy to get people to go up to the coconut tree when they want the auction to take place. Here's what Charlie Munger says about it:
Well, the amicable auction is only for turning the brain into mush: you have social evidence, the other guy is bidding, you have a tendency to reciprocity, you have the super-reaction syndrome of deprivation, the thing goes away..... I mean, it's designed to manipulate people and lead them to stupid behavior.
Thus Facebook and Google exploit to the maximum the desire of advertisers to hold exclusivity. Selling to advertisers on a subscription basis would run counter to their desire for exclusivity, as through Google and Facebook would ensure that advertisers would have an abundance of possible ads. This would increase the number of ads, reduce their impact and degrade the user experience: in short, subscription would be a disaster for both companies.
Let's recall our three criteria for a successful subscription offer:
create abundance with a scarce resource,
identify a utility function that is as differentiating as possible from the abundance created, since the exclusivity of the resource has been destroyed
guarantee this utility function at a reasonable cost: the subscription is a guarantee
With Google and Facebook, we have the opposite of the first criterion: both companies create scarcity from abundance. This is enough to negate the interest of a subscription offer.
Let's follow with the example of a platform such as Uber which does not practice subscription either. Uber starts from a relatively abundant resource: drivers, to make it even more abundant. Uber would like everyone to be able to be a driver (Uberpop). As the regulations have decided otherwise, Uber reduces the constraints to become a driver and subsidizes drivers: the imperative is to create liquidity. However, despite everything, the supply of drivers remains insufficient during rush hour, forcing Uber to raise prices sharply. The conditions for a subscription offer seem to be met: passengers may want to cover themselves against the shortage of taxis during peak periods and the resulting increase in fares. Uber knows that its added value is to create abundance (criterion 1) and then fluidity for the user (criterion 2).
What about criterion 3? In fact, platforms are facilitators that do not transform a raw material as Google and Facebook (data factories) do. Since the raw material does not belong to them, the marginal cost of an additional user is theoretically zero. On the other hand, they are obliged to respect the economic model of their "suppliers". Drivers by definition rent their services and their objective is to rent as expensively as possible: they do not have the customer relationship and have no interest in wanting to retain them by giving them any assurance of their availability at all times. Users on the other hand may well want a guarantee of an abundance of drivers, especially during peak periods, as supply can then dry up sharply, causing prices to explode. Offering the subscription service would be a good idea for Uber, allowing it to stand out from the competition. The problem would be the cost of this subscription. For Uber, without changing the remuneration of the drivers (at auction), it would be a question of taking the risk of invoicing users for the subscription. The company would take a loss if users travel too much and especially during peak hours. As the marginal cost of the race is high, pooling does not make it possible to reduce costs. The subscription price would necessarily be expensive, reinforced by the anti-selection mechanism. It is criterion 3 here that makes it almost impossible for Uber to sell subscriptions.
In the field of transport too, the analysis of SNCF's failure is full of lessons The SNCF also tried a subscription formula in 2015: IDTGVMAX. For 60€ per month, Maxtrotters could build up a stock of reservations up to 6 at any time on the TGV. SNCF's proposal met all three criteria for a viral offer:
transformation of a situation of scarcity (a seat on the train) into abundance: possibility to travel unlimited.
creation of a utility function at your fingertips through a smartphone app: IDTGVMAX becomes THE SOLUTION for all long-distance transport in France
very attractive subscription price since "refunded" from 2 trips per month.
In principle, an attractive price can be obtained thanks to a low marginal cost and the multiplication of subscriptions, which significantly reduces the average cost. The idea is to position the offer price between the marginal cost and the average cost before the subscription formula is implemented, in order to initiate a positive subscription dynamic and be quickly profitable. However, in the case of the IDTGVMAX offer, the marginal cost per km travelled is high, close to the average cost. Aware that the offer would be uninteresting at marginal cost, SNCF positioned it below. The operation was a loser at first. To avoid bleeding, the offer was limited to the first 10,000 applicants: this was in contradiction with the principle of subscription, which uses the law of large numbers to reduce costs. In addition, there was a well-known insurance law: anti-selection. Frequent travellers, those who cost the most, rushed to join the 10,000. SNCF had committed itself over two years, the loss was locked in. From then on, SNCF sought to get out of this trap. At the end of the two-year period, it tried to remove the offer but faced a sling of subscribers and a significant image risk. The SNCF therefore preferred to renew the subscription but to gut it by significantly reducing the number of eligible trains: this is a disguised way of raising the price and disgusting subscribers. The SNCF will remain the school case of how absurd a subscription offer can be....
Let's now look at the case of Airbnb. A success story that does not require a subscription. Like Uber, Airbnb is a platform that connects property owners and potential tenants. Unlike WeWork, which wants to standardize the space, Airbnb wants to highlight the uniqueness of each property. The role of a platform is to highlight the offer that passes through it, to differentiate it. Bill Gates was given this definition of the platform when he was talking about Facebook:
That’s a crock of shit. This isn’t a platform. A platform is when the economic value of everybody that uses it, exceeds the value of the company that creates it. Then it’s a platform.”
By emphasizing the exclusivity of the property, Airbnb maximizes its possible monetization by its owner. The tactic is to surround the rental with a unique experience. Type Airbnb on Google and you will get: "Airbnb / unique offers, best prices". Everything on the site highlights the uniqueness of the properties, experiences, etc.
The owner of an exclusive property can make the most of it by renting it. He does not need to retain the tenant, since the power is on his side, so the subscription is excluded. One could imagine Airbnb intervening between landlords and tenants by creating a subscription offer. Not controlling its offer, this would lead to an anti-selection process, with tenants systematically choosing the most expensive locations. The marginal cost of serving an additional customer would quickly become unbearable.
All these examples show that many business models are not suitable for subscription. In his book, Tien Tzuo gives some graphs showing the growth of the subscription economy, particularly by sector. The latter is interesting:
It clearly shows that the subscription economy still revolves around the usual suspects: media, telecommunications, IT, which produce digital goods at very low marginal cost.
And that's where the bottom hurts: the Internet economy is now focused on the fusion between the physical and digital worlds. Whether Alibaba with "new retail", Grab, Ubereats or Doordash with delivery, Airbnb with accommodation, Uber or Lime with transport, etc. All these cases have the disadvantage of having a high marginal cost... in the end, the future may lie in the economics of non-subscription!