An Overhaul on the DTC Subscription Economy
The emergence of Virtual Cards and the related effect on consumer subscription business models
The rise of the subscription economy has engulfed DTC consumption and touched nearly every product category like never seen before. From snacks to clothing, beauty products, exercise equipment, and barber shops, subscription business models have skyrocketed in popularity. However, the evolution of consumer-facing subscription models is no new feat; in fact, it began long ago in the 1800's with milkman and magazine subscriptions where individuals would pay on a regular cadence for re-occurring goods or services. In 1999, Netflix transitioned from a pay-per-DVD model to a subscription model, allowing users to rent multiple DVDs and consume content at their leisure for a fixed monthly price. This seemingly small change in business model allowed Netflix to grow their customer base from ~500 thousand subscribers in 2001, to ~22 million subscribers in 2011, to ~220 million subscribers today, overtaking the then incumbent Blockbuster. Similar to Netflix, Spotify (launched in 2006 by Daniel Ek) was able to overtake their behemoth incumbent, Apple iTunes, by providing consumers with a subscription option, allowing for unlimited music consumption at a fixed monthly rate. Both Netflix and Spotify have since seen their competitive advantage diminish as competing subscription services have emerged, with the likes of Hulu (launched in 2007), Disney+ (launched in 2019), and Apple Music (launched in 2015) all launching competing subscription services.
Consumer-facing subscriptions have flourished in recurring consumption use cases largely because business execs love them - they typically drive more revenue per customer and fetch a premium in valuation.
Subscriptions drive more revenue per customer not by increasing the average revenue per transaction but rather leveraging a flywheel effect to increase the number of times a customer likely transacts. Feeding off the sunk-cost fallacy, people are far more likely to continue to consume when that additional consumption comes at less incremental cost. Seems fairly intuitive - if you already pay for the content, you're likely to consume more, whether its TV shows, movies, music, health-tracking software, etc.. As one consumes more, they increase their familiarity and dependency on the product/service, increasing their likelihood of "purchasing" an additional months subscription. In conjunction with an autorenewal billing feature that consumers (sometimes unknowingly) agree to at checkout - you can see how the number of times a customer will transact with that product or service will likely increase with a subscription model.
Increasing the sales per customer is more powerful than just incremental revenue, it allows brands to spend more on sales and marketing to acquire new customers. We live in an age where digital advertising is becoming increasingly expensive, and where slight incremental sales spend (that one more ad banner) can mean the difference between choosing one brand over another. Consumer executives often measure sales efficiency by evaluating a common metric: LTV/CAC (LTV = customer's "Lifetime Value", CAC = Customer Acquisition Cost). In this scenario, revenue per customer (LTV) is increasing, allowing the company to increase their sales and marketing spend per customer (CAC).
Revenue generation aside, subscription businesses typically warrant a valuation premium because they create a more dependable stream of revenue. Just as someone with a steady recurring income stream is more likely to receive a loan than someone with one-off sporadic income, subscription businesses are often valued higher because their revenue is more dependable, allowing them to control expenses and reinvest in growth with more visibility and predictability.
Clearly there is plenty of incentive from an executive's perspective to favor a subscription model over a pay-per-consumption model, but why are consumers so willing to accept and adopt subscription business models, especially if it likely results in more cost to the consumer? It is because people have grown more comfortable with both recurring consumption patterns and deferred expenses within the context of an inflationary bull market.
As technology has disrupted the world around us, including the rise of the subscription economy, people have become more used to recurring consumption patterns. Accelerated by the pandemic, our population has grown increasingly dependent on digitally native activity, which is far more reliant on recurring consumption patterns than that of in-person activity - Instagram/Twitter/TikTok feeds are driven by accounts you follow/subscribe and news sources are almost all newsletter/subscription-driven. An example side effect of our increasing dependence on subscription-like products for information is the exacerbated gap in the political spectrum, which has likely resulted from tunnel vision-like views fed by subscription selection bias. In short, the digital platforms around us have encouraged recurring consumption behavior, which has likely contributed to the wild success of consumers easily adopting subscription-based models.
Simultaneously, the emergence of buy-now-pay-later options (e.g. Klarna) has allowed consumers to defer lump sum payments into recurring charges for lower ticket purchases, an offering that has historically been reserved for big ticket items like cars and houses.
Now combine comfortability in recurring consumption and expenses with a highly inflationary environment, where consumers have more money in their pockets to spend on subscriptions, as well as a pandemic lockdown that legally limited in-person interaction and encouraged a hyper-focus on digital platforms for entertainment. The last 24 months have been a breeding ground for DTC subscription businesses. In fact, by 2023, the Subscription Trade Association expects 75% of companies selling DTC to offer subscription services.
The issue here is that not all consumption is recurring in nature. Subscriptions were invented because they were convenient for the consumer - they matched a naturally recurring consumption pattern like listening to music or reading the morning paper. The alure of the golden subscription model has encouraged many consumer brands to try and fit a square peg into a round hole, driving traffic towards a subscription for historically single points of consumption.
With a grim economic outlook ahead as well as technological innovation that makes it easier for consumers to track subscription spending, I believe we are due for a correction. A correction in the success of DTC subscription businesses.
Brands that grew subscriber count through autorenewal features rather than recurring customer demand are likely to be impacted most heavily. Now certainly there is room for subscription offerings across a variety of historically one-off points of consumption, but as consumers increase their scrutiny on budgets, consumption cadences will likely change - people will eat out less often, buy clothes less often, go to games less often, resulting in a reversion from more frequently recurring consumption to more one-off consumption.
Economic outlook aside, there continues to be technological innovation, like subscription monitoring software (e.g. Truebill) and the adoption of virtual cards, that hurt the efficacy of customer retention efforts. In order to fit the square peg into a round hole, subscription businesses will often offer a discounted or free trial to the subscription with the caveat that customers must input credit card details and agree to an auto-renewing subscription at the full price upon months end. This marketing tactic relies on consumers to either fall for the flywheel effect, increasing their consumption habits and product dependency, or forget to cancel their subscription. At its core, these marketing tactics can often be deceiving (sometimes predatory), and a surprising amount of subscription businesses rely on its efficacy. Technological innovation has created a solution for this inefficient marketing ploy - a virtual card.
Fintech startups like X1 and Ramp have already launched virtual card features that allow users to create and cancel virtual credit cards within seconds, with some cards even having 24-hour auto-cancellation features that are created to combat auto-renewing free trials. This allows consumers to place a parking boot on the subscription flywheel while taking advantage of the up-front discounts or need for immediate consumption.
The combination of economic outlook and technological innovation will likely hurt both existing customer retention and new customer adoption of subscriptions in the near future. With many DTC subscription brands relying on consumer payments beyond the free trial/first month to achieve profitability, these factors could have larger 2nd-order effects on the ability of DTC brands to stay in business. While the dominoes seems small, the magnitude of effects could amplify given the volume of consumption that relies on consumer subscriptions. There is no doubt in my mind that DTC subscription businesses will continue to thrive with greater presence than before the pandemic, however the recurring cash flow element of subscription businesses that allows for increased investment in growth also creates a more rigid and precipitous cost structure that is less conducive to the accordion-like expansion and retraction of consumption patterns throughout economic cycles.