Dan Gallagher reports in the Wall Street Journal:
Selling technology used to be all about getting customers into the stores. Now, it’s more about keeping them hooked. Investors love subscriptions because they generate a steady stream of revenue that can smooth out the cycles associated with physical products and consumer-oriented businesses. They have rewarded the tech companies who made this transition with higher market values and higher multiples. The challenge for is to keep consumers paying by continuously improving a product, at a reasonable cost.
Selling technology used to be all about getting customers into the stores. Now, it’s more about keeping them hooked.
Software was the first tech sector that shifted from selling its product outright to offering it as a service. But the number of businesses that have turned buyers into subscribers, generating a recurring base of revenue, is growing across all of the tech sector. Even Apple Inc., which sold nearly $200 billion worth of devices in its most recent fiscal year, has been touting the number of paid subscriptions to its growing range of services, and those of others sold through its App Store. That number has reached nearly one-quarter of a billion.
Investors love subscriptions because they generate a steady stream of dependable revenue that can smooth out the sharp cycles associated with physical products and consumer-oriented businesses. They have rewarded the tech companies who made this transition with substantially higher market values and—in many cases—higher multiples.
Some examples:
Amazon.com , like most retailers, starts out every quarter with zero in sales. That means it is vulnerable to the economy and changing consumer tastes. But now many customers pay the company a monthly or yearly fee to be a member of its Prime program, which brings free two-day shipping plus variety of other benefits. The company made $9.7 billion in revenue last year just from subscriptions, up 52% from the previous year.
Add to that the Amazon Web Services business, which effectively rents out computing services to businesses. AWS generated about $4.3 billion in operating profits last year, which is 52% more than the profits earned by the company’s North American retail arm on one-sixth the revenue. Amazon began reporting AWS results in its financial statements in early 2015, and since then, the company’s market value has surged more than four-fold.
Microsoft has long made the bulk of its profits through its lucrative Office suite of software. By the close of 2017, nearly 30 million consumers, up 17% from a year earlier, were paying Microsoft for a subscription to the online version of its those applications. And while the company’s videogame business is anchored on its Xbox gaming console, the real star is its Xbox Live gaming service, which claimed 59 million subscribers by the end of 2017—up 7% from the previous year. Microsoft’s market value has surged 76% in the last two years.
Videogame publishing giant Electronic Arts generated more than $2 billion in revenue in 2017 for its “live services,” which includes subscriptions to its gaming service known as EA Origins. That’s up 30% from the prior year—and is about 24% more than what the company made selling new game disks through retail stores. EA’s market value has more than doubled over the last two years.
Adobe used to make its money selling updated versions of Photoshop and other software. It now generates more than 84% of its revenue from recurring subscriptions to its suite of software and services. That has smoothed out its top line; Adobe’s revenue has grown every quarter on a sequential basis for the last 13 consecutive quarters. The company’s market value now sits just below $100 billion—having nearly tripled over the last two years.
With subscriptions, consumers and businesses willingly trade monthly payments to always have the latest version of a product without high up-front costs. The challenge for tech companies is to keep consumers paying by continuously improving a product, as services like Spotify and Netflix know, at a reasonable cost.
The next challenge for tech is to adapt the subscription model for a hardware-centric business like Apple. The company already sells some of its iPhones through its iPhone Upgrade Program, which lets customers get a new device every year in exchange for a monthly payment. But that is more of a leasing arrangement. Apple’s business—and stock price—have become highly cyclical with the swings in the iPhone business. Selling devices through a subscription could change that dynamic. The trick would be in pulling that off while maintaining the company’s substantial profit margins.
But hardware is getting more expensive, not less. Apple’s latest iPhone starts at $1,000, for instance. That could mean customers buy phones less frequently, which could lower sales, unless the cost is spread out in a subscription. For a company like Apple, the future will require thinking very different.
Below, Microsoft subscribers per fiscal quarter:
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