At Hummer Winblad, we are seeing a tremendous number of innovative consumer-facing subscription services. Be it on-line storage, photo sharing, social networking, or other creative ideas, there appear to be a myriad of businesses emerging that are dependent on subscription-based business models. A major challenge looms for these young companies in that the major Internet companies' business models - Yahoo, Google, AOL, and MSN, are based on broadcast economics. Their revenues are are tied to page views and ad impressions rather than recurring application revenues. Accordingly, many of the consumer companies we meet with boast great teams and compelling technology, however, their business models are orthogonal to the business models of the dominant Internet companies, whose models allow them to aggregate and provide compelling services and content for free.
Broadcast companies are incented to provide the best content and services possible to draw in more users, more page views, and more ad impressions. Broadcast businesses seek to maximize revenue per impression/costs per impression, and the wonderful scale these models have achieved with respect to ads sales, affiliate models, and infrastructure costs provide for rich marginal profit margins. Scale allows for economics of scope, whereby they can offer great services - for free - knowing that their costs to offer the service are far lower than competing pure-plays and that their ad businesses will reward incremental users and page views.
Subscription companies require a certain level of free to paid conversions to make sense. The challenge is that to compete with the free versions, vendors get caught in a feature battle, where each incremental feature is valued by an increasingly smaller pool of people. Google and Yahoo are able to hollow out subscription businesses, if and when they choose to enter a given market, and stand-alone companies without ad network revenues and dependent on subscription services suffer the consequences.
Subscription models are, in general, driven by four key areas: cost per acquisition, monthly average revenue per user (ARPU), free cash flow (EBITDA), and churn (cancellations/average users per period). Subscription models require a clear focus on acquisition costs, strategies to drive ever higher ARPU, and customer retention strategies. I meet with many companies who are well-versed in subscription economics, however, their business plans often do not sufficiently factor in the power of broadcast/ad models to challenge their revenue models.
Internet broadcast models appear to be dominant on today's Internet. Unlike a focus on ARPU and churn, broadcast models seek to optimize their ability to profile their user base and to serve increasingly relevant adverstisements to their users. Competition centers not on conversion ratios, churn, and subscription revenues, but rather on powerful analytics, user segmentation, and behavioral analysis that allows for "perfect" ad targeting.
Each model relies on a different set of competencies and different set of goals. Consumer subscription models seek to entice free trial users to move to paid services, while broadcast models seek to maximize users and monetize them via advertising.
IMHO, when designing a model today, start-ups should focus on the type of model most likely to succeed - broadcast or subscription - knowing full well that the major players will continue to add functionality and services in a quest for more page views and ad opportunities.
PS. What is interesting to me is that on cable and radio, we are seeing the rise of subscription services challenging broadcast media - eg. HBO and XM Radio. This may be a function of FCC restrictions on broadcast content but is an interesting contrast to the current consumer Internet.