How To Invest

The rise of subscription business models and how to profit as an investor

The subscription model is a business model where customers pay a recurring fee for access to a product or service. This model was first pioneered as early as the seventeenth century by publishers of books and periodicals. Fast forward to the digital age, there is an increasing trend among companies today to shift toward the subscription business model.

A well-known example of a business with a subscription model is Netflix. I pay a monthly fee to watch my favourite TV shows and movies on one convenient location. In fact, I’m also personally subscribed to other services like Disney+ and Spotify, and I don’t think twice about keeping my subscriptions as I consume these services on an almost daily basis.

Why investors love the subscription model

So, what makes the subscription business model so attractive to investors?

Investors love the subscription model because it generates predictable revenue, enhances the return on customer acquisition cost, and encourages more up-selling and cross-selling. If done right, this strategy is a powerful tool for growth. Subscription-based companies can also disrupt traditional industries by offering lower upfront prices, more flexibility, and an incentive to continually upgrade their products for customers.

As investors, we can look out for opportunities in companies that have proven products and services but are transitioning to a subscription model. This gives us some level of certainty that a company’s product or service already has a captive market.

Here are some companies that have successful shifted to a subscription model in recent years and taken their business (and stock price) to new heights.

1. Adobe

The creator of Photoshop, Adobe is a computer software company that specializes in software for the creation and publication of graphics, photography, illustration, animation, multimedia/video, motion pictures, and print. Adobe’s switch to a subscription model (called Creative Cloud) has proved to be a major success for the company.

For example, it currently costs a user US$20.99 a month to gain access to use Photoshop. Previously, Adobe sold its software for a one-time fee through a perpetual license; a single copy of Photoshop used to cost $699 which users could buy and use indefinitely.

The move to a subscription model has allowed Adobe to attract new customers who no longer need to shell out seven hundred dollars upfront just to use Photoshop. Now they can gain access for just twenty dollars and end their subscription if they no longer needed to use the software. At the same time, if users stayed subscribed, they would continually receive updates and access to the latest versions of the software.

Adobe first announced its subscription model in October 2011 and eventually retired its perpetual licence software in January 2017. Since it fully transitioned to a subscription model, Adobe’s revenue has steadily climbed.

Source: Adobe

From 2016 to 2020, Adobe’s annualised recurring revenue (ARR) more than doubled from US$4.0 billion to US$10.2 billion. ARR is the value of the recurring revenue of a business’s subscriptions normalised for a single calendar year.

Likewise, Adobe’s stock has skyrocketed. From January 2011 to December 2020, Adode’s share price rose from US$30.78 to US$500.12 – a return of 1,520%.

Chart: YCharts

Adobe’s transition was not without controversy with over 50,000 Adobe users signing a petition on Change.org urging Adobe to forgo the move to a subscription model. However, the move has ultimately proved to be a huge success for Adobe and Creative Cloud.

2. The New York Times

The New York Times is an American daily newspaper based in New York City with a global circulation of over 7.8 million total subscribers. Founded in 1851, the New York Times has long been considered as America’s ‘newspaper of record’ and is arguably the most respected newspaper in the world.

Newspapers have long relied on an advertising and print subscription. But the rise of the Internet, free online news, and digital advertising has threatened, and continues to threaten, the traditional business model of newspapers around the world.

In March 2011, the New York Times announced a digital subscription plan for its news site, charging readers US$15 for a four-week subscription in a bet that readers would pay for news they were used to getting for free online. This was the first time that a large American newspaper would put its online content behind a paywall and the move was closely watched by peers in the industry. Ken Doctor, a newspaper industry analyst, even claimed that ‘this is practically a do-or-die year’ for newspapers in 2011.

The move to a digital subscription turned out to be a massive success for the New York Times. One year after its launch, the newspaper had gained 454,000 paid digital subscribers. By end-2020, the New York Times boasted 6.7 million paid digital subscribers. Digital subscribers now outnumber print ones by more than eight times.

Source: The New York Times

Not only that, for the first time in its history, the New York Times generates more revenue from its digital subscriptions than print ones.

Source: The New York Times

Investors seem to like the direction the New York Times is headed. From January 2011 to December 2020, its share price rose from US$9.80 to US$51.77 – a return of 428%.

Chart: YCharts

It turns out that in the era of social media and free news, readers were willing to pay for top-quality journalism and impactful news articles all along. The New York Times looks on track to achieving its goal of reaching 10 million subscribers by 2025.

3. Autodesk

Autodesk is a software firm based in the U.S. that produces software and services for the architecture, engineering, construction, and manufacturing industries. Architects, engineers, and structural designers utilize the company’s flagship AutoCAD software to design, draft, and model buildings and other structures.

Autodesk first launched its subscription model in February 2016 and discontinued the sale of its perpetual license software by January 2017. Since its launch, Autodesk now boasts 5.3 million total subscribers (as of 30 April 2021). And the company’s revenue has grown from in US$2.0 billion in FY2017 to US$3.3 billion in FY2021, in tandem with the growth of its subscribers.

Source: Autodesk. Autodesk’s financial year ends 30 April.

Autodesk’s revenue is also extremely predictable; 94% to 98% of its annual revenue is recurring. The stock market appreciates predictability and investors in Autodesk have been richly rewarded – from May 2016 to April 2021, Autodesk’s share price rose from US$60.93 to US$219.91, a return of 388%.

Chart: YCharts

Just like Adobe, Autodesk’s software is the industry standard. It is unlikely that a user will abandon Autodesk and take the risk learning new software. Because of this, Autodesk remains ‘sticky’ among its users, which made the company’s transition to a subscription model relatively smooth.

The fifth perspective

While investors always need to do their due diligence and understand the risks surrounding any investment, finding a company with a proven product that’s transitioning to a successful subscription model could be the seed of your next investment idea.

In many aspects, Autodesk and Adobe are similar. They are both software firms that sold perpetual licenses and gradually transitioned to a subscription businesses model in their respective industries. The New York Times provides us with a fresh perspective on how a firm in a struggling industry can turn around with the proper execution of business plans and capable management. In all these example, the subscription model transformed their business and laid the groundwork for sustained growth for many years to come.

Lim Zheng Jie

Zheng Jie has a keen interest in the growing intersection of finance and programming. He was placed on the Director's List at Nanyang Polytechnic and graduated with a Diploma with Merit in Financial Informatics. An SAS Institute scholar, Zheng Jie was also a PolyFintech 100 Hackathon Finalist for his blockchain project. He will be pursuing computer science as an undergraduate.

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