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February 14, 2005

Subscription Pricing

Customers like subscription pricing.  In fact, they are willing to pay a premium for predictability and simplicity.  If you can find a way to price a service at a flat monthly rate, you can make a better profit per customer and attract more customers than if your pricing is based on reading a meter.  You also save a fortune in detailed billing, dispute resolution, and issuing credits.

Netflix is the most recent example of this I’ve seen.  My daughter gave me a trial subscription (viral marketing at work) and it’s a big hit in our house.  For $17.95 per month, you get all the DVDs you want to watch.  The hitch, which isn’t very important to us, is that you only get to have three at a time.  You go online, make a list of the movies you want to see, and very quickly three arrive.  You can keep them as long as you want.  There’s no such thing as a late fee.  But you don’t get any more DVDs until you return one – they come with a handy postage-paid return mailer.  Almost as soon as you send one back, you get another flick.

That’s simplicity itself.  I don’t think I used to spend $17.95/month on movie rentals but that’s irrelevant.  I hate late fees.  I hate being rushed.  I like having a couple of unwatched movies around for spare time.  Of course, having it all come by mail is also great and could have been done without subscription pricing but, to me, the subscription model with no minimum commitment makes this a winner.  If I had to worry about getting to the Post Office in time to avoid late fees, I don’t think I’d be a customer.  And Netflix gets more out of the Evslins than Blockbuster ever did.  I just noticed, by the way, that Blockbuster now has a similar service priced at $14.99.  Netflix will have to fight for their lives but they got first mover advantage.

Back in the early days of popular use of the Internet, ISPs including AOL and MSN charged by the minute for dialup access with no cap.  People were afraid to sign up because they thought they might leave their PCs on and get huge bills.  Some small ISPs experimented with subscription pricing; all the access you could use for $19.95.  When we started AT&T WorldNet Service, we borrowed that idea and popularized it with the still hugely powerful AT&T brand behind it.  Some said we’d go broke; others that we would ruin the Internet.

To hedge our bets, we also offered a metered access plan.  We didn’t want to lose out on people who planned to spend less that $19.95 per month.  To our surprise, people typically converted themselves from metered access to subscription when their monthly bill was around eleven or twelve dollars.  And their usage didn’t spike after conversion.  People were paying a premium for predictability and simplicity.  With a subscription plan, they didn’t feel they had to keep track of minutes to make sure they weren’t being overcharged and they weren’t worried about surprises.

The rest of the industry was forced into monthly subscription pricing.  There were some teething pains, especially at AOL which didn’t have enough ports available for the extra hours its young customer base had time to use. However, I think monthly subscription pricing was one of the most important factors in the explosive growth of Internet access during the second half of the 1990s.

Of course, the subscription plan also had much lower costs for us as a provider.  We took a hard line that we would not provide usage detail to subscription customers so we could truncate usage information early in the processing cycle.  There were no disputes with subscription customers over whether they actually were online at any particular time.  The subscription customers were also more forgiving of occasional slow service because it didn’t increase their cost and they knew we had no incentive to keep them on longer.  (For more on WorldNet, see Lessons From The Crypt #1, #2, and #3)

Today a flat monthly rate for domestic phone calling is offered by all US VoIP providers that I’m aware of.  Traditional service providers have been forced to respond with unmetered subscription plans of their own.  Customers like simplicity.

There are two good arguments against subscription pricing:

  1. If the subscription rate is high enough to return a profit for customers with typical use, it will be too high for customers with low usage so you will lose them.

  1. Some customers will “abuse” the fixed price and overuse the service; perhaps even resell it.

At the price of some complexity, wireless operators have temporarily overcome these problems by establishing subscription tiers of use with different monthly rates entitling users to different size blocks of “free” minutes.  My guess is that competitive pressure will collapse this into just a couple of tiers with the top – and very popular tier – unmetered.  The complexity cost even with blocks of “free minutes” is still too high.

There is always room, however, for a metered low tier for budget conscious customers – if you can serve them profitably!

The problem of “abuse” is overstated although it is real.  With many businesses, the highest variable cost is the cost of subscriber acquisition.  Following that are a number of per subscriber costs like billing, bad debt, and customer care which are not directly related to usage.  In many telecommunications applications, there is no incremental cost to the provider when the customer uses the application.  (Note that “access charges” levied by monopoly providers of a last mile phone connection are an important exception to this.)  What is important is that the provider has to invest capital to size the network for peak usage.

A provider whose capital cost is determined by peak usage, doesn’t really care whether “abusers” camp on the service during nonpeak times since the provider has extra capacity available then.  During peak times, the normal, nonabusing users are on in such numbers that they dwarf the small number of “abusers”.  The experience of providers I’m familiar with is that small percentage of “abusers” (I’m not sure they’re really abusing anything) account for a relatively large percentage of total usage.  But remember that, since the “abusers” are a small percentage of total users and peak time is when a high percentage of total users are on line, the “abusers” can’t physically account for a high percentage of peak usage and therefore don’t significantly drive capital costs.  If you are planning a service, you need to do a very careful spreadsheet on this.

Subscription pricing for telecommunication is nothing new in the US.  Except in New York City and a few other places, unlimited local calling has been an option for as long as I can remember.

It is important that there be some gate to control usage even if there is no meter.  For example, Netflix only lets you have three DVDs at a time.  With unlimited calling as it offered today, you still can only make one call at a time.  When you buy subscription Internet access whether it is dialup or cable or DSL, the total load you put on the network is limited by the amount of bandwidth you have subscribed to.

Simple pricing, I think, always drives out complex pricing.  Finding a way to price your product or service on a subscription basis is worth a lot of thought.   Netflix sure has a clever way.  Sometimes it is necessary to be as inventive as they have been to find a way to offer your customers the benefit of subscription pricing without risking having your own costs driven uncontrollably through the roof.

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Listed below are links to weblogs that reference Subscription Pricing:

» A Good Argument For Renting, Not Owning, Music from digitalmerging.la
A couple of days ago, I posted an entry about owning downloaded content, as opposed to just renting it. Well here's a blog entry by Tom Evslin, who started flat-rate pricing in the ISP field with AT&T's Worldnet, that makes a good argument for the subs... [Read More]

» Customers Like Subscription Pricing from robhyndman.com
Tom Evslin with yet another meaty post - this one on why subscription pricing is a good thing. [Read More]

» Subscription Overdose? from Opine Online - The Rubicon Blog
Fred Wilson points to a great read by Tom Evslin on subscription based pricing. He brings up Netflix as his first case study then goes on to talk about the flat pricing of dial-up services at AOL and AT&T WorldNet or the pricing of most VoIP service ... [Read More]

» The Benefits of Subscription Pricing from AnumatiNews
Tom Evslin offers his thoughts on competitive strategy in an article on the benefits... [Read More]


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