The Investment Case Behind the Subscription Industrial Complex

As our economies have digitised, the list of disrupted industries is long. As soon as anything moves from physical to a digital format the potential for disruption is high.

It’s simple economics. Emergent startups have the advantage of a lower-cost infrastructure from day one and can tolerate lower margins for digital-only versions of things. Incumbents, on the other hand, have the challenge of maintaining traditional revenue (read here: physical versions) as well as transitioning for lower-cost digitization.

That's a transition few firms have been able to manage. (Netflix is a notable exception, successfully moving from mail-order DVD to online streaming)

But there is something bigger happening in terms of the way we buy in a digital economy. Increasingly our world is becoming one defined by subscriptions. Subscriptions have a habit of creeping up on consumers and are sometimes difficult to turn off. The transition to this ‘Subscription Industrial Complex’ also provides investors with a playbook worth paying attention to.

As a part of this piece, I decided to do a personal subscription audit. The results, although they didn’t surprise me, tell a clear story of power, recurring revenue and, above all, sustainable competitive advantage. It turns out I’m currently spending $430 a month on subscriptions -- $5160 a year. Just over a decade ago, I didn’t have a single subscription – the last one I remember having was to BRW magazine while in my early corporate career.

Subscription Power

Back to the power thing, the breakdown of where my subscription dollars are going:

Software as a Service (SAAS)           = 51%

News & Entertainment                       = 39%

Other                                                  = 10%

The firms getting the money are just as telling. The top six big tech firms take 41 per cent of my total subscription expenditure, which cuts across both software and news/entertainment categories. Within my big tech subscriptions, Facebook Inc. is noticeably absent, while technology stalwart Microsoft still takes the biggest share with 19 per cent of all my subscription expenditure, taken up with office software and a premium LinkedIn membership (which is worth every cent). The other 10 per cent is taken up with telecoms services and an A.I. based legal form generator – one to keep the legal firm partners awake at night.

The only two Australian & NZ firms which are present in my subscriptions are Fairfax with an AFR subscription and Xero accounting software. Even when it comes to news the globalisation of information systems is clearly evident. The news and technology sources I rely on include the New Yorker, New York Times and Wired magazine (of course, I’m lucky my Eureka subscription comes gratis). As we continue down the current path of news and entertainment consolidation it would be smart to assume global brands of repute will only get stronger. If we take a look through the top 30 ASX firms, there are very few which have a firm foothold in the subscription space (with the exclusion of Telstra) which is surely a reflection of the fact that the Australian economy hasn’t evolved as much as it could or should have during the past two decades of digitization.

Historically, subscriptions lived very much in the news and magazine world. Their presence was driven by the need to maintain reader numbers, to then ensure an audience to sell to advertisers. But since software has taken hold it now runs much deeper. Corporations who are able to convince their customer base into subscriptions have the power of Monthly Recurring Revenues (MRR) at their disposal. It creates a new type of customer loyalty, allows for lower marketing costs, direct consumer communication, forward planning of expenses and provides a clear indication of expected revenue retention – an important profit lock-in which investors can rely upon.  

The Subscription Tsunami

If you think the amount of money I spend (sorry, invest) in subscriptions is a lot, then it’s worth me pointing out that this really is just the start of the start. As soon as any purchasing process enters the digital realm, it more easily opens itself up to the potential of subscriptions. Subscriptions will cross the chasm of just being virtual products or software. Mostly anything which has a regular and quasi-predictable consumption pattern can become a corporate subscription play. In fact, no Venture Capital Funding pitch (and I’ve heard plenty) is complete these days without the entrepreneur declaring that their startup is the perfect thing for their customers to subscribe to.

While there has been a large number of weird subscription experiments – from clothes arriving to your door each month (Trunk Club) to local honey arriving at your door (Amber Drop) – as we get better at discerning consumer needs via data, frictionless subscriptions will become the norm. It’s my prediction that a decade from now that a majority of both consumer and corporate expenditure will occur within the subscription realm. And we only need a little imagination to see where this could head.

Subscribing to Future Profits

Things will get really interesting when firms start to bundle benefits inside subscription services.

Energy  – It’s foreseeable that our energy grid will be replaced by firms with a kind of ‘Cloud Energy Service’ (pun intended) where we subscribe to all the energy we need for a certain type of building at a fixed price. Possible because energy will be moving to a zero marginal cost renewable infrastructure. 

Transport  – Whether it is Uber, Toyota and Tesla – we’ll eventually subscribe to transport on demand. Buying a car in the future may also include robo-taxis as part of the privilege – maybe our car gets used when we are not using it as part of a new ecosystem.

Healthcare – Instead of paying to see a doctor, a physio or a dentist, we’ll subscribe to a service that sells our data in aggregate in exchange for free healthcare, circumventing traditional health insurance mechanisms.

Food  – With the number one problem facing supermarket giants being basket switching (taking your purchase to another store) we should expect that a firm like Amazon would offer a significant discount for staying loyal and subscribing to their automated food service. Cost would be reduced by using smart cupboards, fridges, bathrooms, and laundries combined with AI to determine consumption patterns and send us what we need. No pesky shelves or store clerks needed to fill each order.

If what we’ve already seen with big tech and the subscription boon tells us anything as investors it should be this: pay close attention to who is winning the subscription game. Not only because they create wonder corporate MRR, but they are easy to see in the market before they appear in profit announcements. And while subscriptions are now a well-established commodity in our digital lives, the investment opportunities across industry platforms are only just beginning.