The Rise of Consumer Subscription Software
2020 will not go down as anyone’s favorite year this century. With the COVID-19 pandemic, fires raging on the West Coast and geopolitical tensions, it’s safe to say everyone is looking forward to 2021. However, as a small silver lining, 2020 will also be a year remembered for being the beginning of a multi-decade boom in Consumer Subscription Software (“CSS”).
In our second annual research report on the CSS ecosystem, GP Bullhound looks at how CSS companies and their products continue to integrate into consumer’s daily lives and those that have benefited substantially from the COVID impact on consumers and businesses across the globe. Click here to download and read our full CSS report.
CSS is by definition a consumer service that is 100% delivered in a software only format. The consumer pays a monthly or annual fee in exchange for ever-updating content and service options. The consumer never owns anything specifically but is paying for the right to access the service. Sound familiar? You likely subscribe to multiple CSS businesses, without even knowing it. It is part of the tech world’s everyday life. You can read more from my earlier Medium article and how I define CSS here.
As a resident of San Francisco, I subscribe and utilize multiple CSS businesses every day: FitOn while exercising, Spotify while working, Netflix while chilling and Calm for sleeping.
Prior to the COVID-enforced lock downs, smartphone users may have subscribed to less than three CSS services. However, as new CSS offerings proliferate, especially during a pandemic that practically forces us to find alternatives to in-person events, your smart devices have likely doubled their subscription services within the last 12 months. Below are some examples of different CSS niches that make up the CSS ecosystem — how many do you recognize that you already subscribe to?
Outside of the COVID boost, CSS businesses are benefiting from two other influential shifts taking place:
- Many CSS applications are downloaded and paid for through the Apple and Google app stores. They provide valuable services including security for the user and distribution for the CSS business. However, the app stores take 30% of a first subscriber payment and 15% of any renewal payments. Apple is currently in a legal tussle with the maker of Fortnite over the legality of these take rates. As this ‘Epic’ battle continues between application store monopolies and CSS entrepreneurs, any change in the take rates would increase CSS growth rates as entrepreneurs recycle the extra cash into content and distribution — this would create an immediate boost to the CSS ecosystem. Stay tuned!
2. For many years, schools attempted to keep students off their devices and liked to think of technology as an afterthought. With at home and virtual school becoming widely normalized in COVID times, it is impossible to steer away from education technology. Digital tools for learning, studying, teaching and even textbook purchasing are becoming high growth areas within CSS. Examples of companies poised to take advantage of the remote learning boom include Chegg, Vooks and Quizlet.
I have always been a big believer in the CSS ecosystem and I think it is at the cusp of attracting massive attention from financial and strategic investors. GP Bullhound has provided a framework for investors looking to evaluate CSS businesses as well as to educate entrepreneurs on what potential investors will look for.
The CSS flywheel categorizes the main attributes of CSS, emphasizing important aspects for investors. A key valuation driver for investors is the concept of winner-take-all in CSS niches. If the company has the potential to dominate a niche or a broader market through network effects, investors may be willing to pay up.
A unique CSS metric that investors will look into is the free-to-paid customer conversion rate. Freemium content for consumers is critical when having users first try a product; however to effectively monetize them, they need to be converted into paying customers. That means correctly inserting the paywall at the appropriate point to provide the maximum value to paying subscribers. Rushing customers into paying could be a deterrent, so this needs to happen with enough functionality for consumers to have adequate time to explore the service before subscribing.
Flash or Cash? A common misconception is that entrepreneurs should be laser focused on rapid growth of their paying subscribers and minimizing churn. However, this reduces the focus on long-term retention (6+ months), which is massively more important to the long-term viability of a CSS business.
To highlight the importance of retention, I’ve devised a “Cohort Revenue Layer Cake” to show the difference in performance between a business focused primarily on rapid growth (the Cheetah🐆) versus one focused on long-term retention (the Thoroughbred🐎) with both selling monthly subscriptions.
In the Cheetah example, new users are joining the platform at a steady 30k a month driven by celebrity promotions on Instagram. However churn is heavy and the business retains only 40% of its customers after month six and 10% after month 12. In the Thoroughbred example, growth is slower at 10k users a month and users are being acquired through marketing partnerships. Users are inputting health data from their fitness tracker. The Thoroughbred retains 68% of its customers after month 6 and 50% after month 12. In both cases, growth marketing is cut in year 3 and you can quickly see the negative impact on the Cheetah business but continuing strength and cash flow in the Thoroughbred example, even accounting for slower user growth.
Ultimately in the Thoroughbred example above, focusing on engagement and mitigating churn resulted in a better long-term business, as opposed to the Cheetah, with initially high growth and flashy advertising. Cash 🐎 > Flash 🐆 in this example.
A focus on retention allows entrepreneurs to acquire customers and then harvest that subscription cash flow over a longer-term and build a sustainable and profitable business — two words that are magic to investors’ ears.
CSS Tech Stack: As discussed in our new GP Bullhound CSS report, CSS entrepreneurs are benefiting from many tools and services that have been developed to help build the CSS technology stack. The five main ‘building blocks’ are: Subscription Management, Marketing Management, Messaging Infrastructure, Payment Processing and Reporting and Analytics.
In a simplistic example, CSS entrepreneurs are the gold miners in the Old West, hoping to strike it big. The building block companies are providing the tools to the gold miners — i.e. the ‘pick-axes and blue jeans’ for the CSS gold rush. These B2B2C software and payment companies are rapidly benefiting from the growth of the CSS ecosystem and investors are taking notice. AKKR invested in Recurly and Index invested in RevenueCat — both funds are traditionally focused on B2B software and highlight how traditional SaaS PE can begin to invest in the CSS ecosystem by partnering with the building block companies.
GP Bullhound CSS Index: We believe now is a great time for financial and strategic investors to enter the CSS ecosystem. We expect a boom in private transactions in the CSS space in the next 18 months, and we are already seeing public market investors take note of CSS companies. To track investor sentiment, GP Bullhound has created the first consumer subscription software index to track how public CSS investments are valued, the GP Bullhound CSS Index. We expect to add additional companies to the index over the next 12–24 months (see Bumble IPO and KKR invested in Zswift).
GP Bullhound Consumer Subscription Software Index
Whether it’s the application to check your personal finances (Dave), edit photos before posting to Instagram (VSCO), take notes for class (Evernote), practice your Italian (Busuu), manage your family (Our Family Wizard) de-stress (Headspace) or the multiple entertainment streams you must catch up on (MUBI, Barstool Sports and Hulu), CSS applications and subscription services will continue to integrate into our daily lives, more than we know it. I expect the total revenue for CSS companies to be over $150 billion globally by 2023. We are at the start of a multi-decade boom!
