Measuring the Profitability of Subscription Apps

Subscription Apps Today

Today subscription-based products and services are more popular than ever before. According to Statista, in US user spending on subscription apps on the App Store in 2021 reached over $6 billion in revenue, a 33% surge from 2020. Google Play subscription app revenue climbed by 78%, surpassing $2.5 billion.

Subscription-based monetization model is mostly used by non-gaming apps. According to “The State of App Marketing for Subscription Apps” report by Appsflyer & Liftoff, subscriptions drive 82% of revenue generated on average for non-gaming subscription apps, unlike gaming in which only 36% of revenue came from subscriptions.

So, as subscription based products are dominating the apps ecosystem I wanted to focus on the the critical components of subscription monetization and profitability in this post.

Let’s start with the basic equation for profitability; LTV > CAC, which means lifetime value of a user should be bigger than the cost of acquisition.

CAC — Customer Acquisition Cost

As the term suggests itself, CAC is the cost of acquiring a new subscriber to use your product. Usually it’s calculated by all sales & marketing costs divided by the gross number of new subscribers acquired in the specific period measured.

CAC = Sales & Marketing Costs / Total Number of Subscribers

CAC is mostly affected by paid marketing activities such as advertising in Facebook, Google and TikTok channels. Besides paid marketing activities, some of the users will discover your product through referrals, search, etc this type of traffic is considered as Organic. The more organic users & subscribers you get, the lower CAC you’ll achieve, which is critical for the profitability of your product.

The main KPI’s that affect the CAC are:

• CPI=Cost per Install (number of installs/cost)
• Trial Conversion=Percentage of installs that start a trial (# of trials started / # of installs)
• Paid Subscriber Conversion=Percentage of trials that converted to a paid subscription (# of subscriptions started / # of trials started)

Let’s review a scenario to put those KPI’s in place;

Assume you spent 100K for a month and acquired 100K installs, 10K trials and 5K subscribers;

• CPI=100.000/100.000=1 USD
• Trial Conversion=10.000/100.000=0.1 (10%)
• Paid Subscriber Conversion=5.000/10.000=0.5 (50%)
• CAC=100.000/5000=20 USD

To decrease CAC, you need to decrease CPI and/or increase Trial Conversion & Paid Subscriber Conversion.

LTV — Lifetime Value

LTV is the amount of revenue a subscriber will contribute to your product over the time as they remain as a paying subscriber. Understanding lifetime value is very critical as it’s the upper limit on how much you can allocate to acquire a new subscriber. To calculate LTV, first you need to know Churn & Retention performance of your cohorts.

Subscriber Retention

In most B2C consumer apps, churn is higher compared B2B SaaS products and mostly not linear which means you’ll loose higher % of users in the first months. The more you retain your subscribers, the higher your LTV will be.

Let’s review a scenario to put Subscriber Retention in place;

Assume we acquired 5K new subscribers in Month 0, 55% of those subscribers retained in Month 1, 45% in Month 2, 36% in Month 3, 30% in Month 4, 25% in Month 5 and 20% in Month 6.

Higher subscriber retention means more renewals on the upcoming months and directly improves LTV. If your retention is low it will be very costly to build a larger subscriber base therefore retention is the most important part of the LTV equation.

Net Price

In B2C consumer apps ecosystem, you can consider 30% / 15% store commissions and country specific taxes in order to calculate net prices. If you are presenting a 9.99 USD monthly subscription price, you’ll receive net 6.99 USD, considering 30% store commissions Apple takes.

Lets continue with the example above;

We have subscriber retention data for 6 months, if we calculate month-over-month subscription revenue:

We reach total revenue of 108K USD in 6 months, in the beginning we have acquired 5000 subscribers in Month 0, so our 6 months-LTV for this cohort is 22 USD. If we look at this cohort for a longer period of time, let’s say 12 months-LTV, we’ll reach a higher LTV figure as renewals will continue after 6 months until the cohort reaches maturity.

Payback Period

Payback period is the number of months it takes to recover your upfront acquisition costs. It’s one of the key parts of your product as it’s an overall measure of the efficiency of your subscription app. The longer the payback time, the more capital will be required to grow your business.

Lets continue with the example above, this time considering 12 months cohort;

In 12 months we reach a total cohort revenue of 132K USD with initial 5K subscribers we acquired. Our 12 months-LTV is calculated by 132K/5K which is approximately 27 USD. We invested 100K for user acquisition at the beginning of the cohort, in Month 5 the first 100K USD investment is recouped, and on the following months we start writing profits.

Return on Investment — LTV/CAC

ROI or LTV / CAC ratio compares the value of a subscriber over their lifetime to the cost of acquiring them. For example if this ratio is 2 and you spent 1M USD for marketing, you should expect to receive 2M USD revenue in return. If this ratio is less than 1, this means you are spending more to acquire subscribers than you earn. It is also important to look at this ratio along with the payback time. There is a significant difference of 2X ROI with payback period of 5 months or 12 months on your growth plans.

For higher ROI and faster payback periods you need to lower your CAC as much as you can and improve LTV through higher subscriber retention and correct pricing strategy.

Are you interested in understanding how these metrics impact your product ? If so, you can download the simple cohort model including the example above and tweak your assumptions according to your KPI’s.