The Power of Upfront Annual Subscriptions: Leveraging Discounts for Retention and Cash Efficiency

A key determinant of a company’s success hinges on its pricing and packaging strategies. These decisions shape not only the company’s revenue and profitability, but also influence the type and quality of customers attracted to the product or service. A common method employed by companies to encourage customer loyalty is offering substantial discounts on annual plans. What are the benefits of offering these discounts? Is there a ‘magic formula’ for how steep this discount should be? We’ll dive in below.

What is Annual vs Monthly Billing?

Annual and monthly billing represent two primary subscription models used by companies.

• Monthly billing is a pay-as-you-go model where customers are charged a fixed fee every month for accessing a product or service. This model offers greater flexibility as customers can choose to cancel or modify their subscription at the end of any month, thereby reducing financial commitment.
• Annual billing requires customers to make a one-time payment for the entire year, usually in exchange for a significant discount compared to the monthly rate. While this model demands a higher upfront cost, it often results in substantial savings over the long term for customers planning to use the service consistently throughout the year.

In the example above, Peloton’s digital application is offered for $12.99/mo ($155/year) or $129 paid upfront. Members who pay upfront save $26 (17%).

Benefits of Annual vs Monthly Billing

The advantages of annual pricing for companies extend well beyond the obvious inflow of immediate cash. The benefits of this strategy include:

1. Improved Cash Efficiency: Annual subscriptions provide companies with an immediate influx of capital. This cash can be reinvested into various aspects of the business, such as product development and marketing. Read more on the importance of cash efficiency in a blog post I previously wrote here.
2. Higher Quality Customers: When customers commit to an annual subscription, they’re expressing a certain level of trust and commitment in the product or service. They are effectively putting more ‘skin in the game’. These customers often prove to be higher quality, exhibiting deeper engagement with the product and showing more patience with potential issues, as they’re committed for a longer term.
3. Lower Churn Rates: The upfront commitment of an annual plan can contribute to lower churn rates. Since these customers are locked in for a year, they’re less likely to cancel their subscriptions in response to minor issues or temporary changes in their usage patterns. This improves customer retention and adds a layer of predictability to the company’s revenue stream, while improving LTV.

Note that even with these business benefits, you still need to “fight” for the customer’s engagement and renewal via product features, comms, etc. This is not a magic bullet strategy for growth.

Insights from the Data

I analyzed data from 20 companies across different industries, to observe the patterns that emerge when comparing annual pricing, monthly pricing, and the percentage discount offered on annual plans. The landscape presented a wide spectrum, with rates spanning from a modest 13% to a hefty 67%. The average discount settled around 35%, with the most frequently observed discount rate being 17%.

• Combatting Competition with Aggressive Discounts: In industries with high competition and high attrition rates, such as the language learning sector (Duolingo) or health and wellness industry (Lose It, MyFitnessPal, Calm), companies frequently adopt a strategy of generous discounts on annual plans. These markdowns act as an appealing bait for users, encouraging them to pledge to the service for a longer term, which in turn helps to counter churn and boost customer loyalty. If you’re curious to get a sense of a company’s retention profile, looking at their pricing can be strong hint.
• Balancing Upfront Investment with Lower Discounts: For businesses that demand an upfront investment in hardware, such as Peloton, Nest, or Ring, the prevalent strategy leans towards offering lower discount rates. This likely stems from the understanding that customers willing to shell out a significant initial investment are typically more inclined to commit to the service for the long haul, thereby justifying the lower discounts even on a monthly plan.
• Necessities and Lower Discounts: For companies providing services that are deemed essential or hard to replace, such as Dropbox with its cloud storage capabilities, a lower discount rate is a common strategy. These businesses often have a high “stored value,” meaning users accumulate substantial value within the service over time, which makes it more difficult for them to switch to a different provider. Hence, these companies can afford to offer lower discounts on their annual plans while still maintaining a loyal customer base.

For retention benchmarks on digital subscriptions read my popular post where I compiled anonymized data from digital consumer digital subscription businesses across several verticals.

The Strategic Implications of Monthly vs. Annual Pricing Models

• The Dual Pricing Advantage: Offering both monthly and annual subscription plans introduces choice and a comparison shopping effect, a powerful tool for consumers. Monthly plans’ lower upfront costs and reduced commitment let users test services, while annual plans cater to those seeking a long-term commitment with cost savings. This flexibility enhances customer satisfaction and retention, with the discount amount serving as a key lever.
• No Annual Plan: Companies like Netflix avoid annual plans due to their business model and retention strategy. One reason is that a monthly pricing model lowers barriers to entry, making it easier for new subscribers to join. It also provides greater flexibility for subscribers who may want to cancel or adjust their subscription. Additionally, Netflix’s content library is subject to change, and offering annual plans might lead to dissatisfaction if subscribers feel the available content doesn’t align with their expectations throughout the year.
• Annual-Only: Conversely, companies like Masterclass forgo monthly plans as their service value takes longer to be realized by consumers. Their in-depth courses require significant time investment, making an annual subscription more suitable. Monthly plans might not afford users enough time to see the value in the courses, potentially leading to high churn rates.

Conclusion

While offering discounts on annual plans is a common practice, the right discount level varies depending on factors such as industry, competition, product uniqueness, and customer behavior. It’s not a one-size-fits-all approach but requires a keen understanding of the customer base and market conditions. Continual testing and refinement of pricing strategies are critical for maintaining a healthy balance between customer acquisition, retention, and profitability.

Special thanks to my colleague Sam Bauman for reading this post and providing feedback.

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