To put it simply—why not just answer the question in the title early for once?—customers love (some) subscriptions because the consumer surplus is tremendous!
Yesterday’s post really captured why customer hate some companies, so let’s explain the few times when customers love subscriptions. Let’s be clear: in the digital age, when a company decides to lose money, it can be great for customers. Phenomenal even. In business terms, the consumer surplus is huge. That’s right, “consumer surplus” which I introduced on Monday in my article “Theme 2: It’s Not Value Capture, but Value Creation” is a customer’s willingness to pay minus their price. The larger the gap, the better the value.
Let’s use MoviePass as the example of the day to explain the benefits and pitfalls for a company that tries the subscription model.
Why MoviePass?
Mainly, because it simplifies the value creation model to its essence.
First, “willingness to pay” (WTP) is basically a made-up number. Customers don’t really know how much they “would” pay for a good, as that’s not usually how it’s asked. You walk into a store, see a price, and pay it. You don’t usually have a negotiation. Behavioral economics has shown that a lot of pricing is about setting expectations versus a rational cost-benefit analysis. Fortunately, we don’t have that problem with MoviePass. We know the price for a movie ticket, because anyone can just go out and buy one. For this case, we can substitute those prices for WTP. Easy peezy, lemon squeezy.
Second, MoviePass has real costs per transaction, which is that movie ticket from above. One of the big drivers of what I called “digital all-you-can-eat” subscriptions is the low or zero marginal cost of digital products. A DVD needs to be produced in a factory; each additional sale on iTunes has a marginal cost of almost nothing. This can make costs tricky to calculate, amortize or account for. MoviePass doesn’t have that since it’s costs are very clear and very real.
Movie Pass: What is the consumer surplus?
Well, it depends on who you are. In my simplified, single product, value creation model from Monday, the WTP could change per customer, but for the most part everyone is buying one six pack for roughly the same price. With MoviePass, the value per customer depends entirely on usage. Which changes the “consumer surplus” or WTP minus price.
And that single fact explains why subscriptions are either loved or hated.
To show that, we need to make some quick assumptions to illustrate our point. MoviePass—in its epic journey of the last year—changed business plans like ten times. So I’m going to pick what I think was the most popular plan for the longest period of time: seeing an unlimited number of films, once per day, for $10 a month. From Box Office Mojo, I see that an average ticket cost $9 (technically $8.97) in 2017. So we’ll use $9 as the price per movie ticket. (Round numbers, right?)
Knowing this, we can recreate the “value creation” chart from Monday. Let’s imagine four customers, one who forgot to use the service, one who saw one movie, one who saw two movies and one who went hog wild and saw 10 movies.
That can be a bit hard to read, so let’s put it into chart form like Monday.
There is one glaring takeaway from the chart—the fundamental flaw in the MoviePass business model—which is that MoviePass at it’s core is asking a stark proposition: do you use the service or not? If you don’t, like customer one, then you don’t get a value from the product. Even someone who only sees one movie a month would be much better off just buying movie tickets at the theater. On the other hand, if someone goes even twice, they’re clearly getting a better deal than buying tickets from the theaters directly.
What if you’re a “super user”? Going multiple multiple times per month? Well, you’re taking money from MoviePass’ pocket.
The last line on the table shows this trade-off explicitly: MoviePass never created value, it merely exchanged consumer surplus for producer surplus. That’s why you never have the “blue section” (consumer surplus) at the same time as the “green section” (profit) in the chart. MoviePass deliberately couldn’t make money unless a consumer ran a “consumer deficit” versus a surplus. They actively needed customer to sign up for subscriptions and not use them.
That single, obvious fact eluded most coverage of MoviePass.
Taking Our Model and Applying MoviePass’ Real World Numbers
Far from being a bug of MoviePass’ business model, signing up and not using the service was a feature. For this, unfortunately, I have to go to the person running the company, CEO Mitch Lowe, who told the podcast The Indicator that their data showed that the average customer only saw 1.7 movies in a month.
Well, look at where “1.7” puts us on the consumer value chain above. That means he’s acknowledging that at least half of his customer—I’ll be generous and assume the mean is close to median here, though I doubt that—are losing money on the MoviePass subscription. They’d be better off just buying tickets when they go, but instead they’re locked into his long-term contract. (Again, echoes of Columbia House here.)
Months after that above interview, MoviePass had to “pivot” business models. The company was losing lots of money with the unlimited plan, so they changed to a max of three movies per month. Here’s what that looks like in table form:
Essentially, MoviePass limited their upside risk. They made the “super users” who were using it for a lot of essentially free movie tickets capped to only two free movie tickets. This, though, made the value proposition a lot worse. Thus, when NRG researched this for the Hollywood Reporter, after making the change, MoviePass went form 83% satisfaction down to 48%. In other words, if you take away a lot of free stuff, people like you less.
The “Other Business Models” Arguments for MoviePass
Of course, you could make one of two arguments against my clear value creation chart: what if MoviePass had other ways to generate value for either itself or customers?
The first option is the “What if MoviePass negotiated better deals with the theater chains?”
Well, that wouldn’t really help customers, but would help MoviePass. Assume MoviePass used its size (at one point it was estimated it helped sell 5% of tickets in the US) to negotiate a rate of $8 per ticket. The consumers would get the same benefit, depending on how much they used the service. MoviePass would also lower it’s deficit in most cases. Here’s a chart of that:
At first, it looks like we might have created some value.
But not so fast. Where did MoviePass get that discount from? From the theaters. To do a true accounting, you’d have to factor in the new deficit to theaters, which would directly equal MoviePass’ negotiation. In other words, all MoviePass did was enter a value chain and demand payment. This is called “rent seeking” and is specifically not value creation.
(MoviePass would defend itself saying it is increasing attendance which drives concessions sales for theaters. Again, theaters could make that trade off—cheaper tickets for higher concessions—themselves without a middle man taking a cut.)
The second explanation is that MoviePass told us it planned to sell our data.
In general, and I hope to get an article published in another outlet on this soon, I’m skeptical of this idea. I’m skeptical of any “secret business plan” that isn’t core to a product. The more obscure the business plan, the less likely it actually exists. Given that data is already plentiful on movie viewing behavior, and the fact that MoviePass didn’t actually sell a lot of data, and given how much money they lost, well this idea wasn’t really real.
The Lessons from MoviePass for Subscriptions
Lesson 1: Customers clearly saw what was a good deal versus a great deal.
MoviePass made it very stark, as people knew the price of tickets in their local theater versus the price of MoviePass. As MoviePass changed/altered/finessed/destroyed their model, customers could immediately do the math to determine if this made sense. As a result, after prices went up and the total number of films available went down, customers saw this subscription wasn’t a good deal.
With many digital “all-you-can-eat” subscriptions, this analysis is a lot harder. Did you watch Netflix last month? Did you listen to Pandora or Spotify or Apple Music? Was it worth listening or watching without ads? Since those questions are a lot more obscure, it makes the decision to cancel that much harder.
Lesson 2: Companies need to price subscriptions very carefully, especially with marginal costs.
This is why most physical goods don’t bother with subscriptions. Just imagine a McDonald’s or fast food chain offering an all you could eat subscription per month. You’d either eat more or less than the cost of the food; if more, you cost the company money; if less, you wasted your own money. It’s very stark with physical goods.
With digital goods or services, the key—especially for non-digital subscriptions—is to price something at the rate that customers perceive they’re getting a good deal, even when you need a majority of them don’t benefit from it.
This is my worry with Lyft or Uber. At my last company, I had an hour plus commute every day. So if Uber offered me an “all you can eat” subscription for lower than my car payment, gasoline and insurance, I would have snatched it up in a hot minute. But for all the Lyft/Uber boosters out there—especially those predicting subscriptions—that number is impossible, unless Lyft and Uber deficit finance it.
My daily commute would cost $50 (at least) for each trip using a ride share. If not more. The true substitution cost assuming 20 commute days a month is $2,000 per month. If it was truly unlimited, I’d use it to go to the store and other places. I know all the people predicting that ride shares will replace car ownership, but they have to explain how long distance commuters won’t devastate the prices of subscriptions. (The answer is the hypothetical “self-driving cars”.)
More likely, the ride share companies won’t offer customers a good deal. They’ll arrange a program that sounds like a good deal, but comes with a lot of strings attached. Once you get caught in the strings, you’ll find that it isn’t that great of a deal. Again, Lyft and Uber could keep to per unit pricing with loyalty programs. Once they offer subscriptions, one side of the transaction will likely lose.
Lesson 3: Perception matters more than reality.
Arguably, this is the lesson from Netflix. They price their plan at $11 right now. So every other traditional studio trying to launch a new streaming service immediately runs into a problem: if we mimic Netflix’ price, there is NO WAY we can offer as much content as they do. How do they get away with it? (Hold on a moment.)
Netflix set the perception that tons of content should be available for nearly nothing. Or nothing if you’re using your parent’s account. Unfortunately, if they raised prices to cover costs, that perception may evaporate. So when you launch a subscription, the goal is to show how good a value you offer customers. As shown by MoviePass, this usually means a tremendous consumer surplus. Usually, this means losing money for the company in the near term.
At some point, though, if you can’t cover the costs…
The Main Lesson? Subscriptions that are truly good deals lose money (and Wall Street/VCs pay for it)
I mean, all those lessons above are fine, but the best numbers for MoviePass are the losses it sustained:
$40 million lost in the month of May.
$149 million lost to date from January to April.
It was hemorrhaging money in a way no alternate business plan could hope to rescue it from. But it isn’t the only internet company losing gobs of money in an effort to “secure market share”
$2 billion – Netflix free cash flow losses in 2017 (up from $1.5 billion in losses in 2016)
$900 million – Hulu losses in 2017
$418 million – Spotify operating losses in 2017
I’d also add that Amazon says they have positive free cash flow, but this article by New Constructs says even that might not be true. We don’t know how much money Amazon is making on either Twitch or Amazon Prime Video, though my rule of thumb is if they were making money, they would tell us.
In other words, it isn’t a coincidence that subscription services losing money happen to be the ones customers love. Instead, the more likely explanation is that it is directly tied to offering great consumer surpluses at the price of great producer deficits. Basically Wall Street (and venture capitalists for smaller tech companies) fuel huge producer deficits to enable subscriptions that customers love. At some point, they have to identify a way to actually make money, but that’s a problem for the future, not the near term.
Answering the Question at the Start: Who loves subscriptions?
1. Customers love subscriptions where they have huge consumer surpluses. The only examples of these, though, are where the companies run huge cash losses.
2. Customers hate subscriptions where they have low WTP. The main examples of these are monopolists or near monopolists like cable companies, wireless companies, health insurance or alarm companies. Or they are examples of subscriptions most customers regret after a few months.
3. Wall Street loves both types of subscriptions, for different reasons. They love subscriptions customers hate because again they are near monopolies. They love internet subscriptions because of huge gains in the stock market.
