ONE of the most fashionable ideas in business is that companies should earn their crust from subscribers, who are “locked in” for a period of time, rather than from customers who can easily switch to another provider at any time. Subscription models are seen by many investors and executives as the holy grail, because they promise a recurring stream of revenue. But the approach suffers from three underappreciated problems. Acquiring subscribers can be eye-wateringly expensive. Their urge to run away is often only temporarily suppressed. And consumers may have more than one relationship at a time.
The best-known subscription model is probably Amazon Prime. It has about 80m members in America alone and for $99 a year offers films and music, speedy delivery of goods and even discounts on goods such as baby food. There are many other examples. Netflix offers a wall of TV for a monthly fee. And more are coming. Venture-capital firms are pouring money into subscription-based home-delivery firms that bring to your doorstep meals, pills or even fresh underpants. Zuora, a software firm, talks of the rise of the “subscription economy”.
Several star firms floating their shares this year have subscription models. Dropbox, a cloud-storage firm, listed on NASDAQ on March 23rd and is worth $13bn. It boasts 500m registered users and wants to convert them into “paying users”, of whom there are already 11m, who get a superior service. Spotify, a music-streaming firm that listed on April 3rd, has 159m users but derives its $27bn valuation from 71m “premium subscribers” who pay to listen without adverts. On average each generates 13 times more sales and 27 times more gross profit than users who pay no fee.
The attractions of subscription businesses are obvious. Firms can predict the future better and build deeper relationships with customers who have less incentive to shop around. Some venerable firms discovered long ago how to transform one-off purchases into recurring sales. Gillette gets customers to “join” (by buying a subsidised razor) and then charges them “monthly fees” (buying replacement blades). Rolls-Royce, General Electric and Pratt & Whitney rarely sell passenger-jet engines in one-off transactions, but instead offer “power by the hour” through complex service contracts that tie them to airlines for decades.
Subscription models are becoming more popular, in part because technology has made it easier to rent rather than own assets. Instead of buying software, for example, users can get access to it as a cloud-based service. Data mining means that the insights gained from a sustained relationship are more valuable than before, for customers and firms—Netflix purports to know what viewers want to binge-watch. And after a scandal involving Cambridge Analytica’s dubious acquisition of data from 87m Facebook users, there could be a shift from digital businesses built around advertising to subscription models that protect privacy.
The subscription approach also makes investors and creditors more comfortable with intangible businesses, which have no factories that can be relied on to generate goods and sales year after year. Instead, a subscriber base can be thought of as an enduring “asset” in which firms can invest. Businesses that rely instead on a frantic series of one-off transactions—Uber, for example—may be more volatile and vulnerable because barriers to entry are lower.
The subscription boom will doubtless continue. So much so that antitrust regulators may eventually become nervous if too many consumers are unable to switch from their providers, either because they are contractually bound in or because the cost of doing so is prohibitively high (for example, if they lose their historical data). Yet before assuming that world domination beckons, it is worth noting the flaws of the subscription approach.
First, firms have to pay upfront to attract new subscribers, either by keeping prices artificially low or by spending heavily on marketing. Consider half a dozen subscription-based firms: Amazon Prime (defined here as Amazon excluding AWS, its hosting business), Blue Apron, Dropbox, Hulu, Netflix and Spotify. Next, compare their meagre combined free cashflow last year to the amount they would need to earn a 10% return on capital. The total shortfall is $14bn, or $4bn excluding Amazon Prime. This is a proxy for the subsidy being paid to attract and retain subscribers. Eventually these firms may have to raise prices in order to boost profits, or sell a broader range of services, stepping on the toes of other subscription businesses. All these companies use statistical models to try to ensure that the “lifetime value” of a customer exceeds the cost of acquiring them, but it is still a guessing game.
The second problem is that subscribers are annoyingly disloyal. At the end of a contract period some turn to a different provider. Netflix is thought to lose less than 1% of its customers per month to “churn”; this is in line with established subscription-based firms such as mobile-phone operators. For Spotify, a music-streaming service, the figure is a more worrying 5%; for some meal-delivery firms, it is a lethal 10%. Churn could rise further for all these firms as competition intensifies or if they raise prices.
Ménage a trente-trois
The final shortcoming is the lack of exclusivity. Consumers love two-timing companies—corporate loyalty clubs have 4bn members in America alone, as people sign up with lots of different airlines and hotels. Saturation could occur in the digital subscription world, too. America’s 118m households now have over 200m subscriptions to streaming media, e-commerce and other web-based services. The high valuations of the listed firms they subscribe to imply that this will grow to well over 350m by 2027. From newspapers’ digital offerings to car-navigation services and startups selling web-based home-security services, America is at the forefront of a giant boom in subscription businesses. A first sign of trouble could be that there are not enough Americans to satisfy them all.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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