How to Evaluate Amazon Prime and Other Subscription Businesses

How do you evaluate a subscription business like Blue Apron, Birchbox or Amazon Prime? In a lot of ways, subscription e-commerce shares key dynamics with software-as-a-service businesses.

Tren Griffin, a senior director at Microsoft for strategy, competitive analysis and business development, wrote on his blog 25iq a good overview over how to look at subscription businesses:

Successfully implementing a subscription business model can be particularly hard since the customer acquisition cost (CAC) happens up front and the revenue appears over time. These subscription businesses have a revenue profile that is more like an annuity. This revenue profile is not like the manufacturer’s business that many people learned about from a college introduction to accounting class. Unlike an annuity, the revenue stream of a subscription business is subject to risk, uncertainty and ignorance.

​Understanding that the customer lifetime value gets unlocked over a comparatively long timeframe, is the starting point to grasp subscription businesses.

you can’t understand the value of the business by looking at just one month or even a few months since it is lifetime value that matters.

​Obviously, CAC can evolve very differently:

Making management of lifetime value is hard for an entrepreneur in no small part because the lifetime value variables change based on other factors like the sales channel used or geographic factors. A business can start out with very high CAC and then have it it drop over time (XM Sirius or Netflix) or have relatively low CAC and watch it rises over time (Blue Apron it appears).

The reasons for this are embedded in the products: XM Sirius and Netflix provide a product in a known category (radio, TV), ‘just’ with a different business model. A meal-kit subsription like Blue Apron on the other hand has to first create a market, it has to change behavior. Hence, sometimes, this leads to getting the customers first that are willing to change their (in this case, cooking and eating) behavior.

The larger you get the further you leave that enthusiastic niche behind. Getting the mainstream on board may mean larger CAC. (and, not coincidentally, a higher churn rate)

Not looking at lifetime value at all is a huge mistake. A company like Amazon is not understandable if you believe its business model is similar to the steel manufacturer you learned about in your introduction to accounting class. Trying to value Amazon’s Prime business with a P/E ratio is like trying to open a can of corn with a pickle.

Griffin’s post is a good starting point to wrap your head around subscription businesses. He also posted some example of how to go through the numbers.

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