The subscription economy is here. Are you ready?

Editor’s note: This story is part of our Microsoft-sponsored series on cutting-edge innovation. Tien Tzuo is founder and CEO of Zuora, an online subscription billing and payment company.

Just as the Web rocked the bricks and mortar world of business 15 years ago, the burgeoning subscription economy is forcing today’s enterprises to change how they do business.

Subscriptions used to be just for newspapers and magazines, but not anymore. The last 10 years have seen a dramatic increase in companies using the subscription model to offer everything from music, movies and textbooks to even cars for a monthly fee. Every day, more and more traditional players are joining the “subscription economy” in response to changing consumer habits. For most companies, this shift means relearning a lot about selling, pricing, packaging, and building customer loyalty. As we move to this new economy, companies need to move away from a manufacturing-oriented, product-focused way of thinking, and embrace a world of services that fundamentally change customer relationships.

But what will it take to succeed in this new world? Right now, business leaders need to gain a more nuanced understanding of the strategic, financial, and operational implications of a subscription-based model, or they risk losing ground in the time-to-market sprint. They need to understand that the competition will be governed by new rules, and if you can’t provide the right service at the right price, your competitors will.

Consider BMW versus Zipcar. BMW’s leasing business already operates much like a service. You pay a one-time set up fee, and then you pay a monthly fee over the life of the contract. Oil changes and maintenance are all included in that price. In fact, in 2008, 60% of BMW’s sales came from its leases. But compared to Zipcar’s pay-as-you-drive subscription membership, BMW’s leasing service falls short. With Zipcar, you might drive a Toyota Matrix one day and a Mazda the next. If I’m a BMW customer, why can’t I grab a 3 Series for a few weeks, and then switch to an X5? And Zipcar’s fees even include the gas! As companies move to the subscription economy, they have to fundamentally rethink what it is that they sell, not just how they sell it.

Forget fire sales, seasonal specials, and other brute-force price promotions. Armed with better insight into how prices affect demand, subscription companies can lower prices in a more rational, granular way to manage inventory while maximizing yield. For example, when the iPhone 3G was introduced, AT&T dropped the price of the iPhone by $100 and simultaneously raised monthly fees by $10. In doing so, they were able to sell more iPhones (lower entry fee) but earn more money over the life of the two-year contract.

Developing this kind of operationalized pricing capability should be a major focus in the years ahead. In this new world, dynamic and flexible pricing and packaging become the two key levers to driving market share and profit. Subscription businesses will need price plans designed to fit every need: individual plans; all-you-can-eat plans, family plans, prepaid plans, business plans. And by adding a time dimension, they can give themselves more flexibility with packaging: pay-as-you-go, monthly, or annual.

One industry ripe for flexible pricing options is media – the original home of the subscription model. Everyone agrees that “free” is not sustainable for newspapers and magazines, but what’s the right model for charging online? Is it metered pricing like the Financial Times offers? An all-you-can eat model such as the Wall Street Journal? And what about pre-paid debit accounts, micropayments, or something more nuanced like premium packages for affinity sports coverage or stock analysis? The truth is, no one yet knows what model will work best, but publishers need to start experimenting with bundles and packages quickly and give themselves the flexibility to tailor them once they do figure out the optimal mix.

As businesses rethink their fundamental goal – from building products and finding buyers to finding customers to service on a continual basis – guess what happens? Customer relationships come to the forefront. In the old product-centric model, the customer relationship usually ended at the time of sale. In the subscription economy, the first sale is just the beginning of a potentially beautiful long-term relationship.

In fact, savvy subscription businesses understand the importance of giving customers something beyond the service itself. For example, as the Chief Marketing Officer at Salesforce.com, the company that launched the subscription revolution in software, I built long-term customer relationships by creating a thriving community around live events that bring customers together with each other to network, partner, and cross-sell.

We’re already seeing this happen in more traditional businesses. Starbucks is shifting its focus from a difficult-to-differentiate “customer experience” to more profitable customer loyalty. With its Gold program, Starbucks offers loyal customers 10% off every purchase, free Wi-Fi use, free beverages on their birthday, exclusive discounts, and more. Rather than continuing to chase customers, they’ve identified a way to build recurring customer activity.

Or look at Blockbuster versus Netflix. Blockbuster was driven into bankruptcy because Netflix made the old model of movie rentals obsolete with its subscription service. Blockbuster needs to chase customers with coupons and promotions while Netflix generates monthly revenue whether the customer uses the service or not. But Netflix also provides a package that’s more than just DVDs via mail. It has a community of member reviews, provides recommendations, and offers a nearly endless inventory to choose from – added benefits that an in-store experience could never match.

Fundamentally, companies embracing the subscription model must understand that it’s an evolution and an ongoing process. Just as technology consumers have shifted from the mouse to a touch screen and from being disconnected to always-connected, businesses need to address the shift happening beneath their feet: from a product-centric world to a service-centric one, from fixed prices to constantly adapting prices based on market feedback, and from closing deals to fostering long-term customer loyalty.

To beat the competition, businesses will need to rely on accurate insight into price changes, their impact on customers’ psychology and loyalty as well as on the tradeoffs between margin and market share. And as we’ve already seen, this new economy will create a Darwinian struggle in some markets. Because as consumers benefit from greater choice, they will more actively vote with their dollars, making the winning mix obvious to everyone.

Tien Tzuo founded Zuora after spending nine years at salesforce.com. As one of the “original forces” at salesforce.com, he built salesforce.com’s original billing system and held a variety of executive roles in the company’s technology, marketing, and strategy organizations, including building out the product management & marketing organization, serving as chief marketing officer for two years, and most recently as chief strategy officer.

The community responds:

— Simon Buckingham, founder and CEO of Mobile Streams (Ringtones.com), Zoombak, and Appitalism

We are undoubtedly witnessing the emergence of a new economy, it’s just that it is not a subscription economy, it’s a social one. Zipcar and Netflix are not successful because they are subscription services; these companies are primarily successful because they offer a tremendous breadth of product options and simultaneously provide each customer with a tailored experience based on order history, recommendations and community feedback from other customers. Zappos and the iTunes store are two wildly successful non-subscription businesses which succeed for the same reasons. The shift we are experiencing is not from a product to a service centric economy, but from a product and service centric economy to an inherently social economy. Subscriptions are one great way to develop a successful business in a social economy, but they certainly aren’t the only way. Only one thing is certain in the new social economy: power to the people.

— Michael Sippey, Six Apart’s vice president of corporate development; formerly ran the blog-software company’s TypePad subscription service

I think there is a shift happening from a product-centric world to a service-centric one. And I agree with his advice — businesses need to shift their thinking from short-term purchase intent to long-term customer loyalty, and develop capabilities around real-time pricing and yield management.

But I think there’s another subscription-based skill set that businesses should value: curation. In a world where any product is available to anyone, anytime, from anywhere, subscription businesses that come with an embedded point of view will be able to differentiate themselves and develop long term loyalty. Media products are obviously fertile grounds for curation (magazines or music blogs, anyone?), but we’re starting to see this bleed over into physical goods.

The “X of the month” clubs are not only habit forming, but shift the burden of finding the right product for the right time from the consumer to the service provider. It’s great for food and beverages: you can subscribe to wine of the month, beer of the month, bacon of the month and even cupcake of the month. And it’s easy to imagine it applied to other categories with highly differentiated products — fashion, for example. Threadless already has Threadless 12 (“exclusive tees every month!”), but I’d love to subscribe to the “colorful socks of the month” club, or the “hand-made dress shirt of the quarter” club.

There’s a platform opportunity baked in here. Subscriptions to a stream of goods from a single manufacturer will get boring quickly … and have a high churn rate. Someone should empower individual tastemakers to build subscription-based businesses, promoting and merchandising subscriptions to the products they love from the producers they admire. Tomorrow’s product blogger shouldn’t just be linking you to the things they find interesting, they should be shipping them to you.

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