As you know, I’m a big believer in recurring revenue as a way to make your business more sellable. Recently however, I got an interesting email from a reader who asked me about the pitfalls of switching to a subscription-type model:

John: I was led to your website and comments while searching for information on the business pitfalls of converting to the subscription model. The benefits seem clear to me, but I need to do a better job of addressing the potential dangers and difficulties, before I take it to my management team (and Advisory Board) and win their buy-in. If you’re willing or interested, is there a way that you can help with that?

To be clear, I think a subscription or recurring revenue model is the single best thing you can do to make your business more sellable. But it is not without its risks, so let me try to provide the “articles may shift in flight” warnings associated with moving to a subscription model:

1. You can’t be half pregnant:

In my experience, a subscription model will only work if it is the only way for a customer to do business with you.  If you offer both the subscription and a set of “one off” options for buying, customers will always opt for the lowest risk way to get what you sell – even if they have to pay a financial penalty to do so.

2. You live (and die) by your renewal rate

If you switch to a subscription model, your most important metric will become your renewal rate. If 80 or 90 percent of your customers re-up each year, you only need to acquire a few new ones to tread water and can grow quickly if you can acquire customers effectively. If your renewal rate is less than 50 percent, you have to scramble to replace half your customer list just to stand still.  If your product or service falls short one year, you could face a low renewal rate and wish you could sell “one off” stuff to supplement your income. Refer to point 1 for the reason you can’t sell one off stuff.

3. A twelve month lag on making changes

Assuming your subscription is 12 months long, then you always have to wait an entire year to make changes to your business model. For example, let’s say you want to change the price of your magazine subscription from $39.95/year to $44.95 per year. You make the decision but for the people who subscribed yesterday at $39.95, it will take a full year to get them on the new pricing plan.

4. The long, slow death

If you decide to stop offering a subscription, you still have to honor the commitments you’ve made for a year’s worth (or whatever length your subscription is)  of service. Let’s say you run a wine club and you introduce a subscription to your members that offers a bottle of Argentinean Malbec every month for a year. You need 200 members to sign up to break even but after selling for three months, you only get 75 to opt in. You could discontinue the program but that would damage the reputation of the club and make members hesitant to buy your new subscriptions in the future. You’re left having to fulfil the wine for the 75 members at a loss for the next 9 months until you can discontinue the offer. Unlike most small businesses that can pivot on a dime, it takes a year to kill off a bad offer in a subscription business.

5. Some people just don’t buy on subscription

A percentage of your prospects will be allergic to buying on a  subscription basis. They may have been burned by an unscrupulous gym or had trouble getting out of a wireless phone contract.  Some cultures frown on a subscription model (France for example). If you sell to other businesses, they may have procurement rules that do not allow them to buy on a subscription basis.  This narrowing affect may reduce the size of your target market by a few percentage points.

6. Red ink on your P&L

In the first year you make the switch to a subscription model, your Profit & Loss statement will start to show a lot of red ink. Assuming you charge up front for your subscription (I would strongly advise that you do) your cash flow will be fine but you’ll have to deal with a P&L with red ink. That’s because your accountant will need to spread out your subscription revenue over the length of the subscription. For example, let’s say you sell software as a service on an annual subscription model where you charge $1,000 per year to use your software. Instead of taking the $1,000 into revenue in the month you sell the subscription, you  only get to take one twelfth of the revenue ($83) in the first month and the rest spread equally over the next eleven months.  That means in the first few months of your subscription business, you may go from making lots of money on paper to losing a lot. Again, assuming your cash flow is strong, just ignore your P&L for the first year until you start going into months with the revenue on the books from subscriptions you sold in the previous eleven months.

Those are my 6 pitfalls of a subscription model. I’m sure there are others and I’d love to hear from you in the comments section of this post.  To reiterate, I think moving to a recurring revenue/subscription model is the single best thing you can do for the sellability of your business. This post is simply intended to give you a few of the downsides of a possible move so you go into it with your eyes wide open.

In other news, my story “4 Reasons an MBA Is Bad for Entrepreneurs” caused a bit of a fuss among some of my better-educated friends (thank goodness I don’t have many). I’d love to know what you think about the value of an MBA for business owners.

Here are a couple of my new articles on selling a business I thought you might enjoy:

Waiting for the day you can finally leave

~ published February 25, 2011 the Globe and Mail

How does it make you feel when someone resigns?

In my last company, accepting someone’s resignation felt like a break-up. I would go through a predictable cycle of feeling rejected, then angry, then finally settle on a twinge of jealousy as the departing employee set off to do new and interesting things.

Inwardly, I was envious of the sense of excitement that comes with reinventing yourself, while, outwardly, I was left to try to steady the ship, reassuring my people we would get on just fine without the person heading for the exit door. »more

Secret to building company is time

~ published February 28, 2011 the Globe and Mail

I had a friend in university who would always be the last one to leave a party.

When I asked him about his curious habit, he explained it was the best strategy for finding a date — with many of the women pairing off and departing earlier, the ones who stuck around were that much more motivated to try to meet someone.

While I cannot personally verify the efficacy of his strategy, in a business context there is something to be said for just being around longer than anyone else. »more

Entice buyers with a teaser

~ published March 1, 2011 the Globe and Mail

One of the most successful entrepreneurs I know used to keep a two-page summary of his business on his laptop. He was constantly tweaking it with his firm’s latest achievements, wordsmithing it from one day to the next.

It had probably gone through a hundred iterations before I finally asked him what it was.

“It’s my teaser,” he explained.

At the time, having no idea what he was talking about, I asked him to explain. »more

Let suitor start the price dance

~ published March 3, 2011 the Globe and Mail

After the lunch plates were cleared, the man across the table turned to me in a hushed voice and asked his most important question: “Have you ever thought about what your company might be worth?”

Like most business owners, I had indeed contemplated this question, but I hesitated to reveal my number.

The man was the head of business development for a large multinational advertising agency, and he was on a fishing expedition to see if I would be interested in selling my company – and if he could get it for a bargain. »more

Opportunists who offer worthless opportunity

~ published March7, 2011 the Globe and Mail

Nearly 15 years ago, I was setting up a trade-show booth when the exhibitor beside me – a young guy about my age –started a conversation.

Seeing me wrestle with the various poles and staging needed to erect my booth, he came over to help. Small talk aside, he started quizzing me about my little marketing company. At the time, I probably had two or three employees, and maybe $300,000 in revenue, so I was surprised by his degree of interest. He seemed overly complimentary about the modest portfolio of work we had created. »more

Is Your Business Sellable?

~ published March 2, 2011 Inc.com

Recently I spent time with a business owner—let’s call him Jack—who runs a 25-person engineering consulting firm. Jack and his partners have been successful, generating more than $1 million in pre-tax profit last year before the owners divided the spoils.

Jack owns half of the shares, and his five partners own the rest. Approaching 60, he is now starting to think about his exit strategy.

Jack was under the assumption that his business would be valuable to an acquirer because of his blue-chip client list, the team he has built and the seven-figure pre-tax profit the company was able to muster. »more

4 Reasons an MBA Is Bad for Entrepreneurs

~ published March 3, 2011 BNET

I don’t think entrepreneurship can be taught.

In fact, the list of entrepreneurs who dropped out of school reads like a who’s who of company builders: Bill Gates, Richard Branson, Larry Ellison, Paul Allen (Microsoft), Sean Parker (Napster, Facebook), Walt Disney, Mary Kay Ash (Mary K), Coco Chanel (Chanel), Barry Diller, Simon Cowell, Michael Dell, Henry Ford and Steve Jobs are just a few of the Spicoli-esque educated.

I think not only is getting an MBA a waste of money and two years of your life; it may also, in fact, reduce your chances of building a successful business. Here are four reasons why: »more

(image courtesy of Flickr/Browserd (Pedro Rebelo)