• Milton Friedman Society

How consumer behavior is affected by the subscription based economy

By Anton Memminger


How come that Americans have stopped reading books outside of work and school?


Many bibliophiles struggle to give a satisfying answer. Despite accumulating an average of nine years of TV viewing by the age of 65, the success of other media forms cannot be the sole cause of the decline in reading. Much more debated is the thesis that the underlying force behind adult aliteracy is our deteriorating ability to commit. For example, in the US, marriages, possibly the biggest of all commitments, have become less frequent and those couples that do, usually marry at a later age.


The reason why we feel ambiguous about commitments is the resulting loss in our freedom. More precisely this is related to the resources we dedicate and reserve when entering into one. For us, it would be more convenient to have the freedom to reallocate all of our potential resources at any point in time, but by making a commitment, we move away from this comfort spot.


In economics we frequently make commitments, primarily in the form of purchases. For businesses this represents a problem, as particularly in combination with uncertainty, potential customers are reluctant to make the decision to buy. A solution for this problem can be identified in the good’s counterpart, the service. Take the hairdresser as an example. Instead of acquiring the tools and knowledge to perform a good haircut on ourselves, most men simply go to their barber and get it as a service. This is a considerably smaller commitment and people have come to love it.


The idea to put access over ownership, like in the hairdresser example, is shaking up today’s business world. The intuition behind this movement is that in the long run, ownership is static, while services adopt. Assume you bought a beetle right after the second world war. Leaving maintenance aside, you would still have pretty much the same car today. The engine might have lost some power and probably there are some marks of usage in the interior, but fundamentally it still is the same thing as it was 70 years ago. On the other hand, comparing a cab ride from 1950 with 2020s ride-hailing offerings seems almost impossible. First and foremost, digitalization of the order and payment process allow better planning and increase usability- communicating with a taxi driver can be tough (consider the language barrier), but selecting your destination, customizing your experience and giving feedback with Uber is as easy as it gets.


Of course, technological advancement is not exclusive to services, but in some industries, it takes longer for this progress to arrive at the consumer, given the frequency in which we buy them. A great example is the software market. Think about a high school which wants to equip its PCs with a copy of Microsoft’s Office suit. They go on and buy a given number of packaged copies of the most recent release. During the installation process, developers at Microsoft are already finalizing improvements that would be included in a future edition. By the time the school begins to use the software, it is deemed to be outdated in the near future.


Now, major software companies are addressing this problem by converting their products into services. In the case of Microsoft, Office 365 grants access to the most recent edition of the office suit, while customers pay on a monthly basis. Instead of documenting the aging of their product, consumer benefit from constant improvement. Furthermore, the subscription model is flexible, addressing the comfort problem described earlier.


On the business side, the SaaS (Software as a service) model has two key advantages. First, there is the gained transparency. Subscriptions create an immediate link between companies and their clients. This allows developers to understand who their customers are, something which was challenging in the old distribution system, where giant retailers like Walmart were unable to provide granulated data. Second, it leads to predictability. In his book “Subscribe” Tien Tzuo describes that prior to SaaS, companies had to work with “Hollywood economics”. Introduced by Arthur De Vany the term refers to product development under severe uncertainty about its market success. On the other hand, the subscription-based model provides recurring revenues, as new features are steadily implemented in contrast to the sequential product launches.


Unsurprisingly, these advantages have led companies from other sectors to develop subscription strategies. Spotify and Netflix have reshaped the entertainment industry, while shaving clubs and food bundles are replacing everyday shopping.


But the subscription economy and the convenience of passive spending have a number of serious issues, which I have decided to call the three traps:


Let’s start with the performance trap. Humans, by nature, are reluctant to react to threads they deem to be negligible. No sh*t Sherlock! This by itself is not a problem - why would you waste resources on an irrelevant matter? But when we don’t pay attention, it might happen that we categorize an event incorrectly. You might see where I’m going with this. How dangerous is a 10€ monthly subscription? When checking through your bills, which 65% of Americans don’t, it can be easily overseen or won’t even be noticed. In an extreme scenario, we fall into a spiral of spending habits, where our expenditure is significantly different from our real consumption. So passive spending represents a challenge for consumers to live up to their role of making rational market decisions. Similar to the concerns regarding the popularity of index funds, market performance will be impaired.


But even if consumers were acting as rational individuals, the structure of subscription services presents a budgeting problem. If we can replace a big one-time payment with a monthly subscription, we distribute the cost of our consumption and hence face lower current expenses. This is why we can finance nearly every larger purchase, because companies are able target customers, who couldn’t afford the good otherwise. As most subscriptions are paid at the begin of the month, an economy where the bigger part of our expenditures is in subscriptions and subscription-like forms, e.g. rent, our disposable income is dramatically lowered. Given that more than half of American households have less than 500$ in savings, emergency credits might be the only way to react to a sudden need for money. I call this the liquidity trap. The popularization of comprehensive financial apps that visualize our consumption data, may be an important prevention mechanism for these both the liquidity and the performance trap.


The third and final trap addresses our autonomy. A beautiful part of making active spending decisions is fantasizing about the best way to invest our money. In the performance trap, I highlighted that this process is partially suspended, as spending becomes passive. The way social media algorithms build information bubbles around us, showcases our fetish for familiarity and confirmation. My resulting user experience is complicated. When using social media nowadays, I seldomly feel ‘inspired’ or emotional, but I keep coming back to look at my feed throughout the day. It’s a subtle addiction. It seems likely that with the success of the subscription economy the formation of consumption bubbles will result. The introduction of Facebook’s marketplaces is a decent early indicator. The bubble trap deals with the question of whether we might lose our identity by switching to subscriptions. This is especially relevant when thinking about curated subscriptions that is where you sign up to a theme, not a specific product, think of it like an advent calendar.


In the end I want to briefly readdress the initial question about why so many American adults have stopped reading books. According to Steve Kotler the ROI of books is unbeatable, somewhere in the range of factor 10’000 and generally I agree. In the end, I believe the fundamental cause for adult aliteracy is not a fear to commit, but rather a laziness to put up with the cognitive challenges. If I’m right then the success of business models based on recurring revenues might be the next event causing the formation of polarized groups of generic individuals, but for now, it represents a great opportunity for entrepreneurs and corporations alike to structure a new era of consumption.



REFERENCES


http://www.localhistories.org/houses.html#:~:text=In%20the%20Middle%20Ages%2C%20ordinary,big%20improvement%20over%20wooden%20houses.


https://www.amacad.org/humanities-indicators/public-life/book-reading-behavior


https://www.jec.senate.gov/public/index.cfm/republicans/2020/4/marriage-rate-blog-test#:~:text=The%20national%20marriage%20rate%20fell,8.2%20marriages%20per%201%2C000%20people.


https://www.businessinsider.com/you-could-save-1100-subscription-costs-2019-4?IR=T


https://mint.intuit.com/blog/budgeting/spending-knowledge-survey/


https://neilpatel.com/blog/before-starting-recurring-billing/


https://stripe.com/docs/billing/subscriptions/overview


https://money.cnn.com/2017/01/12/pf/americans-lack-of-savings/index.html


https://www.moneyhabitudes.com/understanding-and-changing-spending-habits/


https://www.nytimes.com/2017/04/25/magazine/can-facebook-fix-its-own-worst-bug.html


https://www.cartoonstock.com/cartoonview.asp?catref=WD600163


Steve Kotler, “The Art of Impossible”, 2021


Tien Tzuo, “Subscibed”, 2018

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