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  1. Israel’s Subscription Challenge

    We must build successful subscription businesses in Israel. It is not clear that the background of many Israeli internet execs who come from online gambling and forex is appropriate for growing subscription businesses. Instead we need more focus on great product and customer experiences.

    It is becoming increasingly clear that the two business models winning in the public markets today are focused on subscriptions (Salesforce, WIX, Zendesk) or large, consumer-facing audiences, that monetize through transactions (Zulilly/Amazon) or through direct advertising (Google, Facebook) or through marketplace models (Uber, Airbnb). There are a few businesses, like Zillow, that combine both.

    Israel has always been challenged in building large, consumer-facing businesses due to cultural and geographic distances from large consumer markets (Waze and Wix are the exceptions). However, for years, Israeli companies have succeeded in building meaningful B2B businesses around enterprise software and semiconductors. As the B2B and some of the B2C businesses transition to subscription models, this, a priori, should play well to the strengths of Israeli companies.

    subscription-billing-for-dummiesHowever, I’ve recently noticed something is amiss in building large subscription businesses here and it is something we need to correct quickly. For some reason, the US – Silicon Valley, in particular – has ramped up quickly on subscription expertise. When I recruit for a head of sales for Clarizen or Gigya, there are a plethora of candidates in the US. That same expertise still does not exist in Israel in ample supply. Given the number of companies trying their hand at subscription models, we desperately need to find and cultivate more of that expertise quickly here in Israel.

    A number of additional challenges are due to the volume of people who have come to subscription businesses from the worlds of online gambling and ad tech. These executives and employees have been trained in arbitrage businesses. They often measure their success in Customer Acquisition Costs (CAC) and conversions, and relentlessly think about the “seductive (but tactical) metric of Positive LTV“. Matan Bar of eBay and the Gifts Project said it best at one of our Aleph-Bet sessions, “These companies optimize acquisition instead of value.” While these metrics are important, they are not the core of building a great B2B or B2C subscription business. Product is. That is where true value lies.

    In arbitrage businesses – such as Online Gambling, Forex and Adtech – you focus on margins generated from incoming customers. In the race to get as many customers as possible, so that those customers do not lock in with competitors (and flush their disposable income there), you optimize features for conversion to paying customers. Pause. Paying customersnot loyal subscribers. In addition, the marketing lead at these companies is incentivised to increase margin. How do they “increase” margin? These marketing leads optimize marketing channels and the spend in each channel. What they don’t do is focus on churn (reducing it) and loyalty. In fact, many of them could be considered “churn and burn” transactional businesses.

    These arbitrage skills do not serve us well in the real, high-value, subscription economy. The bane of any and every subscription business is churn. Churn is not solved by more and better marketing. You reduce churn by sure and steady improvement in the product. It is led by the product and engineering teams, not the marketing team. The short lifetime found in Forex or online gambling – even if it is profitable – is not the same as the potentially infinite lifetime of a loyal subscription customer who delights in your product or service.

    In addition, a great product is actually your best marketing tool in a subscription businesses. The great subscription businesses should strive to spend ZERO dollars on paid PPC marketing. In a great subscription business, the product and service should speak for itself. Free users that come of their own desire to your product are far more valuable customers.  They also talk about your product due to their satisfaction (word of mouth marketing). Today, Seeking Alpha (where I serve on the board) is relentless about organic product quality and spends ZERO on free or paid subscriber acquisition. Seeking Alpha organically adds between 15,000 and 30,000 direct subscribers a week, who invest based on Seeking Alpha’s research content and alerts. The only metric Seeking Alpha measures is Daily Direct Users (DDUs) as a measure of the organic stickiness, word of mouth and value of their products and services.

    For years this was the case in the newspaper business, where once great content newspapers like the New York Times and Wall Street Journal had loyal subscribers who could not live without their content. Those newspaper businesses had de minimis churn, which is why Warren Buffett acquired them for years.

    This is particularly acute in low-cost subscription businesses that target consumers and SMBs. Your product should be your customer acquisition strategy because it is a self-reinforcing strategy. Great product brings in users for free and then retains them by providing a great, valuable paid experience. When I was on the board at Wix, the key metric I watched was paid subscribers that came from free sources vs. those that came from paid sources. When they came from free sources, it was a statement that the product was so beautiful and intuitive that a customer had to build his/her website on Wix. As Wix’s free user base and channel kept growing, inevitably churn went down as well.

    In “high-cost” subscription businesses, you can actually afford to pay for some marketing. However, churn is the enemy of any subscription business and especially one in which you paid thousands of dollars to acquire a customer. Here too, focusing on product is much more critical than focusing on marketing. In the Forex or online gambling world, positive LTV is king. As soon as you reach positive LTV (even short term), you have done your job. That Israeli expertise has become our joint achilles heel because in subscription businesses, especially high cost ones like most SAAS companies, positive LTV is insufficient. It might even be distracting. You must arrive at a declining cost of customer acquisition and extending lifetime value (infinitely). Otherwise, the capital required to grow your business will be prohibitively expensive (see Box.net).

    Another way to think about this is through an equation and comment that COMO and Seeking Alpha COO Avrom Gilbert suggested.  “Subscription businesses should use Net LTV.

    Net LTV = LTV – CAC, where LTV = MRR (or ARR) X lifespan and CAC = CPC X 1/convert rate.

    Avrom added:

    “There are two ways to handle growth in net LTV, one is reducing the CAC through optimizing CPC or convert rate, the other is to improve the product so that you grow the lifetime. It’s likely that at some point you will reach a point with your CAC where it will be hard to improve it significantly. However, if you keep improving your product then your lifetime can keep growing indefinitely which keeps growing your net LTV. This in turn means that you can chose to increase profit or, more likely, spend more to take more market share (even at the risk of increasing your CAC). Growing lifespan through improving product gives you another fantastic growth engine for your business in addition to the free customers you get.

    - As an interesting aside – reducing CAC is an exercise with limited upside (put another way, you can only reduce your CAC to zero, but you can grow your lifetime many fold – similar to the asymmetric risk/reward for long positions vs short positions in stocks). “

    Product improvement provides asymmetric upside reward.

    Paying for marketing rather than having the product speak for itself presents an addition problem that my partner Bill Gurley wrote about a couple of years back:

    “Growing Becomes a Grind. Let’s say you have a company that estimates it will do $100mm in revenue this year, $200mm the next, and $400mm the year after that. In order to accomplish those goals it is going to invest heavily in marketing – say 50% of revenues. So the budget for the next three years is $50mm, $100mm, and $200mm. How realistic is it to assume that your SAC (“Subscriber Acquisition Cost” – a better term than CAC in my mind- ed. M.E.) will drop as you 4X your spend? Supply and demand analysis suggests the exact opposite outcome. As you try to buy more and more of a limited good, the price will inherently increase. “

    If you want to build a subscription business, you must discover and refine what I call “natural product affinity.” You must elevate the product manager and customer advocate as the lighthouse for the business. You must get to a virtuous cycle where a great product and experience brings in customers for free and retains them, which in turn lowers your cost of customer acquisition as you grow. You cannot use marketing arbitrage to successfully grow a subscription business.  For Israel to succeed in this growing subscription economy, we need to shed the ghosts of “arbitrage industries past”, and move forward to understand the nature and opportunity of great subscription businesses.

     

    Thanks to Eden, Oona, Eran Shir, Avrom Gilbert who commented on the post before I published.

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