Recurring revenue, usually in the form of subscriptions, is the holy grail for many marketplace entrepreneurs. A subscription revenue model makes it easier to predict your marketplace’s future performance and creates cash-flow stability. This is especially true for those building service marketplaces, which are often vulnerable to platform leakage.
In contrast, commoditised marketplaces like Uber and Deliveroo depend on the reliability of standardised pricing and fast, on-demand transactions to keep large volumes of users within their payment ecosystems. Product marketplaces like Amazon and Etsy simply charge a commission fee on the seller’s asking price. Their reach and convenience ensure that buyers and sellers complete transactions on their platforms.
Most (non-commoditised) service marketplaces, however, face a decidedly stiffer challenge when it comes to owning transactions. The complexity of contracting a service provider often creates a strong incentive to conclude transactions off-platform. A subscription model that gives either buyers or sellers access to each other can solve that conundrum.
However, simply putting a subscription plan in place doesn’t miraculously solve all your problems. Your value proposition must be aligned with your business model. Thus, premium features (for which users are willing to pay) should be geared towards relevant use cases.
A cautionary tale of how not to implement a subscription model
Event-planning marketplace, Eventerprise, found this out to their cost. Despite a premium offering that included a request-for-proposal mechanism, a reputation management feature, and priority placement, service providers stayed away from paid subscriptions, leading to the platform’s demise. An autopsy of their failed subscription revenue model revealed a number of deadly mistakes.
Mistake number one was not understanding and refining their target audience – mostly small-scale event service providers. Many of whom are not digitally savvy and under constant cash-flow pressure.
Instead of getting feedback from a small number of carefully curated service providers, a shotgun marketing approach was implemented. This resulted in a significant number of basic and free trial sign-ups, but almost zero of them took up paid subscriptions.
Their second mistake was to align subscription fees with financial forecasts in an attempt to lure potential investors with promises of miraculous growth. This broke the first rule of marketplace development – putting the user front and centre.
As Bill Gurley warned in his article, A Rake Too Far: Optimal Platform Pricing Strategy,
“The most dangerous strategy for any platform company is to price too high – to charge a greedy and overzealous rake [take rate] that could serve to undermine the whole point of having a platform in the first place.”
Not only does a too high take rate affect small service providers’ cash flows, it also ends up being passed on to the consumer, potentially pricing your platform out of competition. This is exactly how Booking.com undercut incumbent travel platforms like Expedia and Travelocity and became the market leader.
The moral of the Eventerprise story is that product-market fit for a subscription-powered marketplace should include testing if and how much users will pay for a specific set of features. And then of course making sure that those features can’t be easily replicated by a competitor.
Strategies for implementing a subscription revenue model for your marketplace
One of the best ways to test if and how much users will pay for premium features, is through a freemium model. Free basic tiers get them to start using your marketplace and expose them to the advantages of paid premium features. This works best with a large target audience since only a small percentage will usually become premium users.
Care provider marketplace, IHSS Connect, allows care providers to register for free, but access to most features requires a paid subscription. Subscriptions include a basic tier (e.g. custom job search filters and unlimited job applications) and a premium tier (eg. priority messaging and custom cover letters). The kicker is a 14-day free trial that allows users to test-drive the paid features.
Which brings us to the next important step – user segmentation. Analyse on-platform behaviour (e.g. which service providers are driving most of the transactions?) and get direct feedback from users (e.g. what pain points are they struggling with?) to gauge which features would work best for each user segment.
If there is sufficient user differentiation, a hybrid revenue model could be implemented. Listing fees or commission for small sellers and subscription fees for power sellers can drive higher take rates and prevent under-served users from leaving your marketplace. Subscriptions are sometimes implemented later in the evolution of a marketplace to take advantage of clearer segmentation.
Etsy, for example, launched Etsy Plus, a subscription service bouquet that gives access to online shop customisation, in-stock notifications, and ad credits.
Own more aspects of the value chain
Make it easier for your users to do business with each other, and they will be much more likely to pay for the privilege. Marketplace owners can create additional value for users in two ways: streamline the procurement process or help them run their businesses more efficiently with SaaS tools.
Subscription-driven marketplaces can remove friction points by managing various aspects of the procurement process, such as seller background checks, verification of luxury items, fulfilment, and risk management. This is especially true for B2B marketplaces with complex procurement processes that include RFPs, compliance checks and cross-border taxation.
Highly managed marketplaces like Opendoor assume so much control of the procurement process that they become marketplaces in name only. This is mainly due to the lack of interaction between buyers and sellers, which dilutes network effects. In Opendoor’s case the platform buys and sells the inventory, negating the need for buyer-seller contact.
The power of the software-as-a-service (SaaS) approach is that it avoids the potential pitfall of single-use features, such as finding a maths tutor or a plumber. SaaS tools such as payroll software or tax calculators tend to provide independent value that attracts users on an ongoing basis. As they say, “Come for the software, stay for the network.”
OpenTable (acquired for $2.6 billion by Booking.com in 2014) first gained traction with its real-time restaurant reservation system. To stay relevant in a very competitive sector (Yelp, Resy, Eat App) OpenTable expanded its SaaS offering with marketing tools like automated email campaigns and logistics tools like real-time inventory. This has lured more than one billion diners and 60,000 restaurants to their platform.
Additional advantages of subscription revenue for online marketplaces
We started off by mentioning predictability and stability, but there are other advantages to subscriptions for marketplaces. One of the most important is that it supports user retention. It is well-documented that retaining existing customers costs 5 – 25 times less than acquiring new ones.
Subscriptions can also act as a quality control mechanism. Service providers or sellers that are prepared to pay for access to your marketplace tend to be more reliable and offer goods and services of a higher quality.
As marketplaces grow, new revenue opportunities may emerge. Etsy (Plus) and Amazon (Professional Selling Plan), for instance, have both added subscription revenue streams to their initial commission-based model. The trick is to have a process in place to identify such new opportunities, like this tried and tested ‘build – measure – learn’ approach.
Some product marketplaces have also leveraged the stability of subscription revenue. The Box Hut, a subscription box marketplace, drives traffic to their curated inventory of luxury goods merchants via subscribed buyers. In this way, they also solve the chicken-and-egg problem.
Last but not least, investors love the lower risk that predictable subscription revenue represents. Established recurring revenue also acts as evidence of product-market fit, another item high on the investor checklist. According to Consero, a Finance-as-a-Service platform that specialises in SaaS and marketplaces, “a subscription-based business model could increase a company’s valuation by up to 8 times.”
This is not an exhaustive list, but usually a good starting point to track the performance of a subscription model. It should be refined according to actual user flows and business goals.
Customer churn rate indicates what percentage of customers quit their subscriptions over a given period of time. It can be a valuable metric to track affordability, value delivered, competitiveness or lack of features. Calculation: The number of subscribers lost for a given period divided by the total number of subscribers at the beginning of the period multiplied by 100.
Customer Lifetime Value (CLTV) is an indicator of the total revenue that the average customer generates during their relationship with your business. It can be used to identify high-value customer cohorts and fine-tune your customer acquisition strategy.
Calculation: Customer Value [average purchase value (revenue divided by number of purchases for a given period) multiplied by average purchase frequency rate (number of purchases divided by number of customers for a given period)] multiplied by Average Customer Lifespan [total period that customers subscribe divided by number of customers].
Monthly Recurring Revenue (MRR) is an indicator of expected cash flows, in other words, the predictability of your marketplace’s performance. Calculation: Average revenue per user multiplied by total number of users in a month. Segmentation of MRR can help you identify profitable user cohorts.
Customer Acquisition Cost (CAC) is the sum of all the resources (marketing, sales, software, site infrastructure, etc.) that’s required to attract a customer. Calculation: total expenses divided by number of customers.
Payback rate shows how long it takes for subscription earnings to cover your customer acquisition cost. It is a useful indicator of how fast a marketplace is growing.
Many marketplace builders and other turnkey solutions don’t offer subscription payment flows due to its complexity. For example, what happens when a subscription is paused, cancelled or refunded?
Until recently marketplace entrepreneurs had to rely on powerful but complex payment service providers like Stripe to implement subscription plans that support their business flows. This has meant additional integration costs.
Fortunately, the growth in fintech solutions for online marketplaces has expanded the range of options. Chargebee, for instance, simplifies the implementation and management of recurring revenue streams such as subscriptions.
Alternatives to a subscription model for service marketplaces
A subscription model is not necessarily the right or optimal fit for all service marketplaces.
Some service marketplaces follow a lead generation revenue model like Thumbtack. Their platform charges service providers to contact individual job posters. The downside of this approach is that it only covers the initial discovery and not repeat transactions with the same client.
Some highly managed marketplaces like Upwork can get away with a commission-based revenue model because they control such a large portion of the transaction flow.
We’ve already mentioned commoditised marketplaces like Uber. This model requires standardised pricing and service parameters, as well as a relatively simple procurement process.
Some SaaS-powered marketplaces have evolved flexible pay-as-you-go monthly billing plans to compete better with competitors.