TL;DR
Annual subscription plans have advantages over monthly ones.
They help increase cash flow and have the effect of reducing the churn rate.
Subscription plan billing cycles 🚀
When offering a mobile subscription service, figuring out the billing cycle is just as tricky as pricing.
Services we're very familiar with, like Netflix, Melon, and Apple Music, only offer monthly subscriptions. On the other hand, The New York Times, Headspace, and Google Cloud offer annual subscription plans alongside their monthly ones.
I was so confused about what criteria different services use to decide whether to offer annual or monthly plans.
After launching Alarmy's subscription service, we had only offered a monthly plan. (Actually, in the very early days, we offered monthly, annual, and lifetime options, but we switched to just monthly to better observe the user life cycle—including cancellations—over a shorter period.)
The core SaaS metric: MRR 💸
For any SaaS team, MRR (Monthly Recurring Revenue) is probably the most crucial business metric.
The Alarmy subscription team also looks at MRR every quarter when setting OKRs.
We really tore into it as we wrapped up Q1, and we drew up a plan to improve our MRR in Q2.
Before talking about improving MRR, let's take a look at how MRR is structured.
How is MRR made up?
Breaking down MRR
= Retention of existing subscribers + New subscriber sign-ups
= Existing subscribers * Price * Churn rate + New subscribers * Price
= subscriber * price * churn rate + new install * trial cvr * trial to paid cvr * price
In the early days of launching the subscription service, we mostly cared about the top of the funnel—getting new users to convert to a subscription.
However, as our subscriber count grew past 10,000, 20,000... 50,000, the revenue generated from existing subscribers started having a massive impact on MRR, making it incredibly important.
Let's look again at the revenue generated by existing subscribers:
= Existing subscribers * Price * Churn rate
Here, what our subscription team focused on was the churn rate.
Let's look at Churn Rate 😹
For about a year and a half, we hadn't been paying close attention to the monthly subscriber churn rate, but we finally peeked under the hood as we wrapped up Q1 this year. The conclusion? "We need to fix this."
When we crunched the numbers in detail, we realized we weren't doing as well as we thought.
The following example might make this easier to understand.
Do you think a Monthly Churn Rate of 18% is good or bad?
Let's imagine 100 users join in January, and think about how many are left after one year (12 months). (Below is the formula for calculating remaining users)
Current users * (1 - Monthly churn rate) ^ 12 (months) = Users remaining after 1 year
Let's apply this formula:
100 users * (1 - 0.18) ^ 12 = roughly 9 users
Now, let's assume a monthly churn rate of 9%.
100 users * (1 - 0.09) ^ 12 = roughly 32 users
By halving the churn rate, you get about 250% more growth.
As subscribers stack up, the churn rate has a massive impact on MRR.
Improving Churn Rate 💡
"So how do we improve the churn rate?" became the question.
Through team discussions, we set the following directions for improvement:
Top priority: tasks that increase user value (VoC, improving and refining premium features)
Additionally: product specs from a business perspective
In this post, I want to share one of the product specs for "product improvements from a business perspective."
Among the many hypotheses we formed for "product improvements from a business perspective," one was "offering an annual plan."
Once an annual plan is purchased, it is used for a full year, so we don't have to worry as much about next month's churn rate like we do with existing monthly plans. In this regard, "offering an annual plan" presented an opportunity to improve our overall churn rate, making it a product spec we expected would also improve MRR.
(Of course, we anticipate the purchase conversion rate will be lower than that of the monthly plan. That's why we're currently checking this through an experiment 🧪)
It also improves cash flow ♻️
"Offering an annual plan" doesn't just reduce the monthly churn rate; it also provides financial benefits.
For many startups, growth is often bottlenecked when cash flow isn't smooth.
When offering an annual plan, you can bring the payment point forward upfront, which creates a boost in cash flow.
Conversely, since monthly plans are paid month-by-month over a year, they might not help generate cash flow when you really need early liquidity.
By securing cash upfront like this, you can invest faster in hiring, product development, marketing, and more, which helps accelerate the company's growth.
For example, let's assume the monthly churn rate is so low that (looking over a year) the churn rate is similar to the annual plan. (Let's assume the price is 5,000 won for the monthly plan and 48,000 won for the annual plan, which is a 20% discount.)
Looking at annual revenue, the monthly brings in 60,000 won, and the annual brings in 48,000 won.
However, if we look at just the first two months:
The monthly logs 5,000 * 2 months = 10,000 won in revenue,
While the annual logs 48,000 won in revenue.
This way, you secure funds in advance early on, allowing you to quickly and flexibly inject the capital needed for company growth, such as into ads and hiring.
Still, some lingering worries 🐶
We've talked at length about the advantages of annual plans. Still, when it comes to actually implementing it, a few worries suddenly come to mind. I've jotted down our main concerns and dilemmas below.
💡 If we offer an annual plan, early purchase conversion will drop, so how should we decide whether to apply it?
Ultimately, for our annual plan experiment, we need to decide based on revenue factoring in the churn rate.
💡 For the annual plan, we're giving a discount compared to the existing monthly plan, but what should the discount rate be?
Again, we'll probably have to reverse-engineer the ARR (Annual Recurring Revenue) based on revenue that accounts for the churn rate, and adjust the discount rate accordingly.
💡 Then, should we only show the annual plan?
Hmm. Probably not. There are always customers who just want a one-month taste test, even if it's pricier.
Because of this, we decided it was sensible to also offer the monthly plan to serve a diverse range of customers.
Conclusion 😎
Annual plans are expected to improve growth velocity by improving cash flow.
And by reducing the user churn rate, they are also expected to improve MRR metrics.
However, when applying an annual plan, you must consider other business metrics depending on the nature of your service (Churn Rate, Trial CVR, ARPPU).
Since some customers want to verify the product's value over a short term via monthly usage, it seems sensible to offer a monthly plan as well.
Want to work with us? 🙋♂️
We are looking for PMs, engineers, and designers to work with the Alarmy subscription team.
Coffee chats are always welcome, so please email me at jason@delightroom.com.