When was the last time you were lost? Where have you been? How did you feel?
If you come from a traditional linear economy sales model, it’s easy to get lost in a circular Product-as-a-Service model. You have lasting customer relationships. You own the assets. So, assets come back, and you have to do something with them.
Therefore, the key metrics you need to watch are:
- Subscription acquisition costs
- Lifetime value and churn
- Payment success rate
- Investment need
- End-of-life value
More metrics are relevant as well, be it turnover, profitability, ecological impact etc. In this article, however, I want to shed light on the KPI that are essential and distinct from a linear sales model.
1. Subscription acquisition costs
A circular Product-as-a-Service is meant to solve customers’ problems. Although you certainly won’t need to pay customers to use your service, you need to spend money to get their attention.
Subscription acquisition costs are the costs needed to acquire one more new subscription. Acquisitions costs are not exclusive to PaaS models. But be cautious. You usually need extra money and a different way to tell your subscription story. Typically, people are used to buying and owning the products. Now, they pay for the service without owning the asset. Expect some extra effort to make that clear and stick.
But why are we discussing subscription acquisition costs, not customer acquisition costs? There are two reasons for that. Firstly, one PaaS contract is usually directly linked with one asset and its associated costs. These costs constitute a significant share of total unit costs in the area of physical products that need production and shipment. Secondly, one PaaS customer can have multiple subscription contracts. So, you have many customers with one contract only but also customers with many contracts. As the variable costs linearly correlate with the assets under subscription, the reporting is more transparent if you have the same baseline for acquisition costs: the number of subscriptions and not the number of customers.
Of course, it does make sense to track customer acquisition costs, and most of all, it does make sense to understand why some customers have more subscriptions than others.
2. Lifetime value and churn
With a circular Product-as-a-Service you don‘t get all the revenue upfront at once. You get it over time. That time can be short or long, and the revenue fractions can be fixed or change over time. While you certainly need to know your total monthly revenue from all customers, the lifetime value of a specific customer gives you additional insights.
Churn is the ratio of subscriptions that got canceled over all active subscriptions. When you have 100 subscriptions and five subscriptions cancel that month, the churn rate is 5%. The inversion of churn can be the average subscription lifetime. So, if your monthly churn was 5%, the average subscription lifetime is 20 months. Together with the revenue over time, churn defines the lifetime value. In reality, churn is a bit more complicated, as your customer base probably does not behave consistently. Some cohorts stay longer than others. One product segment might attract more sticky customers than another. And sometimes churn isn‘t linear over time either; there might be peaks at certain moments in the subscription lifetime, so linear projection of churn needs to be done cautiously.
Lifetime value is the amount of direct and indirect revenue a subscription generates throughout the contract time. It comprises the regular fees and the time a customer has an active subscription. One-time fees at the beginning, promotions or referral discounts can be added or discounted.
There are three main ways to define and understand lifetime value.
- The first one only includes all revenues over time minus discounts – it‘s then understood as a lifetime revenue.
- The second one discounts all variable costs (e.g., payment fees, repairs, depreciation of used products, shipment costs …) except for the acquisition costs – this gives you a relatively stable lifetime margin that is put in relation to the possibly fluctuating acquisition costs.
- The last version also discounts the acquisition costs and can then be understood as lifetime profitability.
No matter the wording, you must understand the three levels and what drives them. They are necessary to know the profitability of the business.
Again, you may want to decide if you want to look at customer lifetime or subscription lifetime value. This is relevant if a relevant number of customers has more than one subscription. The choice between a customer and a subscription base depends on the purpose of the analysis. If you want to calculate your maximum possible marketing spend, you might want to calculate the customer lifetime value. In marketing, you will target people, so it helps to use the same basis. If you want to calculate the profitability of your subscriptions, you probably take subscriptions as a basis.
3. Payment success rate
Subscriptions are payment plans for the future. For Hardware-as-a-Service subscriptions, the physical product is delivered initially, and the customer pays regular fees in the following weeks, months, and years. However not every customer is able or willing to pay all the invoices.
The payment success rate reflects the share of customers who pay their invoices on the first attempt. The subscription provider takes a high financial risk, especially in the early phase of a contract. It bears cost positions upfront: the product’s manufacturing costs, delivery, and acquisition costs. But the revenue comes later.
The payment risk is undoubtedly different between B2B and B2C subscriptions. It is harder to assess the creditworthiness of B2C customers at scale. Consumers are – for good reasons – more protected by law. In every B2C business, the provider has to deal with payment failures. While typical sales shops can reduce the risk by ensuring the total price is paid before the delivery, this is not an option for subscriptions. Moreover, the situation of customers can change. Someone who was able to pay the fee today might not be able to pay it tomorrow.
There are ways to increase the payment success rate. In any case, it is essential to consider this risk, monitor it and act on it as soon as it leaves the healthy level.
4. Investment needed
If the product is not sold to the customer anymore, the provider still owns it. Therefore, the product’s value must be activated in the provider’s balance sheet. This drives the CAPEX of the provider – something organizations typically try to avoid.
The character and implications of the investment need depends on two main questions:
1) Do you need to buy the products, or are you the manufacturer?
If you need to buy the products, you need extra cash. You buy them from the manufacturer or a retailer in between and must pay the purchase price.
On the contrary, as the manufacturer, you have the products already. Still, they need to be activated, but whether extra cash is needed depends on the cannibalization rate of your subscription offering. If the PaaS cannibalizes your traditional sales, you miss out on cash from the sales business. If there is no cannibalization, the products as a service are additional volume without lost incoming cash flow from selling them.
In any case, the assets need to be activated and increase CAPEX. Whether cash is required and if this creates a challenge depends on your specific situation.
2) What is the financial model behind the subscription?
The funding of the assets can be provided in-house or by external financial institutions. Banks can be the contractual party with the customer, turning the Product-as-a-Service into a financial lease contract. In that scenario, the assets are sold to the bank, and the bank leases them out. The provider has initial sales revenue and no investment need. This also comes with downsides, like the premium the provider pays to the bank and the fact that the bank might set requirements for the credit check of the PaaS customers.
If the funding is done in-house, the assets remain in the company. Hence, CAPEX will increase, and cash might be more relevant. Also, in that case, banks or financial investors could help by providing loans or asset-backed bonds. The customer has no direct contractual relationship with the bank, this is just between the PaaS provider and the bank.
5. End-of-life value
At the end of the usage period, the assets still have a value. The depreciated costs might be zero. Nevertheless, most assets are still working or do have working components. There are three layers of potential commercial value:
- The value of the complete product. This can be captured by another Product-as-a-Service usage cycle or by selling it as a used product to customers or trade partners.
- The value of the components. If the complete product does not work anymore, a few components are usually good enough to be used in other products. These components could be sold or reused in manufacturing or repair.
- The value of the material. If all components cannot be reused, their material could be reused or recycled.
Obviously, there can be a mixture of (B) reusing a few components and (C) capturing the material value of the remaining components. The crucial factor in this end-of-life value is the cost of the process to capture this value. Capturing the value of the complete product might require (manual) refurbishment. Capturing the value of the components will require disassembly. Capturing the value of the material requires a process to separate these materials. These efforts are heavily influenced by the overall logistics and product design of the products at hand. The product/component/material value, logistics costs, and processing value drive the end-of-life value.
The end-of-life value can make a substantial difference in the business case. It is an additional revenue potential.
Next to the commercial dimension, it is a primary motivation to build a circular Product-as-a-service proposition: The asset won‘t be wasted but can be reused again. Ideally, these products, components, and materials can be used as resources and input factors for new products or services – ultimately reducing the need for virgin materials while still serving customers’ needs.
Keeping resources in the loop and monitoring it with the suitable KPI, makes sure that neither the asset nor you get lost.