The Economics of Subscriptions

I recently referred to an article from Marginal Revolution that talked about an over-the-air (OTA) software update that Tesla used to improve the braking performance of their Model 3. Beyond the specifics of the Tesla upgrade, the author also made a more generation observation as to the broader impact of software updates and subscriptions:

The larger economic issue is that every durable good is becoming a service. When you buy a car, a refrigerator, a house you will be buying a stream of future services, updates, corrections, improvements. That is going to change the industrial organization of firms and potentially increase monopoly power for two reasons. First, reputation will increase in importance as consumers will want to buy from firms they perceive as being well-backed and long-lasting and second durable goods will be rented more than bought […] thus solving Coase’s durable good monopoly problem.

The Coase Conjecture argues that suppliers of durable goods have to adopt aggressive pricing because they find it hard to implement time-based price discrimination as buyers will simply wait, and the author is saying that the transition from outright sale to rental will undo this. The technical details don’t matter too much, but what it amounts to is that suppliers will find it easier to raise prices.

But back to the new connected refrigerators. You know the ones? Those that Home Depot has to keep turned off, or has to post an employee to constantly monitor, lest children of all ages draw dirty pictures and leave obscene messages using the electronic note board?

Maybe I’m getting old, but I’m not sure that I want my refrigerator or house to come with a constant “stream of future services, updates [and] improvements”. As the author points out, larger companies like this model as it favors those who can guarantee to be around long enough to provide the follow-up. But it sounds awfully like defining value as that which will help lock-in the customer, rather than something that people actually want, and any strategy that doesn’t start with the customer is a very dangerous thing.

More subtly, even if consumers fall in love with constant updates and the required back-end support enhances the monopoly power of the larger players, does that mean that such services will be capable of real monetization?

Everything tends to its marginal cost, and software updates, incrementally at least, cost nothing. Worse, many of these “connected” markets are operating in a land-grab mode where companies are hooking as many customers as they can with incredibly low fees. Witness the price-per-node trend for IIoT cloud services, or the cost of low-bandwidth cellular data plans. If you’re a player in these markets, do you really want to bet the farm on the assumption that you can pocket subscription revenues when the prices are already tending towards zero, and when you’ll face competitors large and small who either have very deep pockets or are burning VC startup money that allows them to discount you into the ground?

Resilient revenue and subscriptions might make sense in some fields, and they might be exactly what the consumer wants. But if they’re not, and if you try to impose a revenue model that is for your benefit rather than the customer’s, you will either fail, or your success will be short-lived as you are disrupted by companies who better deliver what the market is actually demanding.

 

 

 

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