3 Reasons Why Subscription Businesses Fail

Welcome to the near and Far podcast where we will be reading Near's latest article, 3 Reasons Subscription Services Fail. And today we have a very special guest. My name is Nick Gray. I'm just going to be reading the article. I'm also joined by near the author. And we have a very special guest today. It's nathan latka from founderpath.com Nathan, would you introduce yourself and say what Founder Path does? You're a SaaS expert?

Of course. And I'll never forget near those. My gosh, this must have been four years ago before you moved to Singapore. I read Hooked and you and I got together in a coffee shop and I found out didn't exist yet. But we were talking about how to use open loops in media to hook attend to keep attention effectively. I remember the psychological loops, the mouse and the cheese maze, all that stuff. So it's funny to see full circle here. But yeah, you know, the media, my media business sort of did well. You know, I had my own software company, built it, sold it, launched a podcast called the Top Entrepreneurs where I interview SaaS founders and Nick Near. What happened was a lot of these founders started saying, Nathan, we'd love an alternative path to working with VCs and banks. We want money with and keeping all of our equity. And so we launched Founder path, which is $150 million fund where we give founders up to 50% of their ARR cash, they keep all their equity and it's debt, they pay it back over two years.

That's great. Well, I'm very excited, Nir. Do you want to say a little bit about what we're doing or do you want me just to start reading it?

Yeah, sure. So welcome everyone. It's great to have you with us, listening. And Nathan and Nick, this is like the, the the N Cubed podcast here. I didn't intend everyone's name to start with N, but apparently that's become a criteria to start. So yeah, so we're going to read through this article and Nick always does a fantastic job of reading through it. Nick Gray, by the way, everyone is a fantastic friend of mine. He's also the author of the Two Hour Cocktail Party, which is a wonderful book you should absolutely check out. I love that book. And Nathan of course needs no introduction, even though he just gave a brilliant one. And we're going to read through this article and then I invite Nathan and Nick for any kind of insights, comments, questions, concerns. We'll just toss them out and kind of banter through this.

The name of this article is 3 Reasons Subscription Services fail and it was published in the Harvard Business Review. Here's the summary A subscription business is about more than recurring revenue A successful subscription business is a function of the strength of the habits they create. The author, who has studied the fundamental attributes of habit forming products, has identified three reasons why these businesses typically fail. Number one, there are too many steps of psychological relief. Number two, they don't offer enough novelty or number three, they don't offer enough stored value to build a long term relationship with the customer. Subscriptions are hot and not Companies and investors love subscription business models since they generate recurring revenue that translates to predictable cash flow. The more money a company is likely to make in perpetuity, the higher its share price. From 2012 to 2019, the subscription economy grew more than 300% and 75% of companies selling directly to consumers said they would offer subscription services by the following year. However, with so many companies hopping on the subscription bandwagon, competition is fierce and some big players are having trouble keeping their customers. According to Gartner, only 20% of subscription businesses will succeed in increasing customer retention. What's causing the subscriber boom and bust? What makes an otherwise promising subscription business bleed customers? And how can companies engender loyalty to hold on to their subscribers? Before we answer that, we have to pinpoint what a subscription business is. Nir and Nathan, any thoughts on that so far?

Well, Nir, I think it's a timely statement to say the question about share price, especially in public software as a service markets which is occurring. Revenue is all about who has the highest net dollar retention. World class today is 150%. Snowflake is up there. ZoomInfo is up there. Others though, are really struggling where they're at 110 120% net dollar retention. And just so the audience can follow along, what that means is if you have customers paying you 100 million bucks one year ago, you can you get those same customers paying you 120 million bucks a year later? Can you upgrade them? And near so much of what you wrote about and hooked and delivering great customer experiences has to do with your ability and your sales team's ability to upsell and upgrade those customers one year out. So I'm excited to jump into these.

Three reasons More than recurring revenue A subscription is not defined by recurring revenue alone. Rentals, leases and memberships generate recurring revenue, but none are subscription business models. So what's the difference? A subscription is when the customer pays for the future delivery of a good or service involving A degree of variability. If you're asked to name a subscription business off the top of your head, you might think of a magazine subscription. Subscribers pay an annual fee without knowing what articles they'll read in the latest edition of Time or Harvard Business Review. Many businesses call themselves subscriptions, but aren't exactly. Amazon's subscribe and Save makes for great alliteration, but shipping a predetermined item on a fixed schedule is a delivery service, not a subscription. Similarly, financing leases, rentals and monthly fees give customers access to a predictable good a car, a home, or a tuxedo. So they're not subscriptions either. Fundamentally, a successful subscription business's economic value is a function of the strength of the habits they create. Over the past decade, I've studied the fundamental attributes of habit forming products to identify how companies hook consumers. I identified four steps successful companies build into their customer experience. What I call the hooked model trigger which prompts customers to use the product action, the habitual behavior variable reward, which satisfies users need for the service and investment, which makes the product more valuable to the user with use. A closer look at the hooked model reveals common errors companies make launching and running subscriptions. We'll get into that, but I want to take a minute for NIR and then from Nathan to chime in.

So I really wanted to just emphasize this definition because this, this actually took me a while to figure out what a subscription business because it's really important for me to define what we're talking about so we can talk about those things with any kind of insight. So what is and is not a subscription revenue business is super important and it doesn't just rely upon repeat revenue. I think a lot of people have this misunderstanding that hey, if there's a reoccurring revenue stream, boom, it's a subscription business. And because SaaS businesses are so hot, and the reason they're so hot is because you can create a lifetime value for a customer. And then the way we value equities is that we have discounted cash flow. And so if you see this reoccurring revenue stream, you can assign a very high multiple for that company, which makes the stock value, of course very high as well. But I think many times that's a mirage. And it's a mirage because people don't have a proper definition of what is and is not a subscription business. Just because the revenue is coming in on a predictable basis, on a reoccurring basis does not mean it's a subscription. So I want to re emphasize this Definition that a subscription is when the customer pays for the future delivery of a good or service involving a degree of variability. And we're going to talk about what those degrees of variability are there. It's not necessarily always, you know, some kind of surprise in the mail, but it has to include some kind of degree of variability. If it's the same thing every time, that is not a subscription business.

And near when you just talked about lifetime value and then discounted cash flow models in terms of public markets and buying public stocks. But I imagine a large group of the audience are folks that maybe hope they can grow one day to have the privilege to go public themselves, but they're maybe still private. And so when you think about lifetime value at a, you know, a software company or a recurring business model, what do you think is more important? The lifetime value of a customer that you've already earned or what it costs you the CAC to get a new customer?

Right. So it's always, I mean, I've never seen a case where it's not the case that acquiring a new customer is not more expensive than keeping an existing one. I've seen some metrics that it's multiples more expensive to acquire a new company. So it's always a better strategy for a company to figure out ways to keep the customers they already have. The problem is it's not as sexy. And we find companies kind of, they get addicted to growth because they can always buy growth. You can always back up the truck of money, go get some money from a venture capitalist. You give that, that truckload of money to Facebook or Google or, you know, television commercials, and you will acquire customers.

Right?

You can always acquire customers. There's just a price you pay and you got the customer. The problem is keeping them. And you cannot buy engagement. Doesn't matter how much money you throw at the problem, you can't buy engagement. That has to be designed into the product. So a lot of times we see people at small companies and large companies kind of juicing growth because it looks good and they know how important growth is. And it is important, but it should never come at the expense or come before making sure that we have a product that is sticky enough to keep the customers because if we don't, we have we call a leash.

And there's so much data that backs up what you were just saying. Right. If we look over the past 12 months, you had Meg Whitman and her partner go in and launch Quibi. They raised billions of dollars before they took Quibi to market. Spending it on marketing, advertising, trying to buy attention to your point. And ultimately what they learned very quickly is once Quibi launched, they shut it down less than six months later because you can't buy attention to your point. You've got to follow what you teach and hooked and earn attention. And today, in today's recurring sort of SaaS business model, the most viable companies are the ones that have built a moat. And that moat is typically an attention moat. You would maybe think about this like community, a Slack group, a Facebook group, a conference that the group runs. So you and I are certainly on the same page here. I'm excited to jump into the three reasons you've outlined in this article on why these kind of companies fail.

Well, let's get into those common errors. A closer look at the hooked model reveals common errors companies make Launching and running subscriptions Number one Too Many Steps to Psychological Relief have you ever decided not to use Netflix because you know it'll take too long to find something good to watch? I often waste more time searching than watching. The endless scroll of options on today's Netflix is a far cry from the mailed DVDs and that originally made the company a success. The red envelope wrapped disc simply needed to be opened and put into your player. No choices, no thinking. Just watch what you previously picked. Netflix beat Blockbuster by busting the incumbent's habit through ease of use. When the habitual action of your product becomes more difficult to use than other options for satisfying the same need, your subscription business is in trouble. You're at risk of losing consumers at the action phase of the Hooked model. Just a question for Nir. Would you say again, what is the action phase of the hooked model?

The action phase is the is the effort the user makes to get reward so the smallest piece of work that they can do to get relief from their psychological discomfort. So in the case of Netflix, it was boredom. That internal trigger, that uncomfortable emotional state is, you know, you come home from work, you're exhausted, you're fatigued, you just want to relax and watch a movie. And when you think about how Netflix beat Blockbuster, if you think about the effort involved in that action phase of the hook, what did the action what did the user need to do to get relief from that discomfort? Well, with Blockbuster, I'd have to go get in my car, I'd have to go across town, go to the Blockbuster store, hopefully it's open, see if they have what I want in stock. Did I remember my membership card, pay for the video, come back home, and then finally put it in my DVD player. Whereas what Netflix did, even back in the days when they sent you those red envelopes, it was just so much easier. There'd be a red envelope waiting for you there on your kitchen counter. You, you kind of didn't even care what video they sent you. You know, they had that crazy algorithm that they said would recommend something you probably like. And you could, you know, you could identify things that you wanted in the future, but for the most part, once you did that, it was kind of on autopilot. They keep sending these videos as soon as you sent one back in. And so the effort involved in that action phase to get relief from that psychological discomfort of I'm, I'm tired, I'm bored, I just want to be entertained, was so much easier with Netflix as opposed to Blockbuster. And that was a huge reason why they put Blockbuster out of business.

That's great. Thank you. Today it's Netflix on the defensive. With so many entertainment options offering instant boredom relief. Think YouTube, TikTok, Instagram. Netflix can't go back to the days when subscribers would play whatever came in the mail. But the endless choices came at the cost of simplicity. Netflix is aware of this problem and is trying to simplify selecting a movie or TV show. The streaming service is experimenting with a play something function, quickly picking what to watch for viewers. However, this doesn't quite hit the mark. People don't want to watch just anything. They've come to expect something good to watch. It's telling that viewers are hacking their own solutions to fix this problem by using Chrome extensions to add critic scores to the site to make picking what to watch easier. Netflix should take note. If a subscription service is more difficult to use than other solutions, it's sunk. Well, we'll take a break here to see if Nathan has any thoughts to add. I'll hand it over to the SaaS masters.

Yeah, no near. It's fascinating to hear you talk about sort of the B2C, right. Recurring model in Netflix. When you look at sort of that for the B2B audience listening, and you look at a company like ZoomInfo, you know, you could argue that the dopamine hit ZoomInfo delivers to revenue teams is they help that sales rep fill their pipeline and close a new deal, right? And when they hit the deal, the sales rep earns a bigger commission, right? They hit their quota faster. But what's interesting is there's so many software as a service companies, right? B2B SaaS, companies where they think the psychological relief they're providing is one thing. And they get a couple months of cohort data, and they're never quite sure how to know if that is actually the right thing. So for HubSpot, it's number of contexts added, right. For these copy tools that automatically generate headlines for you and might be number of words produced per month. So near my question to you is, when, when B2B SaaS founders are analyzing this data, this cohort data, they think the psychological relief is at one stage in their funnel, but the data says something else. How do they know when they should switch and test something else in terms of delivering that dopamine hit in the onboarding process?

Yeah. So this is a very, very important question in terms of what internal trigger are you building for? Because a product that caters to one internal trigger is going to be completely, completely different to a product that caters to a different one. So if you're building a product for, you know, workplace anxiety or uncertainty at work, well, then, you know there's going to be a certain type of user interface that scratches that itch. But if you're building a product that's something from. That's for a different internal trigger, well, that's totally going to change the user experience. So it's very, very important to understand what is that internal trigger that you're, you're scratching? What's the psychological itch that you're scratching so that you could build the appropriate relief for that discomfort. A good way to do this. How do you know what to go for? A good way to do this is to do what's called find the habit path. Okay, so by finding the habit path, what you're going to do is you're going to look for the user group that is most habituated to your product. So what I like to do is per cohort, you look at what percentage of your user base is using your product in a cadence that would indicate that they have a habit. So for some products, like for a SaaS product, maybe it's five days a week, right? Five days of the work week. Five days a week is how often you'd expect someone to use the product. But maybe if it's for a communication tool, it might be, you know, twice a day, three times a day. So whatever level of frequency you decide, you look at your user base and you figure out per cohort. So let's say for people who started using the product in October, what percentage of those users are using it in a way that would indicate they have a habit. Okay, so you've got some kind of base number. Then what you're gonna do is you're gonna try and understand what is unique about those people. What path did they take? What was that habit path they took? So Twitter has this famous story where they found Josh Elman told me the story when he was at Twitter. They found very quickly that if you followed, I think it was three people on Twitter, you would become the kind of person very quickly that became a habitual user of Twitter. So what do they do until this very day? When you join Twitter, you are prompted to follow right away from your very first onboarding experience. Three people, right? Maybe they offer, say, hey, would you like to follow Oprah? Would you like to follow, you know, this person, that person? Who would you like to follow so that they can get you to that critical number of three people? And so that was the habit path. At first they did these three steps. At first they identified who are those habituated users. They codified the path those users took, and then they modified the experience so that everybody walks the same exact path. So identify, codify, modify. That's how you figure out that habit path. And so you start changing your product experience so that it, it meets the same steps it take, that the new users take the same steps that highly habituated users took. That's one potential path.

Thoughts on that? I was just going to check with Nathan. You said that you've seen hundreds of SaaS companies fail. And I was just curious in your own experience, Nathan, is it a similar the ones that do fail, is it because of that? We still have three more reasons, but is that first one key to you? Does it ring true?

When I first study this article that near put out and I read a lot of near stuff, I'm going, okay, when I see SaaS companies. So at Founder Path, companies have to actually connect their bank account and their subscriber database to Founder Path to get a loan from us. It's, we call it proof of revenue and proof of Runway. They can't run out of cash. Then we don't get paid back. It's like the number one reason SaaS companies fail, from what I see, is they run out of cash. So, like, why do they run out of cash?

I would say the number one reason all companies fail, right? I had a business school professor who said it very eloquently. He said, said, you know, when you, when you think about why do companies fail, he's like, there's only one reason they run out of cash. So cash is oxygen, oxygen is life. And so I, I Need that like tattooed on my arm. Right. Maybe all your founders do too.

One to your point, the oxygen pump over the past two years was VCs. But that those dollars have dried up so that oxygen pump doesn't exist anymore for these founders that are so used to burning money in the, in the markets where they've raised vc. And so what I look at, when I look at the fast, the, the MO I taught the most sustainable SaaS companies, right, are the ones that obviously they don't run out of cash. But how do they not run out of cash? Well, they really focus, number one on keeping current customers and then they focus on how to get new customers. Right. It's not the other way around. And so this is actually interesting going back to the Netflix example we've been using throughout this podcast. You know, you know Netflix saw subscriber decreases for the first time in history in Q1 and Q2. This year we're recording this year in 2022 and, and now they turned that around. They added I think 2.4 million new subscribers in Q3, but their stock took a massive hit. And so near. As a B2B SaaS guy, I'm looking at Netflix total user base going, man. If they can add $2 in new revenue per customer in Q4 and add no new customers, that's better growth than adding another 3 million customers in Q4. That's how I think about it when I look at the data.

Yeah, yeah, if they can keep them. I guess that's my concern here with, with the competition is now no longer Blockbuster. The competition is TikTok. The competition is the million other things YouTube, the million other things you can do with your time as opposed to going on Netflix. So the question will be, can they boost that price, that monthly fee by $2? Or people say, you know what, Netflix, I don't even know watch you that much because I'm busy, you know, watching some other something else somewhere else.

You nailed it. So Nick, we talked about psychological relief. We talked about onboarding and hits. That was the first big reason. What's the second big reason these companies fail?

Number two, not offering enough novelty. Here's the thing about humans. We're not wired to feel satisfied for very long. Our brains come pre installed with a piece of mental software that makes us tire of the old and seeks out the new. It's called hedonic adaptation. And it's the reason lottery winners and paraplegics tend to eventually revert to the same levels of happiness they felt before their respective Life changing events. Our tendency to quickly return to a baseline level of satisfaction leaves us vulnerable to the one supernormal stimuli we find hardest to resist. Surprise. Variable rewards make gambling engaging, television interesting, sports exciting and social media habit forming. People are insatiably curious and constantly looking for the new and better thing. On the flip side of the coin, they will stop paying for subscriptions that don't offer perpetual novelty. Consider the current anything in a box trend. From lingerie to bones to slime, you can pay to receive a box filled with just about anything these days. Some of these services, like the classic book of the Month club have been around for centuries. But many come and go quicker than you can say, why would anyone want to subscribe to Bones in a Box? A key reason customers churn out of subscription services is declining variability. After a few months, box subscription companies struggle to keep up the element of surprise for each delivery of socks or protein bars. When the ratio of interesting to mundane is too low, customers lose interest and find usually cheaper alternatives. Thankfully, there is a way to boost the ratio of variability and sustain interest in the subscription service. Getting users to improve the service with use, AKA the investment phase of the hooked model. Nir thoughts on that? On the investment phase?

Yeah. So just to reinforce the two points of number one is when the service becomes more difficult to use than alternatives. So the example there of Netflix, it's become so difficult to just find relief from that discomfort of boredom and fatigue at the end of the day that now I think people are going to easier tools like TikTok where you just open the app and instantly you're given a video. You don't have to make any decisions around what to watch. That's step number or that's reason number one that I think subscription businesses fail. And then the second reason is this not offering enough novelty. So for a while now we had this, this trend of, you know, this everything in a box. For a while, you know, it was food in a box, it was lingerie in a box, bones in a box, slimes in a box. And people think that's a subscription business. And I would argue that is not really a subscription business, that's a delivery business because you pretty much get the same thing every time. The novelty eventually wears off. It's cool, once, twice, three times. But how many protein, different kinds of protein bars can you get? How many different kinds of slime can you get? Eventually you run out of that variability and so that's very, very dangerous. And so this lesson isn't just for businesses that send People subscriptions in a box. It's also for anyone who makes any type of product, including software SaaS tools, where if you rest on your laurels, if you just stop innovating that product, that too is a problem because the novelty will eventually wear off. So you have to, for a SaaS product, you know, you're not shipping people things in the mail, obviously, but you are shipping new features. And so you have to constantly innovate those features. I think a good example of this is a product that I was lucky enough to invest in, Canva. Right. I think one of the main reasons that Canva was able to take on the behemoth of Adobe was that they just constantly innovated, right? You go to a, you use Photoshop, it's the same thing every day, day in and day out. It's pretty, I mean, maybe they'll have an update every several years. Canva's cranking out a new update, a new feature like every few weeks. And so that's the kind of novelty that you can take. This type of lesson that I'm imparting here, you can take that same lesson that shows us why these stuff in a box type services fade out. You can apply that same exact lesson to SaaS products as well by realizing that you have to keep the product novel by innovating features all the time.

Now if you guys are a SaaS founder listening to this, going, man. But Nir, it's really hard to produce new products every quarter to keep my users hooked. Engineers are expensive. They're 230,000 doll and they require two points of equity in San Francisco. You know, Canva's done a fantastic job. There's another way, I think, to keep people hooked on these B2B SaaS platforms where they gamify through courses. And so if you guys go to canva.com designschool you'll see they've built a bunch of Near's model into their course creation process. There's a progress bar that's incents you to get to the next course to take you rate them. There's 106,000 students right now. HubSpot, one of the higher valued SaaS companies in public markets, also rode the wave of their HubSpot Academy, which delivers variable rewards as you go and accomplish new tasks inside the SaaS platform. So that's a way to actually deliver on these variable rewards without necessarily having to throw engineering resources at it, but still get the same addictive qualities. Nir, would you disagree with any of that?

That's a terrific point, Nathan. I love that you brought that up, because what they're doing there is they're actually not building new features per se. What they're doing is getting people to use the features they've already built. But they need that hand holding, they need that skill acquisition, they need that course guiding them through how to get the most of the product so they can take advantage of what's already been built for them.

You nailed it. I mean, we're getting now to the good stuff, right? There's too many steps to psychological relief is the first reason these companies so the second is not offering enough novelty. Nick, what's the third reason? Everyone's everyone's wondering.

Number three Lack of Stored Value Software as a service can be a very profitable subscription business. The gross margins on SaaS products are legendary, and companies selling habit forming software for a monthly fee are rewarded with high valuation multiples. Since their products are often free to try SaaS companies have a competitive advantage over software, requiring a high upfront cost. Acquiring new users is relatively easier, with less friction in the way. Keeping customers, however, is another story. Ask Anyone working in SaaS to name their most important metric, the one that keeps them up at night, and they'll tell you it's customer Churn. If you can't keep your customers hooked, they'll stop using and stop paying. Many subscription services neglect the critical fourth step of the hooked model, the investment phase. Here the user puts something into the product that makes it better and stickier with use. I call this principle stored value. Stored value can take many forms, depending on the type of service. Contributing data, adding content, accruing followers, making connections, and building a reputation are just a few examples of how subscribers can make the product more valuable over time. Many companies use the Hooked model to improve their subscription services with use. Take Clockwise, one of my portfolio companies. The SAS calendaring tool is used by big names like Airtable, Asana and Atlassian. And that's just working down the alphabetical list of the company's 15,000 corporate accounts. Clockwise raised $45 million earlier this year and claimed its tool has unlocked 2 million hours of focused work time. When used individually, the software learns the best times to recommend future engagements and time boxes. Francis Larkin, vice president of marketing at Clockwise, told me the tool adapts to the user's energy levels and finds time for focused work. He also said, we have a setting to help with zoom fatigue where we'll automatically give you a break after two or three hours of back to back meetings. But the service really shines when it is used throughout the enterprise. We absolutely see the most benefit when used across an organization because time is a shared resource. Larkin said the more users invest in the service by inviting their colleagues and booking time on their schedules, the more, the more visibility and flexibility each user has. Clockwise can seemingly make time by synchronizing schedules in ways not previously possible. It's a classic network effect that stores value the more it is utilized, making the product more habit forming and stickier with each pass through its hooked model. Well, I'd love to hear your guys thoughts on Churn or whatever else.

Yeah, so this is a great example of stored value. Yeah, so. So stored value here is pretty obvious where the more people you connect with and use clockwise, the better it become comes for you as a service. So that's a wonderful example of stored value. Slack followed a very similar playbook where it was free to use at first and then until a point where you either connected a certain number of APIs or to a certain number of colleagues, then you said had to start paying for it. And that is something that I think we see as endemic of these freemium type products where you start using, they do that so that they can send you through the four steps of the hook model. You can start building that consumer habit and then once you're hooked now, okay, you say, hey boss, can you please start paying Slack or clockwise. Everybody's using it on the team, we love it, we're all hooked to it. Can you please send the, you know, send the payment. That's what we're seeing here in the consumerization of it. It's not so much top down like it used to be, it's bottom up. And the only way you can do that is to start getting people to use the product. They love it, they become habituated to it and then they start paying for it. And to do that you have to have those four steps in particular that investment phase, getting them to store value in the product with use near.

One of the fascinating things we see with the API connections we've got at Founder path to about 8,000 SaaS companies is, you know, they, everyone has a marketing funnel, right? Everyone wants to know how to like get new customers. But you and I have both articulated why we believe keeping customers more important. But very few people have a churn funnel, right? They have no funnel to keep customers when they hit the cancel button. And to your point here, I thought this is just, you nailed it on the head here. Restored value. Some of the most powerful SaaS companies that we're seeing in our data set that keep the most customers and expand them, get them to pay more, are the ones where in the interface when they hit the cancel button, it says, wait, I'm going to use clockwise here as an example. Wait, if you cancel clockwise today, you'll lose all your reporting from the last year or you'll lose this other thing or you'll lose why? And so putting at that cancel moment, hey, you're going to lose. The stored value you've created will decrease your churn substantially. Now, there is a scientific rule for this thing about humans are more likely to not want to lose something versus get something. And you can articulate more on that. But do you see this pattern at clockwise?

I don't know if clockwise does this exact thing, but this is, this is brilliant. Right? Of course you should do this. Right. Loss aversion. This is exactly what we're saying, that we, we hate losing more than we like winning. And so when you say like, look, you've put all this effort into the product, look at all this stuff you've done, the people you're connected to. That is a huge barrier to exit. Absolutely. Now, it has to be done ethically, of course. Right. But it can be used as a learning tool as well to. You know, I love this idea. I haven't heard it before, Nathan, of this churn, what did you call it? The churn funnel.

It's a churn. It's a churn funnel. Yeah. I don't know why it doesn't exist. It needs to exist everywhere. Churn funnel.

So what you're doing is you're understanding as opposed to, you know, you think of funnels as the top of the funnel. New users coming in here, you're asking people kind of why they're leaving or what does that churn funnel involved?

Yeah. So near is a power user of Clockwise, and I'm the CEO of Clockwise. And near just clicked cancel in the interface. The first thing I'm going to put up in the UI is Near. Man, we're bummed to see you go, why are you canceling? And then there's options. You never got onboarded, you never couldn't use it enough. You got stuck on technical issue. Why it was too expensive, you found the cheaper alternative, whatever the reason or other. And near types in a response. Well, depending on what Near's response is for canceling, then as a software company, the requiring revenue business, you come back and say, wait, near, if you felt like you never got onboarded, can we do it for you for $100 setup fee, right? Or hey, if you're not using it right now because you're on vacation for two months, why don't you pause your account for two months? Right? We'll give you two months pause and then restart in two months. So there's all these, we call them recovery actions based off what near selects in the churn funnel on why you want to leave.

I love it. That's awesome. And it makes me think too, we could probably do that earlier as well. So the companies that can collect this type of information in terms of usage patterns for how folks are using the product, they can also preemptively see like, hey, you know, we see that you're not using it as much as you used to before you churn well, before you even think about churning. How can we improve the service for you? How can we make it more likely that you'll stick around well, a quick.

Sponsor Message hey, you're listening to the near and Far Podcast. If you like this episode, will you please leave it a review in any app that you're listening to the podcast on? Near reads all of the reviews. This is the near and Far Podcast and we're going to go back to this article. Three Reasons Subscription Services Fail Better Than Boxes Subscription services are also making inroads into categories previously rife with failure. Consider your morning cup of joe. If you subscribe to a coffee bean delivery service, you'd likely enjoy it for a while, but as the novelty wore off, you'd probably cancel it, as many have with countless failed coffee in a box subscription services. Subscription services don't win on unit price or quality alone. It's almost impossible for subscription services to compete. Once shipping is factored in and you realize those beans cost more than the ones you could buy during your regular trip to the grocery store or are no better than those on sale at the Third Wave coffee shop down the street. But if the coffee subscription service has something unique to offer beyond price, you might stick around for customers. Stored value can justify paying a higher price and can keep them coming back. Consider bottomless coffee. When customers sign up for a subscription, they receive a small, super accurate WI FI enabled scale. The customer keeps the coffee on the scale so the company learns from your consumption and reorders for you at just the right time, according to Bottomless. In the case of bottomless coffee, the service ensures customers never run out of fresh beans. Instead of having to remember to buy or receive too much or too little, or wait for delivery on a fixed schedule. Bottomless Customers get precisely what they need when they need it, as long as they keep subscribing. Getting just in time coffee ensures it never gets stale. But collecting consumption data also helps bottomless tailor future deliveries to customers tastes, thus storing value. For instance, if bottomless sees a particular coffee roast is being consumed quickly, it can infer that the customer enjoys it more and send a similar variety with the next shipment. Giving the customer a variable reward from the novelty of a new roast and ensuring the selection is not too outside the customer's taste preferences. Bottomless plans to expand into all sorts of household products sent to consumers on their schedules and according to their preferences, not the company's. By getting customers to store value in the service with use, Bottomless can potentially disrupt its industry by offering something non subscription services can't provide. Personalization at scale. By making the most of the hooked model, subscription businesses can avoid the common pitfalls that cause customers to churn and build the kind of service customers enjoy for life.

Yeah, so I put in this example of bottomless coffee. I think it's a very concrete example. I think is easy to visualize and see because when you talk about SaaS products and software, sometimes it's hard to get your head around exactly what these companies do. But this is such an innovative idea in a pretty tried and true space. A lot of companies tried, you know, coffee subscription services where they send you, you know, here's our coffee and we're going to just send it to you on a, on a, on a schedule. I would argue that is not a subscription business, that's a delivery business because it doesn't have any area of novelty and variability. What I like about bottomless, and who knows if they're going to succeed, they're brand new, they're super young. But I like the fact that one, it's, it's, you know, rule number one, it's very, very easy, right? It's not, it's not a product that becomes harder to use, it's a product that becomes easier the more you use it because of this amazing scale they have. You just put your bag of coffee on it and it just comes to you when you need it as opposed to the reason. I mean, everybody who's subscribed to one of these coffee in a box services know you either get too much coffee or not enough coffee. And so you're stuck either going to the grocery store to make up the difference or you've got way too much coffee going stale in your house because you can't drink it fast enough. Or with bottomless, it tells you you don't order, you never order. They know when your scale gets to a certain point, boom, you need more coffee and they send it to you automatically. Couldn't be easier. The variable reward. I love the fact that they know your preferences based on how quickly you drink. At least that's one metric they could, they could analyze. So they could send you coffee that's similar or slightly different. So that adds that element of variable reward we talked about earlier. And then that stored value of knowing the data that they're collecting about your usage patterns makes the product also better and better with use. You're storing value and you know what, you've tried coffee on these continents or these countries or these varieties. Look at what you've tried and here's your taste flavor profile. That's, that's only stored with us in this service. That would be a great example of storing value as well. And I think, you know, this is something I'm sure Amazon is going to do. Like, I predict that at some point Amazon will just send you stuff and say, here, we think you need this. If you don't want it, send it back. They might actually find that they save money and this and they can make, they can make more money on each customer by just getting you to send back the things you don't want because they'll be so good at knowing what you do want.

My problem with this part of the model, near, is if Amazon did that to me, I don't want to do the work of like sending it back. Even if they print, pre print the shipping sticker and the box. Like I just don't want to do the work. And so it's, you know, the bottom the boxes one is hard for me because look, I'm a software guy. The reason I'm a software guy is I like 85% margins and box subscriptions have much, much, much lower margins. Typically because you have to ship, you have to produce just a physical object. A question to you though, and this might just be something where I'm either not the mass market, I'm an outlier, but when I'm paying for some of these subscription boxes, like freshly, for example, for food, I'm actually paying to not have to think about food. So I don't want like a change, I just want the spaghetti with the turkey meatballs and I want two of them every Monday. So I never think about it. If you one day want to surprise me and send me the lasagna, like I'm going to Be upset because I have to now think about a different pattern. There's something new coming into my life and I specifically paid for the subscription to not have to waste energy on that decision. How do you think about that sort of counterpoint to your novelty point?

Yeah, that's a great question. So let's do the first one with Amazon. I think you're absolutely right. That's why they haven't done this yet is that they haven't figured out how to make the return of physical products easy because you still have to wrap up the box, put on the label, take it to the, you know, get ups to pick it up or whatever. So that's the innovation to look for. And so the hook model is a diagnostic tool. You could, you can look at the hooked model and say, okay, where is my product efficient? What would have to happen to make it possible to form a new user habit? And so it might be, hey, maybe if there's some day that drop offs magically occur in a much easier fashion, maybe you only go after certain market segments where dropping off is super easy. Right. So in New York City, where they have these, these, these Amazon Go stores, you can actually bring things to return and you just drop it off. You don't have to pack, you don't have to label, you just, you know, you zap in with your app, you drop off the, the thing you want to return. They have a little window, boom. It's super, super easy. Maybe you just, you don't focus on physical products, you do it with digital products. So maybe you'll be able to buy movies or music or anything, books, they'll proactively send them to you, knowing what they think you might want. And then you can say, actually no thanks, I didn't want that. After all we actually seen. Funny enough, when we talked about Netflix earlier, I just saw that they're doing something like this where they'll say we'll automatically download to your phone things we think you will want. Again, they're doing what we talked about earlier that they have to do to reduce that user friction, make it as easy as possible. Here, we picked this out for you. It's already downloaded. Just click play. This is some ways that you might get around that problem. And the second question you asked about was about the need for predictability if you want your spaghetti and meatballs every time, what happens eventually. So I think that's. If you are just a delivery service and you know, hey, that is what you need every time I think there's, it's not necessarily a bad business. It's a very risky business. So if you think about the way milk used to be delivered, this was way before we were born. But remember, like milk used to be delivered on people's doorsteps. Like they would give you these glass bottles and here you go, here's your milk. It's delivered to your door every day. Why don't people do that anymore? Well, because that business model was disrupted from mass market grocery stores. And so what happens is if you don't build a hook around a business, if you don't have these four steps ending with that investment phase where the product gets better and better with use, if it is only predictable, somebody might say, hey Nathan, we see that you buy spaghetti and meatballs from such and such company. How about we give you that very same thing for, you know, a buck cheaper? Well, okay, great. If all I want is the same exact thing every time, I'll go for the cheaper price. Right? Because it's the same thing. Whereas, and so that's where it leaves you susceptible to, you know, having someone else eat your lunch here. Not, not, not, not to belabor the metaphor here too much literally. Right, but so that's where you have to build that hook or your competition is going to, going to take your customer away by competing simply on price. If the product is not variable, if.

It'S always predictable, throw in one out to both of you or maybe to Nathan because you see a lot of people. I'd just be curious. We listed these three reasons that subscription services fail and you guys spoke about how the number one reason is, is that they run out of money. Is there anything else, Nathan, that you would have added to this article?

I think near nailed the points. Right? The, the things that we see, again, they run out of money in this order. They run out of money, they can't keep current customers and then it's, they pay too much for new customers. And so I think we already covered the first two points. But to touch on that last point, the most defensible, highest valued, fastest growing SaaS companies. I'll use Click Funnels for an example with Russell Brunson. They figure out a way to make their to, to, to earn back what they paid to get the customer instantly. And the way that he does that in a B2B world. Now there's, I'm sure Nir probably has B2C examples here is if you want to sign up and, and Russell and wants you to sign up for Click Funnels, the $97 a month software product he will sell his book at the top of the funnel for 10 bucks, right? Shipping only. It's a free book because that's what he spends on Facebook ads to get you to that landing page so it becomes free user acquisition. He then upsells you the software product. So what I would tell everyone listening to the podcast as you wrap up here is if you are spending money to get new customers, don't worry about your lifetime value to CAC ratio. Meaning if you know a customer's worth five grand to you and you can spend a grand, but it takes you 12 months to earn that grand back. In today's risky volatile market, 12 months is a long time. That's risk. Eliminate risk from your business model by saying how can you make a thousand bucks at the initial checkout by putting other things at the top of the funnel. Nir would you agree with this? And do you see examples of this in the consumer space anytime you can.

Make that formula work out and make the lifetime value higher than the cost of customer acquisition. Fantastic. Of course the longer it takes you to recoup that investment, the riskier your model is. But I think there's, there's, there's, what I tend to look at is, is companies that use this, this freemium model where you know it's a zero marginal cost product, doesn't cost you anything to onboard yet another customer. And I really love those kind of businesses because you can very quickly tell whether you're going to have a customer for life. Right. If you, if you build the kind of product that you can see like clockwise, I think is a terrific example. Once you start using it, you use it every day, multiple times a day and you're not going to be that price sensitive, right. Because it becomes an essential part of your, of your day to day existence. Right so. Or another example is a superhuman that I use for email. The day I was onboarded, Rahul the CEO onboarded me. He taught me it was a very high cost onboarding process. Like he literally, you can't use the product unless you have a call with them and they show you how to use the product which is very minute down. It's not a right, a 30 minute demo to actually teach you how to use the product. And at first you're like, well that's crazy, right? Software, you have to be, it all has to be self service, you have to do it all by yourself. But no, you actually have a human being who teaches you how to use this product. And I think that's kind of an Underutilized technique because even though it's very expensive upfront, when you onboard somebody properly and they have that aha moment of wow, this is amazing. And it is something that uses the Hook model in a way like I think Superhuman does, where once you start using it, you build more and more and more value with it. The more it's used like an email service provider would, you know, you're going to have that customer for life. And so I've been paying Rahul my 30 bucks for superhuman every single month for years now, because that's it, you know, why would I live without it? It's such an important part of my day to day use case.

I think the challenging part that was Superhuman though is, you know, they raised a bunch of money, but pre product, pre anything, and so they could afford to hire a bunch of people to give you custom tours to be onboarded, we don't honestly have that luxury of raising. I think they've raised now 108 million bucks in total capital. And so this is why, like, if you don't, if you don't want to sell a bunch of equity to a vc, right, and you want to try and basically say, I want to give everyone this 30 minute call like, like Roald did with near, how would you do that? If you didn't go out and raise a bunch of vc, how would you pay for those folks giving the demos?

It's not easy. It's a, it's a huge challenge. And yeah, as, as markets for raising cash change, it becomes more difficult. You're going to have to be more creative around finding those solutions. So that's, that's maybe where you go to someone like founder Pat to raise some venture debt as opposed to selling a big chunk of your company through equity. But yeah, there's no easy answer. Have you seen anything that works particularly well?

No. I mean, I would just say you have to remember, less than 1% of founders raise capital. Now. They're the ones that we read about all the time. But I think for 99% of your audience, look, and maybe not, maybe the audience is because it's more sort of closer to capital markets, they can raise easier. But generally speaking, I try and challenge founders and say, Listen, if a 30 minute demo is really important for you and you know you want to make that investment on day one, how can you also pay for it on day one? Right. What can you put at the top of your funnel to pay for that instantly so that you don't have to go and have your company depend on being able to raise the next round of capital to survive. And so that's like, if I was Superhuman but didn't raise any money, I would do things like put out a report on best practices or 300 subject lines to use to make your inbox cleaner and put together a report or sell or launch a conference around productivity and sell tickets to the conference and then upsell Superhuman on the back end. There's a bunch of ways to make revenue at the top of the funnel. You just have to think really creatively. And so ultimately, what I'm ultimately talking about is who can get and who has the quickest payback periods today. I think if you don't have a quick payback period today, especially when equity markets are tight, so raising harder, your business is really, your recurring business is really in jeopardy.

I love that idea. So you've seen with conferences, with selling a book, with selling some kind of E content, how do you make sure that the customer isn't just buying that versus making sure it's an ideal scenario? We say, hey, you buy the book, you buy the conference, and you get the software started for free, so to speak, but then you're going to continue using it. How do you make sure that they're not there just for the goodies?

Yeah, I think it's a really good question. I mean, you didn't buy Superhuman to get like a new email interface. You bought Superhuman to get your time back and be more productive. So you want to make sure the thing you're putting at the top of the funnel, to your point about hooks and novelty. Right. Especially the initial touch point, something should be focused on the emotion of what the eventual software product that's further down the funnel delivers on. And as long as you stay true to that, you're going to keep the thing you sell at the top of your funnel aligned with whatever your core software product is.

I love it. A lot of good food for thought there. Thank you so much, Nathan.

Yeah, yeah. And you just to give your audience idea, right. You mentioned a book, right? I've seen people put their podcast recordings on a USB drive and sell the USB ship. USB drives at the top of the software funnel, the recurring revenue model, sell conference tickets, sell courses. If you look at the HubSpot marketplace, you can pay for a bunch of their courses. That helps them get CAC arbitrage because you pay for the course, then you get HubSpot free. But before you know it, you grow your contacts and then you're paid HubSpot customer paying 10 grand per year on average. So there's a lot of really great examples, including the ones that you reeled off well.

This has been a reading and conversation with Nir Eyal and Nathan Latke about nir's latest article, 3 Reasons Subscription Services Fail as published in the Harvard Business Review. Nir Eyal is the best selling author of Hooked how to build Habit forming Products and Indistractable how to control your Attention and choose your life. Near blogs@nearandfar.com and has a weekly newsletter filled with science backed strategies for designing healthy tips your customers will love. Nathan Latke is the founder and CEO of FounderPath, a company that helps bootstrapped SaaS founders turn monthly revenue into upfront cash. Founder Path recently secured $145 million in its own debt and equity financing to help B2B SaaS founders grow their businesses without diluting their ownership. Find them at www.founderpath.com. thank you for listening. We're experimenting with these articles from Near. If you enjoyed this, would you please leave a review for the near and Far Podcast? In whatever app that you listen to, near reads all of these. Send him an email. Thank you so much for listening.