This week I want to talk about something that is more of a personal finance issue related to human behavior and spending — subscriptions. And yes, I do recognize the irony of me talking about subscription spending RIGHT below my link trying to convince you to “Subscribe now” to my Substack newsletter.
According to Wikipedia, a subscription business model occurs when a customer must pay a recurring price at regular intervals for access to a product. So, do you have a Netflix, Hulu, cable, cell phone, Spotify, etc. account? Do you go to a gym that charges a monthly fee, have a Peloton/Strava/Zwift account? If so, you have a subscription. We can even think of rent, insurance, or lawn service as subscriptions as they tend to recur at “regular intervals”, charge a fixed price, and are necessary to have access to the product. One of the newer business strategies has been to move to monthly fees for access to the product. SaaS (Software-as-a-Service) businesses have only been around for a little over a decade, but are now pretty mainstream. Heck, here is a tweet talking about Skiing-as-a-Service, a pretty intriguing idea from both a business perspective and a skiing enthusiast perspective (my skiing experience is limited to one time at a small ski “resort” in the Midwest when I came to the conclusion that my lack of coordination in trying to navigate down a hill — there were no mountains — meant that skiing should fall under the category of hobbies for me NOT to pursue).
Note that this is not a criticism of subscription services. They are convenient and can help meet consumer demand. As a matter of fact, between my wife and I, we have multiple subscriptions.
Advantages to Consumers
There are a few advantages to consumers. First, as mentioned above is the convenience factor. I don’t want to contact Spotify every month (or even once a year) to renew. If you have multiple subscriptions, the time savings to have these auto renew can be very beneficial. However, the flip side is that businesses need to make it clear and easy to cancel. This is not always the case. At one time I had a subscription to a satellite radio service and in order to cancel, I had to call their customer service number and actively cancel. It was not something that could be done through their website and it was not something my wife could do during the day because the account was in my name. Subscriptions that can be activated with a click of a button should be eligible for cancellation just as easily.
A second benefit is that subscriptions can reduce the cost to the consumer. One of the earliest subscription models were magazines. While magazines could be easily purchased at many stores, this required a more complex distribution model. The magazines needed to be shipped to the stores, organized and displayed on the store shelves.1 This also meant that the store needed to get a cut of each sale, there were costs in delivering/processing, the magazines need to be physically printed, etc. In addition, advertising was often based on the number of copies sold. With a subscription, the distributing middleman expenses were greatly reduced which meant that the reader could get the magazine cheaper, advertisers had more reliable reader numbers, and the publisher could make a little more money.
A third benefit is connected to identity. If you’ve read this for awhile, you know I “like” the concept of tribes and how we as individuals also value our societal image.2 Why else would someone pay the kind of money for Supreme, Rolex, Birkin bags, etc.? While discussing the latest episode of Stranger Things around the work water cooler (do workplaces actually have water coolers?) may not be quite on the level of rocking your Rolex, if you are the one person in your office that has no idea what the conversation is about, you are going to feel left out. Subscriptions give us access to things that are popular and can help connect us to our tribe.
Another advantage (especially for software) is that your product can regularly be refreshed. Consider Microsoft 365 (which includes Excel, Word, PowerPoint, OneDrive and more). Instead of buying the product, you can subscribe (a family plan is currently $99.99 per year…note that it is LESS than $100 — no psychological barriers in play here, he says sarcastically). Without a subscription, you might have paid more initially, but then only got a refresh when you paid for the newer version. Now, Microsoft can iteratively update your software online so you always have the most recent edition.
Advantages for Businesses
One big advantage is that recurring revenue improves predictability and reduces risk. Investors do not like risk (all else equal) and therefore will place a higher value on less risky cash flow streams. While subscriptions can be cancelled the default setting is pretty powerful. Two of the more effective nudges in retirement planning are the default opt-in to your firm’s retirement plan and the save more tomorrow (SMarT) plan to increase savings rates.3 These both take advantage of inertia — we are more likely to take the default option than we are to actively change things. A subscription to Spotify or Disney+ is going to work in a similar fashion. Once we subscribe, the default action is to stay subscribed. We need to take an action to change this and most people are less likely to take an action.
Spending sounds smaller when it is broken down by month (or by day). “For the price of a cup of coffee each day” or “Less than $10 a month” are common promotions to get us to participate. However, if I assume that a cup of coffee is going to cost me $1.00 (and a medium coffee at McDonald’s is $1.29), that totals $365 per year! Which sounds easier to convince someone to give your product a try? Part of marketing is to make the value proposition sound more favorable to the consumer and subscriptions can do this.
Not only do subscriptions make cash flows less risky for companies, they make planning easier. Because subscriptions tend to be stickier, firms have a better idea of what their upcoming demand will be. This helps with managing resources for the firm. It also is appealing to investors as the cash flow streams become more predictable.
Check Your Leaks!
The purpose of this week’s post is not to discourage you from using subscriptions, but instead to encourage you to think about how much you are likely spending on subscriptions. How much do you spend a month on subscriptions?4 Seriously, stop and take up to 30 seconds to think about it.
Really, we’ll wait.
C’mon…it’s only going to take 30 seconds.
If you are like most people, you probably underestimate subscription spending by a significant amount. Here are some findings from a recent survey on subscription spending.
The average consumer surveyed spends $273 per month on subscriptions.
This has increased by about 15% since 2018.
89% of consumers surveyed underestimated how much they were spending on subscriptions.
Nearly half of those who underestimated their spending (46%) did so by $200 or more per month!
The first guess (given 10 seconds to think about it) was $62 per month. The second guess (given an additional 30 seconds), increased the estimate to $96 per month. The difference between the second estimate and actual spending is equivalent to over $2000 per year.5
This does not imply that people were overspending on subscriptions by $2000+ per year, merely that it is an expense item that we are not consciously aware of. Here is a chart of subscription spending breakdown used in the study.6
If you have not done so in awhile, it is probably worthwhile to take a look at your subscription spending habits and evaluate each one to see if it is worthwhile. Do you get the value from the service to justify the spending? If so, then evaluate the affordability. Do you have enough income to support the spending? If you answer no to either one of these, it is probably time to cut that expense.
Interesting side note, this was a job my mom did for quite awhile and I did for a summer which involved going to stores on a weekly basis to organize existing magazines, remove the old issue, stock the new issues, and prepare returns to the distributor. Another person was employed to deliver the magazines to the store and a warehouse had staff to process receiving, sorting, and returning the magazines and books for that particular area.
Well, I don’t actually LIKE the concept of tribes as I think it increases our tendency to act in idiotic ways to anyone not currently in our tribe. The concept is interesting, but the practice can create some pretty appalling behavior.
Automatic enrollment in defined contribution plans (where the default is to have someone automatically be enrolled, but allow them to opt-out if they prefer) has been shown to dramatically increase participation rates in these plans. SMarT retirement plans where participants agree to save more each time they get a raise have also been shown to significantly increase savings rates. These actions are nudges which use our behavioral biases to help us.
For the sake of this exercise, ignore things like your monthly mortgage/rent/car payment, insurance, utility, and other repeat payments that act like subscriptions. We can debate whether or not these qualify (I think they do), but they are generally not considered subscriptions.
So, how close were you? I’m not going to give my exact numbers, but the spending on subscriptions is higher than average. From the survey, it is unclear if it is individual or household, but cells, cable internet, DirecTV, Netflix, Hulu, Disney+, Prime, Sam’s Club, Spotify…it starts adding up pretty quickly. I’m thinking Netflix is gone soon and, probably will consider cutting DirecTV after the NFL season wraps up.
A good side lesson here in proofreading as Amazon Prime is listed as $99 per month when it is actually $12.99 per month. On the other hand, I don’t see a category for Sam’s Club or Costco which are similar shopping subscriptions. It also omits a category where people are “borrowing” a subscription (for example Netflix) without following the requirements in the contract.