The popularity of subscription-based business models has exploded in recent years, expanding to more businesses in the food, apparel, entertainment and education sectors.
While such models have long been popular in the software sector, adoption has also grown in this space, infiltrating virtually every part of both the consumer and enterprise landscape. Part of the reason for this boom is because of the flexibility and personalization subscription-based models can offer.
Why Are SaaS Models So Popular?
Alongside this surge, though, federal and state regulators are taking a closer look at subscription-based models. They’re particularly interested in issues that accompany negative option renewals — that is, renewals that happen automatically at the end of a given subscription period unless customers explicitly indicate they do not want to renew.
Technology companies need to understand the changing landscape of compliance and reporting required as a result.
Growth and Proliferation
More and more streaming platforms and specialty retailers have adopted subscription-based models as the software market has boomed — particularly in the software-as-a-service (SaaS) space.That growth is expected to carry on: The SaaS sector was a $55 billion global market in 2015 and is projected to be a $253 billion marked by the end of 2024, according to market research firm International Data Corp (IDC) via the Bloomberg Terminal. The sustained growth and adoption of SaaS products will further the advancement of subscription-based business models.
Globally, the number of adults using a subscription-based service was up from 71 percent in 2018 to 78 percent in 2020, according to a survey conducted by the Harris Poll and subscription management company Zuora, and 75 percent of those polled believe that people will subscribe more to services in the future. On the enterprise front, IDC estimates that by the end of this year 70 percent of new enterprise applications will be developed as cloud-native, and that by the end of 2022, more than 53 percent of all software revenue will be generated from subscription models.
The online gaming sector is another significant contributor to the rise of subscription-based models. Globally, cloud gaming saw a 400 percent growth in revenue-generating users last year, from 4.8 million users at the start of 2020 to 24.7 million by the end of the year, according to research from Kagan.
The number of revenue-generating users in the gaming space is projected to grow to more than 100 million users by the end of 2025. Even with such robust growth, revenue from cloud gaming remains only 1 percent of the overall video game sector, which is estimated to be nearly $188 billion globally. Kagan projects the cloud revenue could grow to more than $6 billion by the end of 2025. Much of this revenue growth will be driven by cloud-gaming subscription services from the biggest players in gaming and technology.
Benefits and Risks for Tech Companies
Halfway through 2021, software companies received 33.8 percent of all venture capital investment, up from just 22.5 percent in 2006, according to data tracked by PitchBook. Gaining market share and a user base by leveraging this abundance of capital provides an opportunity to sell premium subscriptions and additional services to existing users, increasing the average revenue per user. As customers’ expectations evolve, subscription-based services provide the opportunity for resilient business models to continuously innovate the customer experience far beyond a one-time transaction.
The model is not without its risks. Many subscription models come without contract limits or cancellation penalties, and they often involve complex billing and revenue recognition requirements. The low cost of entry to a subscription service is often a low cost of exit as well.
As companies scale both the user base and products they offer via subscription, complexities quickly arise around usage billing, renewals, discounts and trial periods. All of these pricing techniques require their own set of reporting tools to properly manage and meet regulatory requirements related to financial reporting, income and sales tax reporting — as well as other protections for consumers provided by the Federal Trade Commission and other regulatory bodies.
Regulatory Hurdles
As subscription models have grown in popularity, they have also attracted more attention from financial regulators and consumer protection agencies. The Financial Accounting Standards Board (FASB) has recently enacted complex accounting requirements to properly recognize revenue associated with contracts, subscription models and companies legal responsibility to provide the services they promise.. In the past couple of years, the FTC has settled a number of cases involving subscriptions where the companies were found to have violated a number of consumer protections.
One relevant consumer protection law the FTC has applied to subscription model businesses is the Restore Online Shoppers Confidence Act (ROSCA). According to the FTC, ROSCA requires that firms be truthful to consumers when marketing with negative option services (such as subscriptions). Negative option services are a common form of subscription where the absence of affirmative action by the user constitutes consent to be billed for the product or service.
For technology companies offering free trials to a service followed by automatic billing — or services where the subscription is automatically renewed each month until cancelled — clarity around the timing, cost and process for cancellation should be clearly available to the consumer. Subscription-based companies should pay attention to settlements that involve consumer services as the law and findings could apply to subscription services provided in the B2B context.
As the proliferation of cloud-based enterprise software continues, we anticipate that regulatory bodies will look to provide protections for customers as it relates to the use of negative option renewals. One recent case the FTC settled with an online-learning platform resulted in nearly $10 million returned to affected customers.
The Takeaway
Consumers and enterprises will continue to demand subscription-based models for a variety of products and services, and companies will need to pay close attention to how they take payment and deliver those subscriptions. Missteps along the way could result in damage to the brand and quite possibly regulatory consequences.
If you run a SaaS startup, you must embed clarity into the overall user experience and coordinate closely between engineering, marketing and sales in order to successfully navigate the financial and regulatory requirements of subscription-based products and services.
