Valuation of Subscriber Business Models – The Good, Bad and Ugly

Valuation of subscriber business models

In this blog, we will discuss about the valuation of subscriber business models.
All new age technology companies like Netflix, Uber and Spotify have their revenue models as either subscriber based, advertising based or transaction based.
These companies are priced based on the numbers of users who are using their product or service.

Valuation of subscriber business models VS Conventional business model

  • A normal company that generates revenues by leveraging its assets is valued by a Discounted Cash Flow model.
  • In this model, firms are valued based on the future cash flows that are generated by forecasting the projected growth rate of the firm.
  • The growth rate is a function of firms historic growth, its competitive position, the market and industry growth and the capability of the company.
  • These future cash flows are then discounted to the cost of capital to arrive at the present value of the business.

Valuation of an user based company

  • An user based company like Uber cannot be valued using this approach.
  • This is because most of these user based companies are not yet profitable.Most of them are generating negative cash flows or are continuing to burn cash.
  • Hence one of the way these businesses are valued is based on the number of users in their ecosystem or platform and the value generated per existing and new user added to platform.
  • The valuation of an subscription based company is the value generated by the existing customers and new customer.The operating cashflows is net cashflows added by the existing users and new users and the expenses spent by the firm to service their existing customers and cost for acquiring a new customer.

Challenges in valuing a subscriber based business

  • To accurately value these business, it is extremely important that data is available on user renewals, churn rate and new customer acquisition costs.
  • Most of the companies are young and either do not sufficiently large data or do not have the capability to collect these important data metrics.
  • Hence it is difficult for an investor to accurately value such companies or conclude if any user based company is overvalued or undervalued.

Value drivers of User based companies

  • Not all user based companies are profitable and have a sound business model.Most of them do not have a clear business model and are only burning cash.
  • Some of the value drivers for an user specific business would the cost driver and growth driver of these businesses.

Cost Structure of an User based business

The cost structure for these business is cost spent to service an existing customer and cost spent to acquire a new customer.
Existing User Costs VS New User

  • A company spending money to acquire a new customer but is able to generate a high gross margin from its existing customers is far better than companies that spends majority of its expenses to service an existing customer.
  • High gross margins indicate that the existing customers find high value in the service offering and are ready to pay a premium to use that service.
  • The company is using the operating cash flow and the additional funding from VC on sales and marketing costs to acquire a new customer.
  • Such companies have an higher probability to become profitable in longer term.

Fixed Cost VS Variable Cost

  • In case of matured businesses, fixed costs are generally utilized and any additional costs is primarily on the variable costs required to come up with additional product.These are referred to as marginal costs.
  • For an new age user based company, opposite holds true where if a fixed costs constitute a major component of its overall costs, then the firm has higher chance to become profitable. This is because the fixed costs which is generally a platform is highly scalable.Hence when more users subscribe to the business, then the costs per user reduces.

Growth Framework of an User based business

Another important metric for a subscription business is growth – how the company is able to use its customer base to grow.
If the business has a great technology or platform which gives an higher competitive advantage then the value from the existing customers is higher.
Higher revenue from existing customers and higher cost to acquire a new customer

  • This is for business offering exclusive services.
  • The strategy for such companies would be to retain their existing customers and sell more services to them as against looking to acquire new customer.

Low revenue from existing customers and higher costs to acquire a new customer

  • In these businesses, the services provided are low value.Hence customer stickiness are low.
  • These firms would never be profitable at longer term.

High revenues from existing business and low costs to acquire a new customer

  • These businesses are dream for any founders and investors.Such companies have high network effect where the companies become more profitable as more users join their platform.
  • A classic example could be in a ride sharing business where a firm with high market share would drive more customers to use their platform. More customers in the platform would pull drivers to enroll into their platform as it is easier for driver to get a customer for a ride.
  • These businesses also are very adept at using big data to gather additional insights about their user and target personalised service based on each customer to sell more services.

Revenue models for Subscriber based business

An user based business generally follow one of these revenue models.
Subscription based model

  • In this revenue model, business charge customers based on the services used.
  • Netfix is an example of a subscription based model.
  • These revenue models have a higher customer stickiness and the subscribers use the services very regularly. Hence there is an high chance of recurring revenue streams with high revenue visibility at lower sales cost.
  • The downside to this model would be that when the business increases the annual fee then there is an higher chance of users moving to competitors.Already Netflix is facing this issue when there was erosion in their subscription base when they increased their subscription fees in some countries.

Advertising based model

  • This is a classic model followed by companies like Yelp.These companies collect data about their users which allows advertisers to target personalised services to users that has a higher chance for conversion.
  • These business have low costs and high customer traffic because customers don’t need to pay for accessing their service.
  • Companies like Facebook that manage to attract more users to their ecosystem and retains them for more time are in a good position to collect quality data about the user preferences. These data can be monetized by selling ads.

Transaction based model

  • In this revenue model, customer spend money when they use their platform.For instance, customers who want to use Uber generally get into a transaction with Uber for taking a ride.
  • If customers like the service and also frequently use the service, then they can be converted to subscription based model.For instance an office goer who willingly uses Uber to shuttle can be targeted by selling a monthly pass for a discount. This would increase the ride trips and booking volume.

Many companies use a combination of the above revenue models.
For instance Spotify uses a combination of subscription and advertising model.Amazon charges its prime members an annual membership fees plus track for incremental sales from the prime customers.

How to assess if a user based business can be profitable at longer term

  1. As most of the subscription based companies are still burning cash, it becomes difficult for investors to accurately estimate the long term profitability of such companies.
  2. VC firms generally funds startups that are able to attract more users to their platforms.It is easier to bring an user to a platform by offering services at discount.The more important metric would be the business model that companies employ to make money from these customers which would determine the profitability.
  3. Hence firms that typically focus efforts on bringing more users into their platforms but are not taking about selling more services to these users are only interested to cash out or exit at higher multiples but are not interested to generate long term profitability.
  4. Companies using wrong business models or do not generate sufficient insights on their users to target personalized services would see their users base either eroded or not able to add enough value to users.


  1. Valuation of subscriber business models followed for new age platform companies like Uber, Lyft and Netflix are based on no of users/subscribers in their platform as against the future cash flows that can be generated by the company.This is because most of these companies are still burning cash and have not become profitable.
  2. Having a higher number of users in a platform is not sufficient for long term profitability. An investor has to look into how the companies leverage their user base to generate more cashflows and earnings.
  3. For this the firm needs a right cost structure, proper growth framework, right revenue model for its business and the business model that focus on extracting more revenue per user.

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