Among Online Entrepreneurs, Subscriptions Are All the Rage

After Alex Zhardanovsky sold his online ad company, AzoogleAds, he went looking for a new business concept. His search took him from skin care to weight-loss products to prize giveaways. The answer that finally came to him — pet food — was inspired by sheer inconvenience. “If you’re a dog owner like I am, you go out and buy food every three or four weeks,” Mr. Zhardanovsky said. “But you usually don’t realize you need it until you’re out.”

Mr. Zhardanovsky, 34, was well aware that an online pet supply store, Pets.com, had been one of the more celebrated flameouts of the dot-com bubble. But he had an idea to build the business by taking a different approach to sales. While selling online ads, he had seen other companies, like Netflix, persuade consumers to lock in monthly fees for repeat orders. Those companies, he believed, were generally more successful and thus bought more of his ads. For his new business, Mr. Zhardanovsky’s plan was to sell pet food on a subscription basis. He figured that other pet owners had experienced the same frustrations keeping the food stocked and might be willing to sign up for a monthly delivery service as well. “Dogs never stop needing to eat,” he said.

To test his theory, Mr. Zhardanovsky and his co-founder, Joe Speiser, set up a Web page in 2009 with a form that asked customers if they would be interested in signing up for regular deliveries. They then placed a few ads online and waited to see what happened. “We had an overwhelmingly positive response from our customers who wanted to sign up for the service,” said Mr. Zhardanovsky, who lives in New York City and who proceeded to introduce PetFlow in 2010.

Customers who sign up to receive regular deliveries of pet food can determine how much they get and how often it comes through PetFlow’s Web site. They can also suspend or change delivery locations when they move or go on vacation. So far, Mr. Zhardanovsky said, only about 1.5 percent of his subscription customers drop the service each month — and many do so only because the pet has died.

In its first month, July 2010, the company shipped about 60 orders; by January of this year, that number had leapt to 27,000. In 2011, PetFlow exceeded $13 million in revenue — with 60 percent of its sales coming on a subscription basis — and it projects revenue will exceed $30 million this year. “I’ve come to appreciate,” Mr. Zhardanovsky said, “that subscription models are, in so many ways, the holy grail of business.”

They are far from a new concept. Consider magazines, for example, or the record clubs that employed so-called negative-option billing (the record was delivered and you were charged unless you told the club you did not want it). But lately, more businesses have come up with creative ways to use the Internet to sell products that have not traditionally been sold by subscription. H.Bloom, which operates in New York, Chicago and Washington, sells flowers by subscription; Trunk Club sells clothing by subscription (if you do not like what the store sends, you can return it). Amazon encourages customers to place standing orders for products like power bars or paper towels.

“C.E.O.’s are beginning to appreciate the value of recurring revenue in a way I’ve never seen before,” said Jim Schleckser, who heads the CEO Project, an executive coaching firm based in Washington. “I think that the software industry adopted it, which caught people’s attention. Now you’re seeing companies in just about every kind of industry embracing it.”

It is not hard to see the appeal of recurring revenue, but some of the benefits may be less obvious. “This is the best business model you can ever have because we can place inventory purchases against future sales,” Mr. Zhardanovsky said. “I will be shipping out 24,000 products next month whether I land a new customer or not. I already know how many bags of Blue Buffalo brand chicken-flavored dog food I have sold in the next 60 days.”

That predictability allows PetFlow to maintain lower inventory levels and to negotiate better deals with suppliers, who appreciate that PetFlow does not discount its sales and that its customers are much less likely than others to switch to a different brand. “We have 60 percent of our customers telling us that they used to shop at Petco or PetSmart,” Mr. Zhardanovsky said. “Which means we’re taking a lot of people out of the traditional retail channel.”

Subscription sales also mean that the money a business spends to bring customers to its site through, say, Google AdWords, can be amortized over the months or years that they remain a customer, said Brian Lee, who helped found ShoeDazzle (along with Kim Kardashian). ShoeDazzle sells shoes on a subscription basis.

“A subscription model allows you to establish long-term relationships with customers as opposed to selling them one pair of shoes and hoping they come back,” said Mr. Lee, who also was a founder of LegalZoom. It was his experience at LegalZoom, a legal-document business based on single transactions, that prompted Mr. Lee to look for recurring revenue: “I wanted to start a business where you didn’t have to worry as much about whether the customer would come back.” The idea of using a subscription model to sell shoes came to him, he said, after he realized how many shoes his wife was buying on a regular basis.

Subscription models and recurring revenue also tend to impress investors — a lesson learned by Jessica Kim, founder and chief executive of BabbaCo, which is based in Chicago and sells children’s activity products. When Ms. Kim started her business in 2008, she sold wholesale products like car-seat covers and inflatable play mats. But after she was accepted into Excelerate Labs, a business-incubator program in Chicago, she got some advice from Paul Lee, one of the program’s mentors. “He told me that he noticed we had such a strong connection with our community of customers and suggested a subscription-based model,” Ms. Kim said. “That’s when it hit me that subscription models are a great way to build lifetime relationships with our customers.”

Ms. Kim came up with the idea of sending out a monthly “BabbaBox,” a box of projects, activities and books that are tied to a theme and that parents can complete with their children. The change to a subscription model had an immediate impact; Ms. Kim’s business grew more in the five months after she made the switch than it had in the previous three years combined. Just as important, Ms. Kim landed several prominent investors as a result of the change, including Mr. Lee, who is a partner in Lightbank, which was started by Eric Lefkofsky, a co-founder of Groupon.

Given the experiences of companies like PetFlow, ShoeDazzle and BabbaCo, it is tempting to wonder why not every company is trying a subscription model. And, in fact, Brian Lee, the founder of ShoeDazzle, said he frequently heard pitches from entrepreneurs who wanted to create the ShoeDazzle of wine or underwear or some other product. “I think subscription models work best in two instances,” he said. “Where the product is a necessity or when it’s an absolute passion. It stops making sense when you try to do something like a tree-of-the-month club, which doesn’t fit either of those categories.”