The Monthly to Annual Plan Pricing Trick: A Deep Dive
We had a big response to the post about why a business chooses its annual plan discount % and what that means.
We will be diving deep into that this week and addressing many of the questions that came up.
Price Ratios & Why They Matter
As mentioned in the above post, every subscription business eventually figures out the monthly to annual plan pricing trick.
The trick is to figure out how long your average monthly user retains for and then price your annual plan to be 1-2 months more than that.
So, if your average user stays around for four months, price your annual plan at five months.
This allows you to increase your LTV by 25%, and it's a really simple change to make.
We figured this out at Codecademy, and it was one of the highest ROI changes we ever made.
As also mentioned, this means that you can look at the ratio between the annual and monthly plan prices for most subscription companies and basically see how long they retain users.
We're doing to look at this for both "Short Lifecycle" and "Long Lifecycle" products.
Shorter Lifecycle Products
All products are built to solve a problem. The longer that a person has that problem, the longer they will stay on the product.
The longer they stay on that product, the more valuable the business that built that product can be.
By their nature, products that tend to help someone achieve an outcome have shorter lifecycles than products that address an ongoing problem.
Products that help me get to a specific outcome have shorter lifecycles, such as:
- Get a job
- Lose Weight
- Learn a skills
- Find a Girlfriend
- Prepare for something (an exam, marathon, etc.)
The implication of this is that products that are built in these areas have a kind of "natural" cap on their user retention numbers.
When a product is still developing, the team works on finding PMF and raising the quality high enough so that users will retain as long as the use case allows.
We saw this at Codecademy, where someone was coming to us to learn to code. They will either:
- Learn to code and leave happily
- Not learn to code and leave semi-frustrated
Either way, they are leaving. It's just the nature of the problem we were solving, and there is pretty much nothing we can do to change that.
How to Guess Retention Numbers
If you apply this logic to any subscription company that's sophisticated enough to understand its LTV and has been working on it for a few years, you can guess that they're using this tactic.
This also means that if you compare the ratio of their annual to monthly plans, you can pretty much guess how long their users retain for.
- Noom (Weightloss): Annual Plan $209 / Monthly plan $70, = ratio of 2.99, so users are probably staying around for 2-3 months
- Tinder Plus (Dating): Annual Plan $32.04 / Monthly plan $7.99 = ratio of 4.01, so users are probably around for 3 ish months
- Datacamp (Ed Tech): Annual Plan $149.04 / Monthly plan $39 = ratio of 3.82, so users are probably around for 3 ish months
- Headspace (Mediation): Annual Plan $69.99 / Monthly Plan $12.99 = ratio of 5.39, so their monthly users likely stay around for ~4 months.
- Calm: (Meditation): Annual plan $69.99 / Monthly Plan $14.99 = ratio of 4.67, so their monthly users probably stay around for ~3-4 months
If you start to compare companies in the same vertical, you get a sense of how long users stay on that type of product.
Weight Watchers and Nutrisystem are both public companies, so you can see in their disclosures that they retain the average paying user for ~5 months and ~2 months, respectively.
Noom's price ratio of 2.99 would put them in the same ballpark, and this suggests that the "average" weight loss customer is going to be around for 2-5 months.
They are either going to lose the weight or leave frustrated. Either way, the average user isn't going to retain.
Why is This So Effective?
Plan Mix" or the ratio of short to long-term plans, is to subscription businesses what "Average Order Value" is to e-commerce companies.
Improving it helps almost every part of your business. If you can increase it, it will:
- Raise LTV - This effectively raises the value of your business by the same %
- Collect more cash up front- which allows you to use that cash to buy ads, run the business, etc
- Afford higher aquistion costs - An increase in LTV means you can spend more to acquire customers and stay within your LTV to CAC ratio. This might open new channels or just let you bid more in the current ones you use.
- Drop your churn numbers because a % of your users who would leave after 3-4 months are now staying for 12 months. This makes your business stable (and looks great to investors)
- Makes users commit to the product - Users who pay more upfront are (likely) going to feel more invested in the product and use it more.
- Steadily Increases MRR - You typically contribute a 12th of your annual plan to your MRR each month, so you get a steady MRR uptick from plans you've sold in the last year (Note: However, you get a smaller contribution to that month than had you sold a monthly plan)
- Makes Payment Processing Easier - As you're only collecting one payment instead of 12, this is likely also showing up in your churn numbers.
Additionally, a solid % of your users in 12-month plans might renew for next year. So, you might be looking at an LTV that greatly exceeds your monthly users.
Longer Lifecycle Products
The most common question that I received from the LinkedIn post was, "Won't I lose money by doing this?"
If your average user stays around for more than 12 months, then yes, you will. This tactic is only effective for products with shorter life cycles.
Most B2B and mega-valuable subscription services are serving problems that effectively never end.
- Entertainment - Netflix, Spotify, Hulu, Prime Video, Amazon Music
- Communication - Verizon, Google Fi, AT&T, etc
- Utilities - Water bills, power bills, trash collecting, etc
- Insurance - Home Insurance, Fire Insurance, etc
- B2B Needs - Cloud Servers, Email Systems,
It's very uncommon for companies in this group to offer annual plans at all. If they do, you'll see a small discount, but not a big one.
Companies in this group that are discounting are effectively making a loan to themselves to collect the cash upfront.
How do these companies increase LTV?
These companies have a different version of the same problem; they are trying to increase LTV.
Companies in this space have 3 basic options:
- Bundling Products - E.g buy your home, auto, motorcycle, boat, RV, pet, and life insurance together.
- Selling Packages - Spotify, Google FI, and Netflix are now all pushing to sell you multiple accounts for your family.
- Service Tiers - Find a way to charge you more if you use their product more.
Insurance companies typically (but not exclusively) bundle:
Most B2C products with retention over 12 months eventually start selling packages of plans.
Mailchimp bases their paywall on the number of emails you send per month. So the more you send, the more you pay.
So What Should You Do With This Information?
Go make more money.
