SINGAPORE (Apr 30) : The meaning of ownership is changing not only for consumers but also businesses. As a society, we are currently witnessing the emergence of an alternative model to the product-based economy — buying or selling a product and billing for one-time transactions — that shines the light on current consumer preferences such as ease and flexibility of access and high customisation needs. This is what we refer to as the subscription economy.
Subscribing to a service means you do not actually own the product. Recent surveys suggest that 68% of adults no longer value ownership and do not necessarily think that ownership defines what or who they are. However, what we do value is the “usership”and the experience.
But what does this actually mean? To use a simple example that most of us can relate to, we do not particularly care about owning a DVD, but we do value the experience of watching the movie. There is absolutely no need to buy a DVD if you can simply watch it on a video streaming service.
Furthermore, 70% of adults say that the maintenance and costs associated with ownership of material possessions is burdensome and that they would rather subscribe to a service that takes care of these items. As businesses have come to recognise the value and power of data, the adoption of subscription-based models is recognised as an increasingly attractive business model.
Think about it, when a customer signs up for a new subscription, the vendor enjoys recurring revenues that are highly predictable, and usually seen as “high quality”. With more confidence on the revenue side, expenses can be budgeted more precisely with R&D in particular being a big beneficiary.
With lower upfront costs, corporations are also able to extend their target market to customers for whom the cost was too high in a “standard” model. In a subscription model, you also create stronger relationships with your clients.
Adobe is one of the best illustrations of how a move to subscription can be successful. By the beginning of the decade, the developer of Photoshop posted slowing revenue growth due to declining innovation. In 2012, it decided to move to subscriptions, gradually suppressing licenses and offering subscriptions instead.
While the move negatively impacted the company’s financial performance initially, the company rapidly saw its market expanding and is now growing revenue at over 20% — to levels that have doubled those observed in 2012. Today, Adobe is seen as a textbook case for conversion to subscription by many companies that try to replicate it.
How do we at Thematics AM approach the subscription opportunity?
As a firm, we spend a fair amount of our time qualifying and quantifying thematic opportunities, this is what we refer to as setting thematic boundaries.
Firstly, the theme identified needs to be underpinned by secular growth drivers (or primary forces) that demonstrate persistent above average growth that is not necessarily fully appreciated by the market. The subscription economy is clearly benefits from technological innovation (say, digitalisation makes it easier to subscribe while Big Data allows for greater customisation), shifting consumer preferences (for example, convenience, affordable access to a service and declining value of ownership) and sustainability (this includes shifting away from a buy and waste approach, or from a sales model to a service model).
Secondly a theme needs to be diversified (offering access to multiple verticals of the economy) yet focused (identifiable and quantifiable). The subscription economy impacts industries ranging from the telecommunications, media, software, utilities, healthcare sectors through to the retail sector.
At Thematics AM we estimate that companies operating subscription models in the US have grown at an 18.1% compounded annual growth rate (CAGR) over the last six years. This is five times faster than US retail sales (3.1% CAGR over the same period) and not even comparable to revenue generated by MSCI All Country constituent companies (0.5% CAGR over that period).
Finally we identify companies that have both material exposure to the subscription economy in addition to companies that demonstrate leadership positions within segments of our theme. This results in an investable universe of 250–300 companies.
Security selection and position sizing take into account business and management quality, valuation attractiveness, trading and ESG risk.
The end result is a bottom up, high conviction portfolio of 40–60 holdings that is unconstrained by nature (no geographical, sector or market cap constraints) with the objective of encapsulating the growth opportunity linked to the subscription economy.
Illustrating resiliency and providing diversification
At Thematics AM, our value resides also in our ability to offer investors exposure to new areas of growth. After a 12-month process of researching, qualifying and quantifying the theme, our subscription economy fund launched in December 2019.
While some industries were born as subscription services such as telecommunications operators and media companies, many other industries are now offering subscriptions. These include video and music streaming, fitness, video games, mobile apps and retail.
In the B2B space, the growth and success of subscription-based software is pushing companies to use them more extensively. The fund managers believe subscription represents a more convenient and sustainable way to consume while vendors benefit from highly recurring revenue with positive economics.
Since its launch on Dec 23, 2019, the fund has returned –11.88% versus –21.07% for the MSCI ACI NR USD index, hence outperforming by 919 bps as of end of March 2020. It is interesting to take a closer look at two distinct periods: Before and after Feb 19, 2020, the first equity market down leg brought on by the current crisis. The fund has continued to provide resiliency in the downturn while adding value during the market upturn.
As shown in chart 2, since inception, the fund has posted 12 winning weeks versus one losing week against the MSCI ACWI NR USD. An explanation behind the portfolio’s resiliency could reside in the fact that the current situation has only served to further emphasise and accelerate a number of themes at play.
For instance, a basket of 11 stocks owned in the fund that embodies the “stay at home”effect (e-commerce, meal kit delivery, home fitness, music and video streaming, online education, video games, telemedicine and communication software) is down 7.2% from Feb 19 to March 27 while the MSCI ACWI NR USD was down 24.5% over the same period.
With the right supporting demographic, technological and sustainability drivers in place, we believe the subscription economy is poised to see further, accelerating growth. Consumers and corporates increasingly see it as a model that is a better fit with their consumption patterns. At the same time, vendors also benefit from the model in several ways and are keen to offer more of their services under subscription. We are convinced that subscriptions will be applied to more services in the future while their utilization will also increase.
The authors are from Thematics Asset Management, an affiliate of Natixis Investment Managers. Nolan Hoffmeyer is a senior portfolio manager, Karen Kharmandarian is senior portfolio manager and CIO while Sam Richmond-Brown is a client portfolio manager.
