Don Ward is the most common shoeshine on the streets of Manhattan, diligently shining shoes for 18 years.

If anything, Don has never moved his nest in 18 years, shining his shoes outside the Manhattan office building of Barron's, one of America's top financial newspapers.

But it is this location that has brought about a major change in Don Ward's "career", allowing the shoeshine to join the world's hottest economic model:

Since 2010, Don Ward has followed the trend and launched its own "subscription pay" model-customers can enjoy unlimited shoeshine service for a year for an annual fee of $100, and platinum membership for a lifetime free shoeshine for life!

Fengyun can't help sighing that you really have to make a good circle to be a shoeshine: this guy's business acumen may be acquired by chatting with financial reporters every day.

Therefore, Feng Yunjun is also very glad that his career choice is so wise that he must park his car in Bailemen. If you go to a small place, it is estimated that the cigarette butt can not be found, not to mention occasionally lying at the door, peeking at the colorful world, bright lights, and snow-white long legs.

1. Chatting about subscription economy

When it comes to subscription, all we can think of are newspapers, magazines and fitness cards. But now, unwittingly, our lives are surrounded by the subscription economy. Every aspect of daily life you can think of-software, music, movies, costumes, dinner. There are service providers that can start canceling at any time

From the daily life of an ordinary American family, the commonly used paid subscriptions such as Amazon.Com Inc Prime Membership (there are separate subscription items such as Pantry,Kindle Unlimited and Music Unlimited,Audible Audiobooks), Netflix/HBO/Hulu and other online videos, Spotify, software such as Dropbox, newspapers, magazines, and professional websites.

In addition, advertisements bombarded from time to time, such as children's Book/Toy Subscription Box, clothing Stitch Fix, beauty products Ipsy, food delivery service Blue Apron/HelloFresh, and even niche, such as wine tasting booking Wine Box, bacon box.

From the consumer's point of view, the subscription business feels like a bit of a waste of money:Introductory offer, which is often given a free trial period or extremely cabbage price at the beginning, can bring stable cash flow income for the company once it recognizes or relies on products and services and becomes a full-price user.

However, "free is the most expensive thing in the world", so much so that the subscriptions we unwittingly participate in have become rampant.

So someone found a new business opportunity: the emergence of subscription assistants (such as Trim) to monitor subscription fees for users, remind and agent users to cancel paid services that have been forgotten.

The subscription business model has so penetrated into the consumption habits of ordinary people that even the public's mode of thinking has been nurtured by the subscription economy.

Unlike some companies that have applied the subscription model from the very beginning, the successful transition of some traditional software vendors to SaaS (Software as a service, Software as a Service) is regarded as a new take-off for mature companies.

At the end of 2018, Microsoft surpassed Apple to become the company with the highest market capitalization, which also marks the success of SaaS strategy. Among them, the most important thing for investors is the stable income brought by Microsoft Corp's cloud computing services and office software Office 365 franchise.

From the table below, we can see how the software industry has gained market recognition and brought rich returns to investors through the transformation to the payment model in the past decade.

(source: https://www.barrons.com/articles/how-subscriptions-are-remaking-corporate-america-1544233694)

Of course, the transition to the subscription model was not smooth in the first place.

In 2013, Adobe Inc stopped selling boxed Photoshop and other design software, which cost about $2500, and instead adopted a monthly usage fee of $10 to $50.

For users who are used to paying an one-time payment for the right to use the software, they suddenly cannot accept the new model of continuous payment of royalties during the period of use, and there is a lot of opposition.

But from the perspective of attracting new users, the subscription model has obvious benefits: hundreds of dollars of physical software packages have been turned into monthly mobile App, with immediate access to as little as two cups of coffee a month, greatly lowering the barriers to entry.

Therefore, for users who need to use it in the short term, this mode of canceling payment on demand at any time increases the attractiveness of the software.

For long-term users, this payment method makes it easier for them to issue the "threat" of unsubscribing, and service providers have more incentive to continuously meet the new needs of customers and speed up the upgrading of software.

Stable cash flow can also support the continuous update and improvement of products and services. In this way, the interdependence and promotion of product service providers and users are enhanced, and customer satisfaction is further improved.

Gradually, these transformations and advances are gradually recognized by the market, reflected in investors' confidence in the company and the stock price.

2. CBCV valuation method

From the perspective of valuation methods, the first thing that comes to mind is to choose the traditional discounted cash flow to value. Market capitalization Fengyun has been introduced in an article before. For more information, see "valuation discussion: free Cash flow valuation method | Fengyun classroom".

Below, we focus on a valuation method suitable for subscription model companies: customer (i.e., user/subscriber/member)-based corporate valuation (CBCV), that is, company valuation based on customers (users / subscribers / members).

The meaning of "customer" applicable to this valuation includes the customer concepts of several different revenue models, but there is no special distinction in this article, which is explained here.

User can be seen as a user, such as a registered user of Facebook,Uber. Users are not required to pay specifically for the use of the product, Facebook Inc earns money through advertising, and Uber earns money from each use of the platform.

Subscriber is the subscription of online videos by subscribers, such as software, newspapers and magazines, Netflix/HBO, etc., and subscribers pay a fee on a regular basis (such as monthly).

Member is a member, such as Amazon Prime Member. In addition to regular membership fees, Amazon can also benefit from transactions on the platform.

Although the revenue model is different, under the customer-based valuation framework, we focus on the value of each customer, such as new / existing users, user retention, revenue patterns of different users, and so on. in order to distinguish the impact on the value of the company.

(I) user value dynamics (User Value Dynamics)

Before diving into the numbers to begin the calculation of model variables, let's analyze the mechanism by which these variables affect value.

The study of the characteristics of individual customers is also the category of marketing. However, in the early marketing literature, the differences in individual characteristics of users concerned by the research are difficult to be transformed into model calculation variables that can be captured and observed or obtained in time.

With the evolution of the literature (such as Gupta, Lehmann and Stuart,2004), the bottom-up valuation method of the company through the value estimation of individual users is becoming more and more perfect.

Although some assumptions in the model are biased, such as fixed customer retention rate, cost allocation, capital structure and so on, this customer value-driven valuation framework provides a good basis for follow-up research.

In the user-based valuation model, although many variables need to be estimated, the analysis method of this framework can reflect the dynamics of user value (that is, separating the key variables that affect the value of the company).

We disassemble it through the analytical structure of Damodaran (2018), and provide some positive and negative examples.

(2) user cost analysis

1. Existing users vs. New user cost

We see that many user-based companies are burning money and losing money, mainly because they are still start-ups. If we analyze the composition patterns of their income and costs, and carefully analyze the reasons behind these money-burning methods, we can tell which companies are viable and ultimately profitable, and which are lossmaking companies with no future.

Remember, how much money you lose is not the focus, but the key is to understand the logic behind the company losing money.

Law of user value 1Among companies with the same degree of loss, companies that lose money to acquire new users are more valuable than those that lose money to provide services to existing users.

Here, we use a failure case to understand this law of value: a big failure of the subscription model is MoviePass.

In 2017, MoviePass offered a free pass to see a movie for a monthly fee of $10. Ten dollars is only slightly more expensive than a movie ticket, so subscribers can get most of their money back even if they only watch one movie a month, and MoviePass will lose money to see two movies.

But MoviePass is also betting on the popular mindset that most users visit the cinema once a month on average, so they can make up for the losses caused by a small number of frequent cinema users by making a small profit from most subscribers.

But such business expectations ignore the problem of adverse selection-movie enthusiasts will go to the movies more frequently, while users who often go only once will gradually cancel their subscriptions. In the long run, the remaining users will only keep MoviePass losing money.

Let's take a look at the stock price of MoviePass's parent company and feel the end of this money-burning model:

(source: https://markets.businessinsider.com/stocks/)

2. Fixed cost vs. Variable cost

The company's fixed costs (that is, costs that do not change with revenue) can be diluted by the expansion of the number of users and economies of scale.

However, the variable cost of the company goes hand in hand with the growth of users, which limits the space to increase the value of new users through economies of scale.

Law of user value 2A fixed cost company is more valuable than a company with the same degree of development but variable cost.

For example, Netflix and Spotify have similar revenue models, but the differences can be seen by comparing the cost models:

First, when Netflix buys the film and television content of the broadcast right, it pays an one-time expense, that is, a fixed cost; but the royalty of Spotify needs to be paid according to the amount of broadcast by the user, that is, the variable cost.

Second, Netflix spends more and more of its content costs on original film and television, which will increase the uniqueness of its products and the competitiveness of the company, resulting in higher renewal rates and price increases, attracting new users and increasing the value of existing users at the same time.

Therefore, the cost model of Netflix can form a scale effect with the increase of the number of users. Once the income of some users is successfully recovered, the marginal income of the new users can greatly increase the value of the company.

Therefore, the marginal value of a single Netflix subscriber is higher than that of Spotify.

If you analyze the reverse side of the coin by the way:That is, once Netflix user growth slows and cannot offset the huge fixed costs of adding original content, it is more likely to get into trouble.

Recently, there are news reports that Netflix wants to cut some of the low-hot original content to save costs.

(source: seekingalpha.com)

(3) user growth

One of the misunderstandings of valuation is not to consider the business model, but to consider a company in terms of the rate of user growth.

However, not all growth can create equal value.Some user growth creates more value, while some growth is reducing value.

Law of user value 3Companies that increase individual user revenue are more valuable than companies with similar growth rates but expand by increasing the number of users.

The choice that young enterprises often face is to spend their resources on developing new users or to explore the value-added of existing users.

Of course, some companies (such as Netflix) as a pure subscription model, price increases and the risk of losing subscribers, so the development of new users is the main goal. For example, the mixed mode of Amazon Prime is membership fee + platform trading, so increasing the trading volume of existing users can have a lot of room for value-added.

The following table provides a framework for thinking about user growth value by analyzing the costs and benefits of existing and new users.

-- the value of the company's existing users is higher: if the cost of acquiring new users is also low, it will become a Value Stars;, but if the cost of acquiring new users is also high, then focusing on high-value users can survive.

-- the value of the company's existing users is low: if the cost of acquiring new users is low, the companies that get the majority of users in the market can win; but at the same time, the cost of acquiring new users is also high, so it becomes Disasters and will eventually fail.

(source: Damodaran, Aswath. Going to Pieces: Valuing Users, Subscribers and Customers. P38)

(4) Business model and revenue model

MoviePass's revenue model is destined to have limited value for new users, while long-term users left behind through adverse selection will not generate any value and will only continue to lose money.

We can learn from its lesson why Uber and Lyft can never adopt the subscription model: a large part of the company's revenue is generated by a small number of users; if you do not generate more revenue from these high-value users, but use the package model to fix the revenue, then turn high-value users into lossmaking users.

Law of user value 4The "best" revenue models vary from company to company, depending on their life cycle, their own products or services, and their focus on user growth, revenue growth, or revenue sustainability.

Advertising, subscription and platform trading have different effects on the value of the company. For example, the advertising model contributes to the rapid growth of the company in the early stage, the subscription model can produce sustainable development, and the transaction model can tap the maximum business growth potential among existing users.

The following figure shows the importance of some value drivers in different business models. For example, user stickiness is the most important in the subscription model because it is the main driver of business revenue, but it is less important for companies in the advertising model.

(source: http://aswathdamodaran.blogspot.com/2017/07/usersubscriber-economics-value-dynamics.html)

Whether a start-up company can eventually develop into Value star or disaster is based on comprehensive dynamic analysis of revenue model, existing user value, new user acquisition cost, user stickiness and so on.

I hope that the above analysis of several value mechanisms can give you an analytical framework.

Next, let's have a hard-core version of Jie Niu.

III. Netflix valuation case

Below, we take Netflix as a case to disassemble the calculation process of CBCV estimation method in detail.

It is important to note that the original author of this case numerical calculation is Aswath Damodaran (Esworth Damodalan), a professor of finance at New York University's Stern School of Business.

Professor Damodaran mainly teaches MBA courses, focusing on corporate finance and valuation. He often shares his professional experience and research results on his website (Musings on Markets).

Because of his great influence in the industry, he is known as the Dean of the Wall Street valuation Institute (Wall Street's Dean of Valuation). Several of his valuation-related textbooks have long been translated into Chinese and widely circulated.

Similar to the traditional discounted cash flow valuation, we also need to find three key data in the CBCV valuation: expected future cash flow, expected growth rate, and rate of risk return.

The difference is that under the CBCV framework, we have to do the calculation in three parts:Existing users, new users in the future, minus the operating costs that cannot be directly attributed to user services in the survival of the company.

The general formula is as follows:

Value of a user-based company = Value of Existing Users + Value of New Users-Value of Corporate Drag (i.e., those expenses that are indispensable to business existence but unrelated to users and netting that value out of the user value)

One of the calculation difficulties of the CBCV method is caused by the traditional disclosure of accounting information: each valuation-related information in the financial information is summed up and is not decomposed according to the data needed in the model according to different users.

As a result, many projects need to be estimated for allocation. For example, let's do a cost allocation. According to the key to distinguishing users from the valuation method, it is first separated from the total cost:

(1) cost of existing users

(2) cost of obtaining new users

(3) other operating costs of the company that cannot be directly attributed to (1) or (2).

Accordingly, we can assume that administrative expenses are all classified as (1) existing user costs, and marketing expenses are all allocated as (2) the cost of obtaining new users. This allocation is relatively straightforward and easy to understand-that is, general administrative expenses are classified as the cost of serving existing users, and marketing expenses are mainly to attract new users.

In terms of content cost, you can take the difference between the actual cash outflow of the content cost and the amount included in the expense, that is,Capitalization的Content cost, regard this part of the capitalized amount as (2) the cost of obtaining new users.

The reason for this allocation is to assume that if the actual cash outflow is greater than the portion included in the current expense, it will be deferred to the later recognized expense as the cost of capitalization, so it can be roughly matched to provide services to future users.

After allocating the difference, we'll take a look.ExpendingContent cost. In such cases, it is sometimes necessary to make some major assumptions based on an understanding of the company's business in order to continue to push forward valuations.

Here, Professor Damodaran assumes that 20% of the cost of content directly represents (1) the cost of services to existing users, and the remaining 80% as part of the operating costs of (3) the company. In addition, the investment in technology research and development is also part of the operating cost of (3) the company.

Summary of financial data:

We combine the revenue model of the above analysis: Netflix has no advertising (such as Spotify), no free services and value-added paid services (such as LinkedIn), and no transaction model outside membership fees (such as Amazon Prime).

Netflix's financial data for 2017 are used here: operating income of $11.693 billion, operating profit of $838 million, and the number of subscribers increased from 93.8 million to 117.6 million.

(I) valuation of individual existing users

Netflix's original play has greatly reduced the turnover rate of existing users.

Based on 2015-2017 data, the estimated subscriber retention rate in the valuation model is 92.5 per cent. The life cycle for a single user is set to 15 years.

In addition, the hypothetical investment in original content can enhance the price increase advantage of Netflix over existing users' subscriptions (such as 5% increase per year), while maintaining the annual fees of existing users (that is, administrative expenses + 20%).ExpendingContent costs) maintain an inflation rate of 2%.

In the valuation assumption, most of the content cost is regarded as the company's operating cost. As a result, the cost of a single user is only what was mentioned earlier: administrative expenses + 20%ExpendingThe cost of content, the sum of these two pieces is actually very small compared to the revenue generated by a single user.

In addition, by setting a global average tax rate of 25% and the cost of capital (discounted cash flow rate) of 7.95%, the current value of a single existing user is $508.89, which in turn values existing users at about $60 billion.

(note: due to typesetting, only the data for the next 1-3 years are displayed.)

(II) valuation of individual new users

First consider the total marketing expenses andCapitalizedThe cost of content, the sum divided by the number of new users in the same period, gets the cost of obtaining a single new user$111.01。

You read it right, this is the cost of getting customers for new users!

In this way, we can estimate the value of a single new user as follows: the previously calculated valuation of a single existing user-the cost of obtaining a single new user, that is, $508.89 / 111.01 million 397.88, and assuming growth at an inflation rate of 2%.

(note: due to the limitation of typesetting, only 1-3 years of data are displayed.)

Assuming that the growth rate of new users is 15% in the first 5 years, 10% in 6-10 years, and 1% after that, and new users are discounted at a cost of capital of 8.5% (higher than the 7.95% used in existing user value estimates, because the uncertainty of new users is higher), the final value of future new users is about $137.3 billion.

(3) costs of other business activities

For other costs of the company that cannot be directly attributed to existing users or access to new users, it is assumed that technology development costs will increase by 5% a year based on the company's past experience.

But the increase in content costs is harder to estimate, and Professor Damodaran set an annual growth rate of 3 per cent over 10 years based on Netflix's efforts to invest more to secure its market position.

Finally, it is discounted at 7.95% of the cost of capital to get $111.3 billion in other costs of the company, which will reduce the value of the company.

The final summary, plus the company's existing cash, minus liabilities, get the value of the company's equity. In addition, after subtracting the option value of equity incentive, divided by the number of existing outstanding shares, the final value per share is $172.82.

(4) Analysis of some details

In different company valuations, there is often a value driver that has a decisive impact on value. The key driver in the Netflix case isContent cost.

As mentioned earlier, once the growth of Netflix users slows, the huge cost of content will become a burden. So after a period of rapid growth in Netflix, the cost of content will gradually begin to be controlled in the long run, and recent news reports have also confirmed this expectation.

——Subscriber retention rate:Strictly speaking, the "net increase" of users is not equal to the "new" users in the current period, because there will be a continuous loss of users, but also rely on new users to maintain the number of users. In addition, there are users who continue to cancel and renew their subscriptions, so the values used mostly rely on the overall prediction assumption.

——Income vs. Cash flow:The subscription revenue of a single user is not equal to the cash flow of a single user. In addition to the impact of taxes, the costs directly attributed to the user should also be considered.

——Competitors:Disney announced Disney+ 's plan this year, which is expected to have an impact on Netflix's business.

But how to reflect the impact of these competitive changes in valuation? If you think that the new and powerful competitors want to steal some users, do you want to adjust the following assumptions?

IV. Conclusion

Growth is not without cost, risk will reduce value, and the generation of scale effect is very difficult.

We need to jump out of the seriously simplified analysis that only looks at the number of users for the valuation of companies in the subscription economy.

It should be combined with the company revenue model, future user retention, new user growth, user acquisition cost, external competition risk, whether and how to achieve economies of scale, and how to tap the revenue potential of high-value users.

Only in this way can we strategically qualitatively analyze which are good companies worth investing in and which will be disasters to be avoided. As for the numerical calculation in the valuation model, it is only based on the quantitative estimates obtained from the above analysis.

Last but not least, while making the above calculation, the value of Netflix (Value) was $172.82 (April 16, 2018), and the company's stock price (Price) was $280 on that day.

Does such a big difference mean that Netflix's share price is seriously overvalued? If we jump to conclusions about this, we will confuse the concepts of value and price.