In the earliest phases of launching a subscription offering, companies often start with a simple pricing strategy—a recurring charge for an ongoing service. But as companies gain traction, they seek to become more sophisticated in the way they price and charge for their offerings. We think of this shift as “usage-based monetization.” Simply put, usage-based monetization is the ability to monetize an offering proportional to the amount a customer consumes.
Uber is a service we’re all familiar with that is capitalizing on usage-based monetization. Think about Uber’s pricing model: They charge consumers based on the amount of usage consumed, in this case, miles traveled.
We’re seeing two key reasons behind this shift to usage-based monetization.
First—we see price-sensitive customers wanting a clear understanding and alignment between the amount they consume and the charges they are billed.
Second—as companies observe cohorts of customers consuming massive amounts of their service, they identify significant potential revenue being left on the table.
Many companies want to implement usage-based monetization, but, operationally, the process is much different than that of a simple recurring model.
In order to monetize on usage, companies must think through and execute on the following steps:
Let’s take a deeper look into the decisions and processes needed to operationalize this new monetization model.
To set up usage-based pricing, you have two initial decisions.
1. Determine your value metric
The value metric will align with the value your customer gets from your service. This variable is dependent on your offering, but some common value metrics are:
2. Determine your usage-based pricing model
Within usage-based billing, there are variations in the pricing model you present to your customer. At Zuora, we divide usage-based billing into these categories:
Once you’ve determined usage-based pricing and your users begin consuming your service, you will need to track their usage records. The process of collecting, cleaning, and routing usage records is called mediation. When your service has multiple daily active users, and usage records flow from different data sources in different formats, mediation can become complex.
Let’s examine Gogo Aviation, the in-air wifi provider. Collecting usage is a complicated endeavor for Gogo: They have to collect data from multiple planes and multiple towers, some in different countries, to determine who was using what plan when. Imagine if you signed up for a global pass and a two-device plan as you hopped from SFO to JFK to LHR with your partner; that’s data from two planes, three airports, and two devices, in two countries.
Obviously there’s some complexity there, and yet there’s no way around it. Clean data is an important part of understanding the customer journey and accurate billing.
As Nicole Greczyn, manager of systems engineering at Gogo Business Aviation, puts it, “There’s a need to collect data in a structured manner. This allows you to evolve as your customers do.
For any company utilizing a usage-based model, you have to ensure clean usage data records to ensure customers’ invoices are accurate. If not, you run the risk of revenue leakage or error-prone invoices and a negative customer experience.
Once you’ve collected and summarized usage records, you’ll need to make sense of them by assigning a price to derive a charge to the customer. This process is called rating.
Depending on the sophistication of your pricing model, rating can become complex. Also, different business models call for different frequencies and timings with which rating needs to be performed. Lastly, with a large subscriber base, complex rating calculations can be difficult to scale.
Let’s examine a common rating process for Verizon. Verizon’s Shared Data Plans consist of a monthly recurring fee for each line as well as usage-based fees which are derived from volume-based tiers proportionate to the amount of GBs of data consumed. In addition, customers can purchase 1GB blocks of data if they hit overages on their plan.
Rating is a sophisticated process for Verizon. First, their billing system needs to constantly measure usage intermittently throughout the billing period. As a consumer, you would expect to have an accurate, transparent view of your data consumption at any given point in time. Second, at the end of a billing period, the billing system needs to measure usage summaries and apply the appropriate combination of charges for millions of subscribers.
The ability to rate usage in near real-time is significant to both to the customer and to the business. With a constant point-in-time measure of usage, the business can send customers notifications as they approach data limits. With this information, a customer is better equipped to decide whether to use less data or upgrade to a higher package.
The business benefits from this as well. Threshold notifications also give the company a mechanism to upsell and increase average revenue per user, but at the same time it saves customers from surprise overage fees, which ultimately provides transparency and improves the customer experience.
At the end of the billing period, once usage has been rated, you have a set of accurate charges that you’re ready to bill the customer with.
Usage-based billing is typically performed in arrears (as opposed to billing in advance). For example, AWS charges for GBs of data sends their customers invoices at the end of the month rather than asking customers to guess how much data they’ll consume in advance.
The result of a usage-based bill is a customer with a clear understanding of what they consumed and what they’re being charged for. This detail allows customers to easily associate the value they’re paying for with the service they’ve received. This makes for a good customer experience, but it also makes decision-making and planning easier for your customer. If customers understand their underlying usage patterns, they can make the decision on whether to consume carefully or expand their plan.
We’re observing an appetite for the shift to usage-based monetization across all industries, from traditional auto manufacturing to software. Why are companies so bullish on usage-based pricing? Because, through a usage-based model, today’s modern consumers get the flexibility, transparency, and perception of value that they demand—and, as customers grow into your offering with increased usage, your revenue grows as well. Win win.
In fact, our Subscribed Institute research found that companies with usage-based pricing comprising between 1-50% of their overall revenue grew by 28% year over year. That is 1.5x higher as compared to companies with no usage-based pricing at all.
In short, usage pricing is really, really important. As Zuora CEO Tien Tzuo has noted, “Without usage-based pricing, you limit customers and your growth.”
But businesses that successfully align price with usage—and set themselves up to efficiently manage usage-based billing on the back end—will be well-positioned to optimize upsell opportunities, customer success, and overall revenue.