New technology and fierce competition are compelling businesses to monetize their products in new ways, with a significant shift toward consumption-based models. According to new research from Zuora’s Subscribed Institute and Boston Consulting Group (BCG), nearly half (46%) of companies analyzed implemented some form of consumption-based pricing in the last three years. And hybrid consumption models, businesses that drive both recurring and usage revenue, increased almost 3X (from 9% to 26%) between 2020 and 2022.
Our own customer data supports the value of considering consumption—companies with at least some mix of consumption experience a higher rate of growth. However, identifying the right consumption-based model often takes iteration. It’s important for companies to be able to adapt as customers’ needs and economic conditions change to create ongoing value and predictability. While tracking consumption produces a wealth of data on how a product is used, translating this unpredictable raw usage into the right pricing model can be challenging and complex.
Launching a consumption-based model can seem like an insurmountable challenge, but this guide will provide the knowledge and strategies you need to successfully make the shift and drive recurring growth.
Watch now: Building a recurring-growth flywheel
Consumption-based pricing allows customers to pay based on how much they’ve consumed of a service. This means that customers don’t need to buy everything upfront and they can start where they are comfortable and then pay for more if they need it.
Designing a consumption-based pricing model starts with anchoring your pricing logic to a clear, measurable consumption value metric. Commonly referred to as the unit of measure or unit of consumption, a consumption value metric represents how you will quantify how much of your service a customer uses and, ultimately, how much you will bill them for that use.
The next most important feature of a consumption model is the way in which the price per unit of consumption is determined. Commonly called “rating logic,” this approach can be as simple as a flat price for every unit—to as complex as multi-dimensional algorithms that can be based on everything from geography to time of day. In addition, discounting is frequently employed as a strategy to incentivize more consumption.
The final, and in our opinion, most overlooked feature of consumption models is the notion of time. More specifically, when a customer agrees to pay for their consumption of a service.
It’s a common misconception that consumption models only bill for customers after they actually use a service. The technical accounting term for this concept is “in arrears” billing, but these use cases are better known as usage-based or pay-as-you-go models in the market. However, recent Subscribed Institute and BCG research indicates that companies utilizing hybrid consumption models—with a mix of in-arrears and in-advance billing—outperformed all other businesses in terms of year-over-year (YoY) annual recurring revenue (ARR) growth.
Therefore, we want to be clear that consumption models aren’t just about usage vs. recurring or in-arrears vs. in-advance. The best consumption businesses today anchor their pricing on a solid value metric first and then engineer their recurring growth by successfully balancing between low risk pay-as-you-go models and high predictability pre-paid models.
Customers are increasingly demanding a clear return on investment (ROI) and lower upfront risk—they want a better picture of what they’re using and how much value they’ll derive from your product. And 80% of customers report that consumption-based pricing provides better alignment with the value they receive.
Customers like flexibility when they are first trying a product, which makes simple pay-as-you-go pricing a good option for onboarding new customers. But as they adopt and grow more confident in your solution, they are going to want more predictability.
Therefore, customers will expect the nature of how they pay for their consumption of your product to change as their relationship with you grows. Subsequently, your monetization capabilities need to be ready to change to meet customer expectations.
Read more below: What are the advantages of a consumption model?
Many of the fastest growing public companies leverage a consumption-based model. Why? Consumption-based pricing can be a competitive differentiator and may enable a lower cost of sale and lower barriers to entry.
This strategy also presents an opportunity for companies to align on value and pursue recurring revenue growth. Businesses are significantly shifting towards adopting models anchored on consumption value metrics that drive both recurring and usage revenue, increasing from 9% to 26% between 2020 and 2022. This is most likely driven by the recognition that consumption-based models can drive ARR growth for businesses of all sizes.
Consumption-based pricing models can be a powerful lever for growth, but in our experience, many companies don’t leverage them due to the perceived risks and very real investments involved. Building the capabilities and deploying in the appropriate situation is critical.
We have observed three keys to deploying these pricing models in a way that delivers on the growth potential promise.
When choosing the appropriate pricing model, it is crucial to consider multiple dimensions:
A key insight from our data analysis reveals that most deployments of consumption-based pricing models involve some mix of usage and recurring models. Companies that succeed in their deployment often target use cases more aligned with the benefits and value they bring.
A few example use cases where consumption-based models often make more sense include:
Generative AI tools that have a variable consumption of tokens.
As we’ve discussed before, there are different flavors of consumption-based models—not all of them are the paid in-arrears, pay-as-you-go models most of us think about. For example, some common options include:
Learn more: BCG and Zuora Consumption Report
There isn’t a one-size-fits-all model for consumption pricing. As our data shows, you have to find the right level of usage-based pricing within an overall consumption-based business model to maximize growth. To see the greatest recurring revenue growth, consider a combination of several models to achieve a hybrid consumption model.
Common pricing models include:
Choosing the right consumption model, mix of pricing, and go-to-market strategy depends on multiple variables, including what you sell, how your customers want to buy, what behavior you’re trying to optimize, which strategies have proven success, and what your competitors are offering.
Subscribed Institute research suggests that there is a “just right” level of revenue from usage pricing that correlates with better overall business performance. The cohort of Zuora customers with the best performance are those that have some, but no more than, 25% of their total revenue coming from pure usage-based pricing, like pay-as-you-go.
Traditional pure usage-based pricing models bill customers solely based on the usage metric. But many businesses are combining several pricing strategies into a hybrid model to achieve the mix that works best for their business, product, and customers.
Subscribed Institute research is revealing that many of the most successful consumption-based models are adding another factor to secure recurring revenue and drive a product-led growth flywheel—commitment. In fact, businesses both large and small can see greater YoY ARR growth by adopting a hybrid consumption model, combining both usage and recurring charges.
These companies are orienting their go-to-market motions around driving adoption and building trust, so that customers eventually commit to upfront, recurring contracts. And it’s this commitment that adds the necessary predictability for the business, while maintaining flexibility for the customer.
Image: The most successful consumption-based models combine usage pricing with commitment in the form of a recurring payment
To adapt across the customer journey, the top performing consumption businesses apply product-led growth (PLG) to help reduce barriers to onboarding and drive a continued growth flywheel. Consumption models can also have a massive impact on the go-to-market strategy.
Subscribed Institute findings indicate that consumption leaders employ hybrid models with 3 to 5 pricing (charge) strategies that include some mix of the following components:
Learn more: BCG and Zuora Consumption Report
To further help validate if a specific model works and is acceptable in the market, evaluate what your competitors are offering. But, keep in mind, your competitors don’t always get it right. Pricing structure is often a competitive tool you can deploy to stay differentiated amongst competitors.
To help ensure the successful company-wide roll out of a new consumption-based pricing model, multiple stakeholders, such as sales and revenue accounting teams, must be consulted and included in the planning stages.
For instance, revenue accounting teams are uniquely positioned to help the business understand the key role that rev rec systems and processes will play in the overall success of a new pricing model rollout.
Read more below: How do you track and recognize consumption revenue?
Many companies we have worked with are convinced of the value of consumption-based models, but they are daunted by the scale of the new capabilities needed to make them successful. For a successful implementation of a consumption-based model, specific capabilities are required, especially:
Your consumption value metric should not only be a usage attribute that your company can track, but it should also satisfy value alignment, leave room for growth, and offer predictability both for the customer and your business. Common metrics include: number of users, amount of data consumed, or number of events.
When determining the right value metric for you, consider metrics that are:
Much like the electric meter on your house measures your power usage and turns it into billable kilowatt hours, mediation meters and measures each of your predefined consumption value metrics.
The process of mediation consists of:
It’s critical that metering and billing speak the same language by providing data in the same format. Mediation architecture is crucial, allowing you to plug in new sources of consumption data very quickly, in a standard format that billing can consume.
After your raw data has gone through the process of mediation, and you’re able to correctly track a value metric, you then need to rate and bill a customer account for their consumption.
Rating is the process of:
Unlike your standard subscription charges, which are typically rated and billed altogether, either in-arrears or in-advance, consumption rating and billing may not happen simultaneously. Because consumption is happening continuously, it’s important to have insight into consumption that has been rated over a billing period but not yet billed.
For consumption monetization, the ability to continuously rate charges helps businesses avoid revenue leakage from inaccurate usage tracking. In addition, an automated rating engine helps avoid errors from manual uploads, processing, and calculations.
Learn more: Guide to billing for consumption
To stay competitive in the market and keep delivering value to your customers, you need to continually evaluate and adjust your pricing models. This means evaluating data insights, forecasting trends and opportunities, and balancing revenue goals with the need to attract and retain customers.
Customers like to see what they’re paying for, what they’ve used, and what their usage patterns are. This can be achieved through the use of a mediation engine that can enable continuous usage monitoring and threshold notifications. By performing continuous rating and mediation, you can process data in near real-time to provide visibility into consumption charges for customers, sales, and finance.
For example, when a customer reaches 90% of their plan, you can send a threshold notification, ensuring proactive communication. Based on this customer’s previous consumption, you may also be able to estimate when they’ll hit their committed amount. Customers can then be presented with the option to upgrade their plan to avoid overage charges.
Making the move to consumption-based pricing can be a win for both your customers and your business—but what does it mean for revenue accounting teams? Accountants often have an aversion to consumption-based pricing, because it introduces a whole host of new variables to revenue accounting, which is already extremely complicated.
Consumption models require granular, real-time visibility, not just to total up usage at the end of a billing period, but also to monitor customer usage at any given time. In addition, consumption forecasting capabilities must be in place, enabling revenue teams to anticipate how much revenue will be gained through consumption-based pricing models. This means forecasting variables such as usage, lifetime of the customers, and potential overage charges. Look for technology that can capture and analyze multiple dimensions of upstream data to quickly identify and resolve issues. In addition, real-time reconciliation and a close process dashboard can increase visibility and the accuracy of your revenue forecasts.
The revenue policy for a consumption model can be complex, due to its inherent multifaceted nature. Revenue accounting teams will need to evaluate whether variable consideration should be included and how it should be treated.
Revenue teams can usually leverage existing estimations as a starting point for new consumption revenue recognition policies. For example, if the decision to adopt consumption has been pushed by sales, then someone in sales should be able to present a business case with estimations around usage and revenue.
All revenue accounting teams are familiar with ASC 606 and IFRS15. However, leadership may not have considered the implications of these standards with respect to consumption based-pricing models. Revenue automation can help reduce errors, risks, and audit costs by taking humans out of the equation with a hands-off data management approach.
As companies mature in their pricing capabilities and build out technical infrastructure, many try to optimize their charge models by focusing more on customizing pricing schemes to reflect value delivered and address specific customer needs.
At the same time, they must invest in strategies that offer the predictability that the business requires. Many are finding that consumption-based pricing models provide an optimal way to achieve these goals.
Implementing a consumption-based pricing model can yield the following benefits:
Implementing a consumption-based pricing strategy can present its challenges. Companies need to balance value, while also having enough cash to cover costs. Pricing too high could put some customers off, while pricing too low will result in a loss.
Implementing consumption-based pricing requires planning and consideration of the potential risks and challenges.
Revenue recognition and reporting can hinder the success of the model: Under ASC606 and IFRS15, there are specific revenue recognition rules that accounting teams will need to adhere to. Without a system in place to handle complex consumption revenue recognition, this will lead to manual efforts and hundreds of thousands of lines of spreadsheets to reconcile.
Revenue accounting teams are often asked to do this additional work with no added headcount, adding stress to the teams and increasing control risks. And since consumption pricing is dependent on how customers consume the product, there’s a lot more dependency on data from the product team.
In addition, reporting and forecasting consumption revenue is critical for business leaders when reporting to investors and executing strategic planning. Companies must be able to have granular visibility into their consumption revenue at any given time, especially with the fluctuation some consumption models can bring.
Implementing a new pricing strategy can be tricky and can entail a lot of IT overhead. The right approach and technology are key factors in the ultimate success of a consumption-based model. Even with a good strategy, out-of-date technology may hamper efforts to evolve. Look for technology that allows you to quickly and easily price, meter, stay informed, and recognize revenue.