Launching a Consumption-Based Pricing Model: What, Why, and How?

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Consumption. It’s what drives every business, because the whole point of a product, whether it’s a good or service, is that it gets used. But you wouldn’t know that based on the pricing models that most businesses use. The fact of the matter is, consumption-based pricing is a win-win for customers and industry—if it’s done right. To find out how, we asked Lucasz Weber, Product Management Director at Zuora, to give us all the tips and tricks.

What is Consumption?

Consumption is anything that customers use after the point of sale: gigabytes of data storage, kilowatt hours of energy, or miles on a rental car. All too often, companies see revenue as limited to the initial sale itself. But the key to supercharging growth is being able to capture the consumption that occurs after you have acquired a customer.

How to Capture Consumption?

Traditionally, there are two ways of capturing consumption, both of which have their pros and cons:

Pure recurrent pricing. This includes the likes of HBO. It’s essentially a flat fee for unlimited usage. Every customer pays the same amount for HBO, no matter how much they watch. Some people probably binge watch because that’s how they capture value. But that can feel like a burden, and after all, you can only consume so much content. Customers are always left wondering, “Am I wasting my money?” The whole model just feels too simple, because it’s one size fits all.

Pure usage. Examples of this model are utilities or pay-as-you-go cloud platforms. Customers pay for as much as or as little as they use. Sounds good, right? The problem is that the pricing isn’t really transparent: how is the price set for a computing cycle, exactly? Also, it can be unpredictable for both the customer and the company. Bills spike or plummet every month depending on usage, and there’s no way for either side to negotiate. The price per unit is what it is. Not exactly a model for stability, or satisfaction.

Hybrid Pricing Model

Imagine that your company provides in-flight internet to enterprise customers. One of your customers owns a fleet of business jets, and they want one internet plan priced for the entire fleet. Looking at the two traditional pricing models, you could charge one monthly or annual fee based on the total number of jets. Or, you could charge completely based on passenger usage. Which is the best model for growth?

What we’ve discovered is that the ideal consumption pricing model is a blend of recurrent and consumption-based pricing. This hybrid model allows businesses to capture a minimum revenue for providing access to a service. But at the same time, you’re not overcharging your customers, and there’s room to negotiate pricing based on how much of a product or service they actually use.

So new customers who are just trying out your offering can dip their toes in the water for a reasonable spend. And power users can negotiate a higher-level plan with more included, and a better overage rate as well. Best of all, we’ve found that hybrid pricing is what achieves maximum growth. Year over year, companies we work with who adopt this model average about 28% year-over-year growth, which is the highest of any peer group.

The Benefits of Consumption-Based Pricing

From a business perspective, consumption-based pricing achieves:

Customer satisfaction. When customers can self-serve, they’re more likely to feel they’re receiving value for the price.

Go-to-market agility. Flexible combinations of recurrent and consumption pricing allow companies to experiment, testing in-market and readjusting quickly.

Reduced revenue leakage. Efficient pricing models mean there’s less money left on the table as you optimize product usage—and revenue generated—from each customer.

Adding Consumption to the Pricing Mix

Ideally, you should be architecting consumption-based billing with three main components.

Metering. Every consumption-based business needs to track how much of your services are going out to your subscribers. You may own this process because it’s your service; however, many businesses do not because the service being consumed is being provided by a third-party partner. For example, if you are an Azure reselling partner, the billing for Azure is coming from Microsoft, and you’re just going to pass it through.

Billing. You can also track usage on the other side of the transaction, when the information comes back through Billing. Billing then decides what the pricing is, what the plans are, how to charge, how much to discount, and other aspects of the pricing strategy, based on the usage information they receive.

Mediation. In an ideal world, Metering and Billing would speak the same language. Unfortunately, that doesn’t usually happen, because they aren’t providing data in the same format. Mediation architecture is crucial because it allows you to plug in new sources of consumption data very quickly, transformed into a standard format that Billing can consume. The billing side also leverages mediation to not only get the right data, but also to enhance the data with more information. For example, the metering service may not actually know the name of the customer that is consuming the product.

Our inflight internet company is a good example. The plane knows the exact percentages of WiFi used per passenger. But in order to find out the total usage, we need data from the satellite. Mediation is needed to correlate this data into one record that can be used to effectively price.

Implementing Consumption-Based Pricing: Build or Buy the Capability?

The first choice to make when implementing consumption-based pricing is whether to build or buy the capability. When evaluating platforms to help you add consumption-based pricing into the mix, you’ll want to consider and look for the following features:

Flexibility. The ability to collect any type of data. You may have a specific type of data today, but in two years, it will probably be something different.

Automation. Getting rid of manual processes (like spreadsheets) will cut down on errors. It will also be more scalable. You may have 100,000 records a day right now, but what if that goes up to a billion?

Collection and normalization. You’re likely to have many different data sources, from Excel to Kafka to PubHub. You need to collect it, then normalize it, so you can apply the same rules to every piece of data.

Usage binding. There is often a need to bind usage data to a specific customer. Once you bind that to a customer, then you apply the business logic that’s specific to the product and service they’re consuming.

Aggregation correlation. Aggregation allows you to take many records that are the same and combine them into a single record so you’re not overloading the rating engine. Correlation allows you to take disparate records and make that into a single record.

Let’s return to our fleet of private jets one last time. The satellites provide usage data every 10 minutes, but the plane only gives data when it lands. Through our architecture, we correlate each 10-minute time slice with the total usage and combine them into a single record.

With this level of detailed information, you can provide value to your customer, while leaving no revenue uncaptured.

And this, in summary — optimum value for customers, optimum monetization of customers accounts over time — is the win win of adopting a consumption-based pricing strategy.

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