Consumption or usage-based pricing models, once rarely found outside of the software and telecommunications space, are rapidly becoming more common across every industry. From agriculture equipment manufacturers selling solutions on the basis of acres planted, to medical device companies that are monetizing data in new ways to drive better health outcomes, almost every company in every industry is moving in some way towards subscriptions and consumption.
While the momentum towards usage-based pricing has been present in recent years, the pace has accelerated in recent months due to global macroeconomic factors such as inflation, rising interest rates, and supply chain realignment stemming from the pandemic and the war in Ukraine. As a result, B2B and B2C customers are monitoring their spend more closely and driving more potential for downsells and churn from current recurring revenue contracts. As customers threaten to pull back, companies are looking for ways to better define value in order to retain and grow market share. Consumption-based pricing models, which are built on the “only pay for what you need” principle, can help unlock this.
Usage-based pricing offers several benefits that can boost customer acquisition and retention. It allows customers to start small, testing a company’s services without significant upfront investment, and then increase their usage commitment as they become more familiar with the benefits of the offer. It also empowers customers with information they can use to control, track, and predict their costs, allowing them to scale up or down as their needs change.
Because they have typically been in the consumption game the longest, it’s helpful to look at public SaaS companies to illustrate the impact usage can have on business results. According to an OpenView Advisors report, SaaS companies that utilize consumption-based pricing models outperform the broader SaaS index in year-over-year revenue growth by four percentage points — 17% compared to 13%. Zuora research also shows that companies that rely on consumption-based pricing for up to a quarter of their revenue experience five percentage points higher annual revenue growth than those that don’t. Consumption-based pricing also has a net positive effect on annual revenue per account (ARPA) and churn rates.
These findings highlight the fact that consumption and recurring revenue models are not mutually exclusive, but rather work together and depend on one another to maximize impact. Think of SaaS companies that sell on a license model and then charge on the volume of data flowing through the system, or manufacturers that sell a machine on a one-time, perpetual basis, then charge a license fee for access to a data platform along with a usage fee based on how much data is consumed.
But companies aren’t making all or nothing decisions as it relates to consumption-based pricing. Most of them are adopting a hybrid approach that blends subscriptions with usage. Michael Kanazawa, Principal and XaaS Innovation and Transformation Leader at EY,describes the most progressive companies as hybrids: Hardware, software, and professional services are all integrated in a usage-based, consumption-based, or outcome-based model.
Even among hybrid models, there’s a range of strategies companies can implement. For example, pay-as-you-go is among the most flexible options, while prepaid models allow customers to draw down a balance over time. Companies can also offer consumption pricing alongside subscription pricing for a flat fee, giving consumers a variety of choices.
Once you have a consumption-based pricing strategy in place, a thoughtful — and thorough — implementation plan is the next step. According to Kanazawa, there are four critical areas to focus on to ensure a smooth transition:
To move to consumption-based pricing, companies must uplevel their metering capabilities so they can learn, iterate, track, and bill for usage of products and features — not simply collect customer data. Companies often acquire other companies with consumption-based pricing models but aren’t able to scale them successfully because their core operations aren’t configured to store and utilize telemetry data. That results in data and intelligence that aren’t being stored or acted on anywhere in the company, stunting the growth potential of these businesses.
Companies also need to transform multiple aspects of the business, including core finance and IT systems, or consumption-based pricing won’t be scalable. Customers increasingly expect to have self-service options that allow them to see where they are in their consumption and turn certain parts of the subscription on and off to avoid surprise bills.
As Kanazawa puts it, the challenge today is no longer strategy — it’s getting the systems and operations in place. The key to success is to take small steps with scalability in mind, maintaining an expansive vision of what subscriptions and consumption-based pricing mean to the marketplace and customers.
The benefits of consumption-based pricing are significant and the effort to get there requires an enterprise-wide focus on understanding and driving customer value. Coordinating capabilities around metering, iteration, automation, and engagement are the ingredients to creating a winning value proposition that will drive more growth, less churn, and greater lifetime value.