The future of software lies in usage-based pricing
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Every software company preaches customer focus. However, the subscription pricing model that is common for most cloud software is anything but customer-oriented.
With a subscription pricing model, customers must choose to pay a recurring fee per month. The recurring fee is set in advance of the software purchase. It is usually calculated based on the cost of a license multiplied by an estimate of the number of units of that license needed in the next year or a longer contract period. These subscription models are a great for the software provider, as this is paid for the term of the contract, even if the software is not used. This is not so great for you as a customer. If you underuse, you are wasting your budget on shelving. Expect overuse penalties if you use too much.
Compare that to how we use water in our homes. The resource is always available and you can throttle your usage as needed. When you decide you need an extra long hot shower or you have guests over, just consume what you need and then pay for the added value you get. It’s intuitive and predictable with a price based on the value you get. Now imagine if we subscribed to a certain amount of water usage every month. Why should you pay for the water you didn’t use because you installed more efficient showers? It’s just unfair. Or worse, why risk running out of water from your guests taking long showers? It just doesn’t make sense.
Much like water at home, software has become a utility at work. For this reason, consumption prices for software are becoming more and more the norm. Amazon Web Services (AWS) is a prime example. It popularized consumption pricing, where customers only pay for the features they use and get value from. Since then, a number of other high-profile, high-growth software companies have successfully adopted this model, including Twilio and Snowflake. And the data supports this trend: According to the 2021 SaaS price survey by OpenView Venture Partners, 39% of SaaS providers now offer usage-based prices, compared with around 23% in 2014.
Consumption or usage-based pricing fundamentally shifts the relationship between software companies and their customers away from unfair subscription models and towards an inherently fair exchange of values. By matching revenue with usage, software companies know they’ll only get paid if they develop products that customers both enjoy using and add value with every use. Companies that are continuously innovative and offer differentiated value are rewarded with accelerated sales growth and customer loyalty, and the positive cycle continues. Consumption is more than a business, pricing, or sales model; It is an obligation to focus every function in a company on making customers successful and ensuring that they get real value from the platform, products and / or services.
It is now clear that consumer pricing continues to be accepted as the business model of choice by customers, from high-growth startups to the largest global corporations. Looking back and from our conversations with customers, we have learned three factors that will contribute to the continued success of consumer prices:
- The consumption prices make it easier to get started: Subscription pricing enforces an upfront commitment, which is an artificial barrier for customers to know if the software will be useful to them. Sure, a 15 to 30 day trial will help, but that’s too short a period of time to really understand its value. In contrast, consumer pricing enables customers to get started free of charge and without obligation. Customers can scale when they find value and only then pay for the value they get. Internally at the software provider, this model also frees customer-facing teams from negotiating and renegotiating complex deal structures, and allows them to focus on ensuring customers get value by collaboratively helping to drive engagement and product usage based on customer needs.
- The consumption prices offer more flexibility: The “all or nothing” aspect of subscription prices can have a negative impact on customer satisfaction and retention. As we’ve seen through the global pandemic, when businesses are forced to cut costs, they may not be able to keep up with a high flat fee. Consumption-based pricing enables customers to throttle and reduce that consumption in real time as business needs change – creating a better customer experience and driving loyalty. It also relieves the customer of managing the software and the high upfront costs. In other words, it really shifts cost control to the customer. For example, the hospitality industry has understandably suffered over the past 18 months as it had to quickly downsize or change its supply models to adapt to declining demand.
- The consumption prices are more scalable: As we’ve seen over the past decade, today’s startup can be tomorrow’s global company. Consumption pricing provides an attractive option for growing businesses that may need to scale quickly in the future. With older subscription prices, scaling requires renegotiation and re-contracts, which can be time consuming and put additional pressure on companies trying to scale up quickly. Just as consumption prices give customers the flexibility to reduce their consumption if necessary, they can be scaled quickly and kept pace with rapid growth. No new contracts or negotiations are required to use more software. As a current example, the scalability of consumption prices is well suited to support the sudden and rapid growth of digital business and the accelerated innovation deadlines due to the pandemic. In just a few days, businesses had to scale their digital presence faster than ever – including grocery stores, food delivery apps, video conferencing tools, online education apps, streaming video platforms, training apps, and more. Thanks to consumption prices, meeting customer demand was easy.
But as with any change, the pricing of consumption also has its critics. The main concern revolves around controlling the IT budget of companies. Many IT teams, especially in larger companies, have to manage their software spend on a monthly budget. A sudden spike in software costs due to increased usage in a given month without adequate controls to streamline the increased usage is a frightening business. There is a strategic solution to addressing this “staying within budget” concern: Offer real-time usage reports as well as an option for an “annual pool of funds”. Real-time usage reports provide administrators with a complete picture of how their teams are using their software tools and can be notified of changes in usage patterns. In this way, they always know, can be sure that the increased usage is valuable for the company and throttle if necessary. The “annual fund pool” option should / could give customers the opportunity to pay for their use over a period of 12 months and to compensate for seasonal peaks and drops in use with monthly roll-overs. Taken together, these capabilities give IT teams the control and confidence they need to adopt consumption pricing models. Twilio, AWS, Stripe, and other leading SaaS companies are doing well with this next evolution in software prices.
In summary, it can be said that consumption prices will eventually become the de facto standard for all software companies. It is the latest step in the three decades of development in the software industry to put the interests of customers at the center of everything it does. It’s about aligning with customer success. Forward-looking software companies will continue to embrace this model as true vendor partners. Those who fail to evolve risk erosion not only of their sales growth, but also of customer trust and loyalty.
Manav Khurana is New Relic’s Chief Growth Officer. Prior to that, he held product and marketing leadership positions at Twilio, InVision, Aruba (HPE) and Motorola.
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