Recently, many enterprises have realised the importance of recurring revenue and have adopted subscription-based pricing models. New research from the international growth strategy expert Manifesto Growth Architects revealed that 70% of businesses have moved towards a subscription model.
However, subscription models alone do not bring optimal revenue growth. In fact, it also attracts a few challenges for businesses, for e.g.
- Customers may not be using everything that they are subscribed to. This then brings into question the “value” of the offered services and this may have a negative impact on the customer retention rate in the long term.
- It is difficult to accommodate the ups and downs in businesses. For e.g., some customers have higher service demands during peak seasons, but very low demands during the off seasons.
- Most customers feel that their vendors are only more customer-centric up to and at the point of renewal. This feeling then creates friction in the long-term relationship and partnership between the customer and the vendor.
These challenges can be addressed using a much finer and optimised pricing model called “Usage-Based Pricing”. There are many names and forms of this pricing model, but the most common ones are: Consumption, Pay-as-you-go, Value-based pricing (My favourite terminology), Time/Unit-based pricing and Pay per transaction. As it suggests, this pricing model allows customers to pay for the value that they receive. Customers subscribe to products or services, but then pay based on the usage, unlike a standard flat subscription price.
The advantages of usage-based pricing are that:
- The customer pays for what they used and hence it is the most efficient and value-oriented pricing.
- Being a highly flexible model, it addresses ups and downs in the customer’s businesses. Customers do not need to terminate services during lower usage.
- Businesses get more insight on the usage patterns of customers and hence can have more focused cross-sell and up-sell offerings.
- Usage data is also a valuable input to the product and service management team to finetune features and capabilities. This way, there is a dedicated effort to upgrade and improve the product continuously, to make it more valuable.
- It serves as a low entry pricing point and provides an easy way for a customer to try a new service and evaluate it for a minimal cost.
To demonstrate the advantage of the usage-based pricing model, let’s analyse some of the public SaaS companies using this model. These companies are expected to grow revenue at a faster rate and are growing more efficiently compared to a broader list of 50 public high-growth SaaS companies. With usage-based pricing, these public companies are experiencing faster and more efficient growth. As a result, compared to their peers, they are being valued at a premium (24.8x vs 17.7x) by the public markets.
Source: NDR are from Company filings (S-1 or 10-K), EV/Rev Multiple Representative 01/06/2021, Revenue Growth are Analyst Consensus Estimates for FY 2021-2022 Revenue as of 01/06/2021
“Customers are well aware that a usage-driven pricing model will encourage service providers to keep their customer engagement at the highest level at all times, not just during renewals”
Although the usage-based pricing model provides numerous advantages, moving to this model does bring a few challenges, for e.g.
- As usage-based is value-centric, it is always a challenging situation to identify the correct usage unit, value-matrix, prices and to perform the margin calculation.
- Usage data collection and processing is a huge challenge. Details are always needed as the customer may prefer the usage details on the invoice.
- Rate and, in some error scenarios, ‘unrating’ the usage data requires a thorough exercise.
- The legacy products may not support the usage-based pricing model, which can bring a new set of challenges during the implementation.
- The backend financial and revenue calculations need to be more sophisticated to support this model.
Using Usage-Based Pricing on the Salesforce Platform:
Most of Salesforce based CPQ/Billing products provide support for usage-based pricing & billing. Salesforce CPQ/Billing and Apttus/Conga CPQ/Billing have extensive support for this model, with variations to address different business needs.
Key points to be aware of:
Usage-based pricing model suits certain businesses better, and may not be suitable at all for other businesses. So, do your thorough analysis before implementing this model.
For some business, a hybrid approach is more profitable. Remember that subscription, usage-based and even one-time billing can co-exist for a business.
Usage-based need not to be always per unit. It can be based on volume, multiple attributes, range based etc.
The usage-based pricing model aims to provide flexibility to customers so that they pay for the value that they need. It is a value-centric flexible model, but does come with few challenges. If you plan to introduce this pricing model, please feel free to approach to me.
Author : Ashish Arya
Ashish Arya is an enterprise Lead-to-Revenue Solution Architect, with a vast experience of implementing QTC business processes for enterprise customers on the Salesforce Platform. He currently works as a Global Solution Director with Hansen.
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