Also known as pay-as-you-go or usage-based pricing, a consumption-based pricing model enables customers to pay for what they use or consume – no more, no less. In contrast to subscription pricing models, consumption-based pricing is on the fast track to becoming the pricing model of choice for many businesses.
While consumption-based pricing isn’t right for all products, services or companies, we’re seeing an increasing number of software-as-a-service (SaaS) businesses migrate to this pricing model. Before counting down the benefits of a consumption-based pricing model, let’s see how incorporating a consumption-based pricing model helped put one company on the road to being a multi-million dollar success.
The company we’re referring to is HubSpot. Founded in 2006, HubSpot is a provider of marketing, sales, customer service and customer relationship management (CRM) software. In the beginning, HubSpot offered three subscription-based packages. However, they struggled with customer churn, resulting in net revenue retention (NRR) rates (aka recurring revenue from existing customers) in the low 70’s – nowhere near the 100%+ that most SaaS companies strive to achieve. In 2011, they launched a consumption-based pricing model that delivered almost immediate improvements. By 2014 net revenue retention reached nearly 100%.
What is it about consumption-based pricing that can have such a positive effect on a business, and what other benefits does this pricing model deliver?
A Consumption-Based Pricing Model Delivers Value to Businesses and Customers Alike
Although not as clear-cut as other pricing models such as flat-rate, consumption-based pricing is a win-win for businesses and customers alike.
- Provides the agility and flexibility to quickly respond to changing business and customer needs.
- Enables businesses to grow faster with price points that are attractive to a larger customer base.
- Eliminates or shortens purchasing cycles.
- Improves customer retention by allowing customers to upgrade or downgrade based on their needs and budgets.
- Reduces revenue leakage, as you’re better able to optimize product and service usage.
- Allows you to quickly experiment and test various recurring revenue and consumption-based pricing combinations.
- Enables you to collect copious amounts of data on how customers use your products and services.
- Delivers a competitive advantage by enabling you to combine consumption-based pricing models with additional features or options to create differentiated packages and bundles.
- Increases investor appeal – on average, companies that incorporate a consumption-based pricing model trade at a 50% higher revenue multiple premium over their counterparts.
- Improves customer satisfaction since customers can easily equate value to price.
- Empowers customers to take advantage of only the features and options they need.
- Gives customers greater control over their budgets since pricing is directly related to usage.
Now that you have a better understanding of the key benefits, the question becomes – are there any disadvantages? As with any pricing model, the answer is yes. Unlike basic subscription-based pricing models, usage fluctuation can result in a less predictable revenue stream. Does this have to be a negative? Absolutely not. Although your monthly revenue may rise and fall depending on if you’re retaining customers and/or acquiring new ones, your annual revenue should remain stable or increase.
The next question that may come to mind is – Is a consumption-based pricing model right for my business? To answer this question, a second question is needed – Are you able to accurately and easily break down your products or services usage units? If the answer is yes, then implementing a consumption-based pricing model may be the right choice for your business. To acquire the data you need for this pricing model to be successful, you need three primary components – metered billing, mediation, and billing.
The 3 Components of a Consumption-Based Pricing Model
Like all pricing models, your billing system takes center stage as a key component, and a consumption-based pricing model isn’t any different. To help determine the right billing platform for your consumption-based pricing model, we’ve listed the 3 necessary components for a successful consumption-based pricing strategy.
Primary to the success of a consumption-based pricing model is your ability to track the exact amount of usage. Metered billing (aka usage-based billing) incorporates a unit of usage (i.e., for electricity companies, this is Watts and kilowatts) and charges a fixed amount per unit used.
Since all data isn’t always presented in the same format, a mediation engine is needed. That way you can collect and convert raw usage data from multiple sources, filter out unnecessary usage records, and route the information to be rated and billed. For instance, in the case of Voice Over IP (VoIP), mediation captures and normalizes data such as call duration, the transfer of megabytes of data, pricing for video usage, and the number of text-based messages from short message services (SMS) or multimedia messaging services (MMS).
When data doesn’t come through a mediation engine, billing will intermittently measure usage throughout the billing period. At the end of the billing period, billing uses the usage information to determine the price, plans, how to charge, and other pricing strategies such as discounts and promotions.
Isn’t it Time to Update Your Pricing Strategy?
To get the most from a consumption-based pricing model, you need a powerful billing solution. One that delivers automatic rating, data mediation, and invoicing. Unlike other cloud and legacy billing solutions, BillingPlatform aggregates and analyzes usage data from any source and transforms it into revenue potential – in real-time.
Isn’t it time to capture the advantages of a consumption-based pricing model? This pricing model gives you the freedom to let your imagination soar and develop pricing strategies that boost your revenue potential, reduce churn, and put you on the fast track to gain a competitive edge. Talk to our experts today if you’re ready to learn more.