The future of software is usage-based pricing

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All software companies preach customer focus. However, the common subscription pricing model for most cloud software is anything but customer-centric.

In a subscription pricing model, customers must choose to pay a recurring fee per month. The recurring fee is determined in advance before the purchase of the software. It is generally calculated based on the cost of a license multiplied by an estimate of the units of that license required over the next year or a longer contract period. These subscription models are a great I deal with the software vendor because they get paid for the term of the contract, even if the software is not being used. That is not so good for you as a customer. If you use too little, you’re wasting your budget on shelving. If you use too much, you will be caught in excess fines.

Compare that to how we consume water in our homes. The resource is always available and you can accelerate its use according to your needs. When you decide you need an extra long hot shower, or have guests visiting, you simply consume what you need and then pay for the additional value you received. It is intuitive and predictable with a price based on the value you receive. Now imagine if we subscribed to a certain amount of water usage each month. Why should you pay for the water you didn’t use because you installed more efficient showers? That is unfair. Or worse yet, why should you risk running out of water because your guests took a long shower? That just doesn’t make sense.

Like water at home, software has become a utility at work. That is why consumer prices for software are increasingly becoming the norm. Amazon Web Services (AWS) is a great example. It popularized consumer prices, where customers only pay for the capacities they use and from which they derive value. Since then, several other high-profile, high-growth software companies have adopted this model successfully, including Twilio and Snowflake. And the data supports this trend: according to the SaaS Pricing Survey 2021 From OpenView Venture Partners, 39% of SaaS providers now offer usage-based pricing compared to approximately 23% in 2014.

Pricing based on consumption or usage fundamentally shifts the relationship between software companies and their customers away from unfair subscription models and towards an inherently fair exchange of value. By aligning revenue with usage, software companies understand that they won’t get paid unless they create products that customers enjoy and that realize value with every use. Companies that continually innovate and deliver differentiated value will be rewarded with accelerated revenue growth and customer loyalty, and the virtuous cycle continues. Consumption is more than a business, pricing, or income model; is the commitment to focus every function in a company on making customers successful and ensuring that they get real value from their platform, products and / or services.

Today, it is clear that consumer prices will continue to gain acceptance as the business model of choice for customers, from hyper-growth startups to the largest global companies. Looking back and building on our conversations with customers, here are three factors we learned that will contribute to continued consumer pricing success:

  • Consumer prices make it easier to get started: The subscription price forces an initial commitment, which is an artificial barrier for customers to know if the software will be useful to them. Sure, 15-30 day trials help, but that’s too short a period for anyone to really understand the value. In contrast, consumer prices allow customers to get started for free and without any obligation. Customers can scale as they find value and only then pay for the value they get. Internally at the software vendor, this model also frees customer-facing teams from negotiating and renegotiating complex deal structures and allows them to focus on ensuring that customers get value. collaboratively helping to drive engagement and increase product utilization based on customer needs.
  • Consumer prices provide more flexibility: The “all or nothing” aspect of subscription pricing can negatively impact customer satisfaction and retention. As we’ve seen through the global pandemic, when businesses are forced to cut costs, they may no longer be able to keep up with a high flat rate. Consumption-based pricing enables customers to accelerate and support that consumption in real time as business needs evolve, creating a better customer experience and inspiring loyalty. It also alleviates the customer’s burden of managing the software and high upfront costs. In other words, you really transfer cost control to the customer. As an example, the hospitality industry has understandably suffered over the past 18 months, having to rapidly downsize or make changes to its supply models to align with declining demand.
  • Consumer prices are more scalable: As we have seen in the last decade, today’s startup can be the global company of tomorrow. Consumer prices offer an attractive option for growing businesses that may need to scale quickly in the future. With legacy subscription pricing, scaling requires renegotiation and re-hiring, which can be time consuming and creates additional pressure for companies trying to scale quickly. Just as consumer prices offer the flexibility for customers to cut back when needed, it makes it easy to scale quickly and keep pace with rapid growth; no new contracts or negotiations are required to use more software. As a recent example, consumer price scalability was adequate to support the sudden and rapid growth of the digital business and accelerated innovation timelines brought on by the pandemic. In just a few days, businesses had to scale their digital presence faster than ever, including grocery stores, meal delivery apps, video conferencing tools, online education apps, video streaming platforms, exercise apps and more. Thanks to consumer prices, the path to meeting customer demand was straightforward.

However, as with all changes, consumer pricing has its critics. The main concern revolves around the company’s IT budget controls. Many IT teams, especially in larger companies, have to manage their software expenses on a monthly budget. A sudden spike in software costs due to increased usage in a given month, without the proper controls to streamline the usage surge, is a terrifying proposition. There is a strategic solution to address this “stay on budget” concern: offering real-time usage reporting, as well as an “Annual Pool” option. Real-time usage reports allow administrators to get complete visibility into how their teams are using their software tools and receive alerts on changes in usage patterns. In this way, they are always in the know, they can be sure that increased usage is of value to the business and, if necessary, slow down. The Annual Fund of Funds option should / could provide customers with the ability to pay for their use over a 12-month period and accommodate seasonal peaks and troughs in use with monthly renewals. Together, these capabilities give IT teams the controls and confidence they need to adopt consumer pricing models. Twilio, AWS, Stripe, and other major SaaS companies have been successful with this next evolution in software pricing.

In short, consumer prices will eventually become the de facto standard for all software companies. It’s the latest step in the software industry’s three-decade journey to put customers’ best interests at the center of everything they do. It’s about aligning with customer success. Forward-thinking software companies will continue to embrace this model as true vendor partners. Those who don’t evolve run the risk of seeing an erosion not only of their top-line growth, but also of customer trust and loyalty.

Manav Khurana is Director of Growth at New Relic. He previously held product and marketing leadership positions at Twilio, InVision, Aruba (HPE), and Motorola.

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