Making a case for consumption-based pricing

In the past decade, software innovation has moved at the speed of light. Cloud based software solutions have enabled companies of all sizes to modernise, developing technology stacks and businesses rapidly and effectively. But commercial strategies surrounding these innovations have often struggled to keep pace. Born at the end of the 90’s – when software was essentially sold as fixed price perpetual licenses – cloud based software solutions remain largely priced through unit-based pricing and an array of complex unit counts. Assorted with a commitment in the form of a one year or multi-year subscription and upfront payments. These often led to under-utilisation and shelfware or overage fees, causing frustration and difficult conversations at the time of renewal.

With increased reliance on digital experiences, Gartner forecasts worldwide end-user spending on public cloud services to grow a staggering 23% this year alone. But as software becomes easier to build and distribute, the way we buy it must also change.

Enter consumption-based pricing, also called usage-based pricing or consumption modelling, which is set to take centre stage in cloud-based services and the Software-as-a-Service (SaaS) market. What does consumption-based pricing mean, how will it benefit your business, and why is it leading the future of the technology industry? Outlined below, is a case for why consumption-based pricing is fast becoming mainstream and a leading model in the software industry.

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Consumption-based pricing 101

Consumption-based pricing, or usage-based pricing, is a model that’s based on paying for what you use – and not paying for what you don’t use. This is already widespread in our private lives from a number of industries. For example, utilities companies typically charge water or electricity based on meters; the resource is readily available and as a consumer, you have full control on how much you use, and hence how much you pay. Creating a direct link between cost and value. Consider, how it differs from unit-based subscription pricing, for instance for a mobile phone package, where you need to make multiple up-front assumptions on your needs. Most of the time, you get your initial sizing wrong, only to discover after a few months that your actual roaming, telephony, SMS or data usage widely underutilise your package in some areas and exceed it in others. Either wasting money or triggering unplanned additional charges.

Challenging traditional models

Usage-based business models have now hit the cloud and SaaS scene and are challenging historical unit-based subscription models.  Amazon Web Services (AWS) actually pioneered this move to consumption on the premise that customers should only pay for the products they use and from the value they get. Since then, several other high-profile, high-growth software vendors have adopted this model with success, including Twilio and Snowflake. The trend is strong, and according to the 2021 SaaS pricing survey from OpenView Venture Partners, 39% of SaaS providers rely on usage-based pricing as compared about 23% in 2014.

As cloud and SaaS adoption continues and accelerates, I believe consumption based is set to become the standard. It is value-based, fair, simple and predictable. It removes the hurdle of high upfront payments, overloaded feature packages and flattens complex fee structures hiding millions of combinations. It also fundamentally changes the rapport between solution providers and customers for the better. Aligning service providers, all their employees and their success to how customers really use their products and the value they get by using them. Software companies who keep innovating and provide differentiated value in this model will see accelerated revenue growth and an increase in customer loyalty. So, consumption-based pricing is not simply a business mode for service providers; it is a commitment to focus the entire company on customer success.

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The benefits of consumption-based pricing models

According to an IDC survey, 61% of enterprises agreed that their organisations are aggressively shifting toward paying for technology services based on consumption. This highlights the appetite for this value model in the SaaS market. Here are three reasons why consumption will continue to gain acceptance as the preferred business model by SaaS providers and their customers, from large enterprises or hyperscale digital natives:

  1. It’s easier for users to get started: unit-based pricing can cost a lot for small or emerging businesses. However, consumption-based pricing enables customers to start at the entry-level and scale up as needed. This is appealing as some businesses’ needs can be met through using free software tools before needing to upgrade to paid subscriptions. Being able to start on a much smaller scale also frees sales and customer-facing teams from focusing their time on negotiating complex deal structures to turning their attention to other matters. This includes ensuring customers achieve value, are driving engagement and increasing product utilisation.
  2. It makes happier customers: legacy subscription models took an archaic approach to selling. Customers had to be all in, or all out. This often resulted in poor customer satisfaction and retention, as companies forced to cut costs could not keep pace with a high flat rate upfront fee. Consumption-based pricing, on the other hand, enables customers to tailor their up-front commitment and use in accordance with their business needs. It’s more customer friendly. Consumption can then be scaled in real-time, which in turn, creates a better customer experience and inspires loyalty. This is of paramount importance in a post-pandemic world, where businesses must prime themselves for ongoing uncertainties and turbulent change.
  3. It embraces scalability and agility: the pace of the technology industry means today’s start-up can be tomorrow’s global enterprise. Consumption pricing is an attractive option for fast-growing businesses who may need to scale quickly in the future. Furthermore, this model provides customers with the agility to pursue a land-and-expand business approach, starting small but driving growth by delivering consistent value.

Preparing for the future of observability

One particular area of the SaaS market that is ripe for consumption-based pricing is observability – giving software developers and engineers the tools and capabilities they need to get a real-time view of their company’s digital architecture. Allowing them to manage uptime and performance, maximise customer experience and increase velocity of the development cycle. Furthermore, instrumenting software and unifying telemetry in an observability platform enables developers and engineers to make data-driven decisions, detect issues early, troubleshoot and resolve problems quickly, and continuously improve technical and business performance.  Observability has also become essential to DevOps teams so they can maximise their software and cloud investment, innovate and grow the business, keep pace with competition and market shifts, and win over customers.

Setting up for a successful future

The consumption-based pricing model is leading the future of the SaaS market by providing businesses the scalability and agility they need to operate in a post-pandemic era. As organisations explore the next phase of software development and embrace Cloud, SaaS, DevOps and observability, consumption economics will play a key role. Giving companies the accessibility they need to experiment with the latest software innovations and to secure predictable value as they scale. The sooner businesses adopt consumption-based pricing models, the quicker they will be able to pave their path to sustainable growth and success.

Written by Greg Ouillon, field CTO EMEA at New Relic

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