How you charge is often more important than what you charge when defining your pricing strategy. There are a lot of moving parts to a pricing model, and yet it’s a topic that lacks clear, simple definitions. Below is our attempt to bring clarity to the complex area of pricing.
The combination of decisions you make to charge your customers is what I define as the ‘model’. It’s the detailed set of rules which determine how you will charge your customers.
Of these, the ‘metric’ is one of the most important decisions. You can think of the metric as essentially what the customer buys; whether that’s a license to software or an hour of compute resources. It’s the unit by which payment in the model ticks over.
Metric and model decisions are crucial, because they take time to execute and can be difficult to change. Plus, selecting the wrong metric and model can torpedo your chances of maximising revenue if they do not scale well with customers’ willingness to pay. These are therefore decisions that require careful consideration and scrutiny.
“I'm a big believer in the fact that if you can align with the interests of the party that you're serving, then that's the best way to go”, says Richard Valtr, founder of Mews, a property management system for hoteliers. Mews has achieved tremendous growth by remaining hyper-focused on what success looks like for their customers, creating win-win outcomes by aligning how they charge to the business cadence of their customers.
There are essentially five approaches a business can take to charge its customers. Multiple approaches can also be used in combination. Below, we offer definitions as well as some simple examples to solidify your understanding
Ownership: The customer pays a one-time fee for the right to use a product in perpetuity. The customer owns the product and is free to use it as she wishes (with potentially some conditions attached). Example: purchasing a server.
Access: The customer buys a license to use a product under a set of conditions. The conditions of the license are likely to include who can use the product, for what use cases the product can be used, and for how long. The customer essentially rents the product for a fee, she does not own the product or have the right to use the product/service in perpetuity. To maintain access, the customer will need to pay a recurring fee. Example: paying for a user license to Salesforce.
Consumption: The customer pays only for her usage of the product. A set of conditions will still limit what the customer can and cannot do. How consumption is measured will vary widely between propositions but will generally be based on inputs, activities, or transformations. Example: paying for compute from AWS.
Transaction: The customer pays a fee based on the value of a monetary transaction between two entities, which could be individuals or businesses. The fee is usually levied as a percentage of the transaction value, or as an amount per transaction; hence this model is typically used in financial services. Example: paying a payment processing fee on PayPal.
Note that both consumption and transaction based pricing models are examples of reoccurring revenue streams; i.e. the charges occur periodically or repeatedly but not with the same level of predictability as a recurring pricing model, such as a subscription. Consequently, they can be more difficult to forecast.
Outcome: The customer pays a fee based on the economic benefit that the product or service delivers. This is typically very difficult to execute, and is rarely seen, but is the ‘holy grail’ of value-based pricing. In order not to over-complicate the number of approaches, I would include insurance and assurance products and services here. Example: a venture capital fund taking a share of profit in the form of carried interest.
A key dimension to consider when selecting an approach for your business is to ask who bears the most risk in the event lack of adoption and use of your product/service. If you were to sell your product in perpetuity, it would be entirely the customer’s responsibility to get value out of her purchase.
A subscription for access to a product or service shares risk more equally between supplier and customer. The supplier would earn fees for a time even if the customer was not using the product, however, eventually, the customer would churn.
Consumption based pricing places the majority of risk with the supplier: if the customer does not use the product, the supplier will not get paid. The same applies to transaction-based pricing and to an even greater extent when pricing is based on outcomes.
Consumption based models are therefore increasingly aligned with customer success, presenting a win-win opportunity for both supplier and customer. In the Technology and Services Industry Association (TSIA)’s book ‘Consumption Economics’, they make an impassioned argument for suppliers to pursue consumption-based revenue models to best align the interests of suppliers and customers and drive great outcomes for both parties.
Establishing the right model is only half the story. The model operates with a metric: you must decide what the user is actually paying for.
As we saw briefly above, metrics are as infinite as businesses – users may be paying for a month of access, an hour of usage, 100MB, a whole box…
The right metric will depend on the nature of your proposition, how it delivers demonstrable value to your customers, your commercial objectives, and your customers' preferences. There are a number of considerations to take into account, but by systematically identifying the options available and evaluating them through the lenses of both your business and your customer’s needs, you will be well prepared to make smart metrics decisions.
A note on volumetrics: An additional decision you will need to make is how prices change as the volume of your metric increases. Customers are generally going to expect a lower price per unit of metric as they purchase higher volumes, due to a better negotiating position. My advice here is to use real negotiations and market feedback to fine-tune price-volume curves, and not second guess where negotiations will end up.
Models and metrics are not necessarily exclusive. Mews charges subscription fees for its platform, transaction fees for the processing of payments and additional fees for third-party products purchased through its marketplace. Customers can choose to process payments outside of the Mews system if they wish; however, by leveraging Mews’ integrated solution, the customer gains benefits beyond just the processing of payments in the form of greater convenience and productivity. The addition of payments as a revenue stream ultimately enables Mews to capture a greater share of the value chain.
Easol, an all-in-one platform to help ‘experience’ businesses manage bookings, payments and marketing, also leverages a dual SaaS subscription (to use the platform) and payments (fees per transaction by end-customers) revenue model. This proved especially valuable during the COVID lockdowns as the business could still generate revenue from subscription fees, even though events had stopped. In Easol’s case, multiple revenue models produced a more robust commercial profile to cope with market disruption.
Finally, let’s remember that customers should be at the heart of your pricing strategy. They are going to have different preferences over how they would prefer to be charged. It’s important to take these considerations into account, potentially offering different models to different customer segments.
Low spending small customers who are new to your proposition are likely to prefer a consumption based model, or access based model with compact license rights, where they can keep the commitment low, and grow over time as they see the value. A larger, big-spending customer who is familiar with your proposition might prefer an unlimited usage model, even if it means a higher fixed fee, as they are likely to value cost certainty. Consider each customer persona and their preferences when designing your model.
A success-based pricing model for SaaS founders. Stephen Millard and Richard Valtr
Consumption Economics. J.B. Wood, Todd Hewlin, Thomas Lah