STRATEGIC GUIDANCE
Consumption Based Pricing
As companies tighten budgets during uncertain economic times, aligning your pricing to the value your customers get from your product or service has never been more critical. Customers will always prioritize and continue to invest in products that they deem valuable, so creating that flexibility for them as their needs change is key to retaining your loyal customers. Using a consumption based pricing strategy companies can create that close value alignment, but there needs to be a balance between the right amount of flexibility to offer your customers while still having revenue predictability as a business.
In this guide we will discuss:
- What is a consumption based pricing model?
- What are some common consumption based pricing models?
- What are the advantages of a consumption model?
- What are the challenges of consumption pricing?
- How can Zuora help me implement and optimize for consumption pricing?
What's a consumption based (or usage-based) pricing model?
A consumption based pricing strategy is where usage is one of the metrics that make up the overall price. The provider tracks the usage metric (or multiple metrics), then bills accordingly; also known as metered billing, or usage-based pricing. The model has been used for decades by utility providers like gas, electric, and water services, but increasingly more B2B and B2C enterprise businesses are taking advantage of this style of pricing to create and nurture valuable subscriber relationships
As business needs fluctuate, there’s a real need from your customer for this type of flexibility.
One of the key reasons behind the shift to consumption based pricing is that price-sensitive customers want a clear picture of what they’re using and how much it costs. The metrics to consider should offer a positive impact on the business, as well as highlight the full customer value. Companies can see real value with this model, but so can the customer:
What to think about before executing on a consumption pricing strategy:
- Determine the correct value metric.
This metric should not only be a metric that your company can track, but satisfies value alignment, leaves room for growth, and offers predictability both for the customer and your business. A few common metrics are number of users, amount of data consumed, or number of events
- Determine your consumption model.
Within consumption pricing itself, there are variety of different strategies you can take advantage of. From the most flexible pay-as-you-go to more nuanced consumption models like prepaid with the ability to draw down units over a period of time, or even coupling consumption pricing alongside flat fee and subscription pricing, companies have a wide range of options at their disposal.
- Mediate and rate customer usage.
Depending on the type and sources of data, usage may need to be mediated which involves collecting, cleaning, and routing data. After the usage data has been summarized, a price needs to be assigned to them to be able to accurately charge your customer.
- Bill your customer.
Once usage has been rated, you now have an accurate set of charges to send an invoice and bill your customer.
What are some common consumption based pricing models?
Pay-As-You-Go
With this model, customers pay for what they use. This is a solid option for businesses with unpredictable needs, and this method does come with spikes in usage and those associated costs. This option gives the most flexibility for customers to consume only what they need.
Overage Pricing
With overage pricing, you decide on different packages for your value metric at different price points and then charge extra if a customer exceeds the usage in their package.
Minimum Commitment
This allows you to charge your customer at their commitment level on each invoice, even if they don’t fully consume the committed usage amount, which is reflected toward the minimum commitment. With this model, businesses have a level of predictability into revenue expectations given the customers commitment level.
Pre-paid with drawdown
Customers pay upfront for a set of units (or hold a cash balance) that is drawn down from over a period of time. This offers a mix of both flexibility for customers in terms of choosing a pre-paid amount and revenue predictability for business.
Companies are making more considerable investments in consumption strategies across the board. It’s the smart move for a specific business, considering it’s a growth pattern that packs a real punch. EY’s data shows that 61% of companies are looking toward consumption within the next three years.
If you’re considering going the consumption-based route, consider whether this method works for you and your goals. We’ll line out both and show the pluses and minuses so you’re armed with the information to make informed choices.
What are the advantages of a consumption model?
Lower adoption barriers
Consumption pricing gives customers the ability to “start small” and grow with you since consumption pricing can be increasingly flexible. Because the barrier to entry is lower, customers can see the product in action and consider if they want to sign up for a more robust package when the time is right. This also helps customers control, track, and ultimately predict their costs thanks to a transparent process that is true to their usage via billing.
Retain loyal customers
Consumption pricing gives your customers greater ability to use only what they need when they need it. As their needs change, consumption pricing adapts to that and can scale up or down with them. With consumption pricing they are also able to see, and stay up to date only exactly what they’re paying for.
But then, there are challenges with consumption-based pricing, too.
What are the challenges of consumption pricing?
Implementing a consumption-based pricing strategy can present its challenges. Companies need to balance value and generate enough cash to cover costs. It’s a balance because pricing high could put some customers off while pricing too low will result in a loss. Implementing consumption-based pricing requires planning and consideration of risks and challenges.
Legacy systems are not built for consumption
Today’s CRM and ERP systems are still built on the basis of handling one-time product fees, and are often not able to fully support consumption pricing models without significant customization efforts. Consumption models require the ability the quote, meter, rate, and add up all of those charges. For consumption models that require granular visibility, that doesn’t only mean totaling up usage at the end of a billing period but rather knowing exactly how much your customer has used at any given time. The time and money spent on retrofitting these systems can not only stall initiatives, but result in rigid, hard-coded pricing, making it challenging to iterate on in the future.
Billing operations become complex
Consumption charges are typically billed in arrears (after the billing cycle), which may be different from the way your billing team operates today if your customers are typically billed in advance. This new process for billing in arrears means that billing teams will have to ensure charges are calculated accurately, invoices are sent out on time, and they maintain billing operations for customers who may not be on a consumption model. Often this means that billing teams are having to work out of multiple systems to collect the data they need for accurate billing.
Revenue recognition and reporting can be challenging
Under ASC606 and IFRS15 there are specific revenue recognition rules that accounting teams will need to adhere to. Without a system in place to handle complex consumption revenue recognition, this could lead to manual efforts and hundreds of lines of spreadsheets to reconcile, putting your business at risk for financial compliance. In addition reporting and forecasting consumption revenue is critical for business leaders to have not only to report to investors but for strategic planning. Companies must be able to have granular visibility into their consumption revenue at any given time, especially with the fluctuation some consumption models can bring.
How can Zuora help me implement and optimize for consumption pricing?
Zuora is helping companies unlock resilience through flexible, out of the box consumption monetization models. Here are some ways Zuora can help your business:
Iterate quickly with consumption pricing strategies through flexible out of the box monetization models
After helping hundreds of companies like Zoom, Siemens, and New Relic monetize their offers with the best pricing strategies, Zuora has differentiated expertise on how to find and implement the right consumption-based offers to provide even more flexibility to your customers. We’ve turned these best practices into a set of pricing models for businesses to easily launch and test out of the box, in order to perfect their monetization strategy and retain loyal customers by closely aligning value to their services. Out-of-the-box monetization models, such as prepaid drawdown, minimum and maximum commit, pooled usage pricing, give businesses the ability to quickly react and adapt to their customer’s needs.
Reduce the risk of consumption strategies with automated consumption revenue recognition
Consumption-based reporting, dashboards and analytics, allow companies to operationalize and automate consumption revenue recognition policies. This enables Revenue Accounting teams to better predict, forecast, and mitigate financial risks related to taking on the consumption-based pricing models.
Provide near-real time visibility helping increase revenue forecasting and drive customer retention
Zuora provides near real-time consumption processing, consumption analytics, and the ability to push out threshold notifications allowing customers to monitor their spend. The same capabilities enable companies to monitor and forecast expansion opportunities for customers with high consumption.
With Zuora, we’ve implemented consumption in a variety of ways that provide immediate value, increasing flexibility for our customers while making revenue more predictable. By powering these models, Zuora is a critical partner that is helping us achieve stronger retention and faster growth.”
Moshe Sarusi – Director of Finance Operations and Global Billing, Yotpo
See Zuora’s Consumption Solutions in action:
ZUORA PLATFORM
Advanced Consumption Billing
ZUORA PLATFORM
Consumption Revenue
Since 2018, the rate of companies adopting consumption pricing has doubled, with over 60% planning to test or launch a form of consumption pricing. If you’re already taking advantage of consumption pricing or considering adopting, Zuora’s market-leading solution now provides end-to-end billing and revenue recognition for consumption based pricing, giving companies a comprehensive solution to quickly iterate across quote-to-cash and revenue accounting. With experience powering consumption-based billing for hundreds of companies over the past decade, such as Zoom and Siemens, Zuora offers numerous complex models, while helping companies overcome the operational complexities that can come with consumption based pricing.
Let’s talk if you want to level up with consumption based pricing.