During the past decade, the subscription pricing approach has been widely adopted. After all, many tech companies have built thriving businesses with this business model, such as Salesforce.com.
Then again, subscriptions provide simplicity and predictability for customers. As for the vendors, there is the benefit of recurring revenues.
But as for the past few years, there has been a change—that is, a growing number of fast-growing tech companies, like Twilio, Snowflake, Jfrog, Stripe and DigitalOcean, have been eschewing subscriptions. Instead, they have focused on usage-based models.
Why so? Well, first of all, there are some problems with subscriptions. Perhaps the biggest is that customers often purchase licenses that they never use. This has actually been made worse during the COVID-19 pandemic.
“In general, we’re all users of a variety of subscription models and we’re super frustrated with them,” said Khozema Shipchandler, who is the Chief Financial Officer at Twilio. “You’re locked in from the start. There’s no room for movement and no way to account for the peaks and valleys that inevitably fill any business season such as the holidays, increase or decrease in demand, etc. In fact, the subscription model is increasingly becoming a relic of a bygone era. In my opinion, it will ultimately disappear.”
But with the usage-based pricing model, there is much more flexibility. It’s easy for a customer to try a new service and evaluate it for a negligible cost. This approach has proven quite effective with developers.
“A lot of times, especially for us, developers are the ones who get started with it first,” said Shipchandler. “They see how easy it is to use our products, they get a use case up and running, and the customers start benefiting without a major decision maker having to weigh in.”
There is also an alignment of interests between the vendor and the customer. If the service does provide value and is used frequently, then the customer will definitely be willing to pay more, right? Definitely.
“Adopting a usage-based model is the ultimate realization of being a customer-obsessed company,” said Kyle Poyar, who is a Partner at OpenView. “There’s no room for shelfware or bad user experiences. The upside is that you directly share in the success of your customers, which pays dividends years into the future.”
He points out the following metrics for those companies using the usage model:
- 38% faster revenue growth rate than their peers.
- Stronger net dollar retention rates (seven of the nine most recent IPOs of cloud companies have shown this).
- 50% higher revenue multiples versus the broader SaaS companies.
Of course, the usage-pricing model will not suddenly transform a company. There still needs to be a strong product and a top-notch team.
Yet it still a good idea to evaluate the usage model. If anything, as it becomes more common, customers may demand this approach.
“I strongly believe a consumption model is the future for software because it changes the fundamental nature of the relationship between the vendor and the customer,” said Bill Staples, who is the President and Chief Product Officer at New Relic. “The vendor understands that if they don’t build great products that customers enjoy using, they won’t get paid. And consumption isn’t just a revenue model. It is the explicit understanding that if we aren’t focusing every function in the company around making our customers successful, we aren’t living up to our commitments or our ability.”