2022 was the year of uncertainty for many consumers and businesses. The effects of the pandemic were finally retreating, companies shifted to hybrid work environments, the economy was unstable, and consumers and businesses alike were faced with a looming recession.
It’s no surprise that consumer habits changed and continue to do so as markets fluctuate. With much of 2022 threatening a recession, nearly half of adults over 18 transferred their buying habits from “want” to “need” and 33% became more budget conscious.
While consumer habits are changing, the financial systems businesses use to manage, sell and bill their products have not kept pace. This technology deficit, along with challenging economic conditions, has put businesses under more pressure than ever before to ensure they’re being efficient in their spending to alleviate the financial impact of the past few challenging years.
One way they’ve adjusted is by embracing a subscription-based service offering because of its long-term advantages which include a consistent, dependable revenue stream, superior visibility into revenue forecasts, deeper relationships with customers that in turn can prevent them from churning and greater enterprise value.
In order to balance revenue streams and keep pace with changing consumer behaviors, businesses need to rethink their go-to-market and pricing options and, fundamentally, modernize their business models to meet evolving customer expectations effectively. This is a wake-up call for businesses to adapt and avoid being left behind.
One approach increasingly being used those benefits both businesses and customers alike is Usage-Based Pricing (UBP).
What is Usage-Based Pricing (UBP) and how can I implement it?
As its name implies, usage-based pricing is a model that only charges customers for what they use. Through UBP, customers can see exactly what they’re using and paying for, providing full transparency into their accounts and putting them in control to optimize usage and costs. By doing this, the price they pay aligns with the value they perceive, and churn is reduced. If customers don’t like what they’re spending, they can adjust their usage instead of canceling a subscription entirely.
Many businesses shy away from implementing a UBP model because they don’t have the systems to accurately track usage in real-time and monetize it through tiers of usage, overage on baseline amounts or other options. Additionally, it can be challenging due to new technical and process considerations, and, if it isn’t managed correctly, it can lead to inaccurate billing.
However, global enterprises urgently need to modernize their operational and financial systems to adapt to these modern revenue models, which will ultimately create new revenue growth opportunities, improve operational efficiency and reduce cost. The opportunity lies in turning a customer’s own behavior into recurring revenue. The key to this is mediation, or the process of automating the collection of usage data, metering that data and rating it based on who is using the data, what exactly is being used, how much and when. Doing this correctly, in real-time and on a massive scale is a challenge, but it empowers businesses to accurately capture usage and bill the customer accordingly.
Businesses across a wide range of industries are implementing this type of pricing model. For example, software companies that charge based on the number of API calls from their software each month and medical device companies that bill a flat monthly lease fee for imaging equipment with an incremental charge per image taken.
Why UBP is a win-win for businesses and their customers
Before the pandemic, with the influx of subscription-based offerings, if a customer didn’t like how much they were spending or couldn’t afford the subscription anymore, they would likely cancel their membership. UBP helps reduce churn and increases recurring revenue from existing customers, all while improving the overall customer experience. According to the State of the Cloud 2021, companies that use a usage-based pricing model average about 10 percentage points higher in net dollar retention than those that only deploy a subscription-based pricing model.
Additionally, by offering a UBP pricing model, businesses stay on top of their consumers’ habits because they have a core foundation of customer data and insights. Businesses are more in-tune with their customers and can tailor product offerings and marketing collateral based on current usage trends.
With UBP, businesses gain the agility and flexibility needed to respond to the changing needs of their customers. UBP also gives businesses the chance to grow at a much faster rate because their pricing model appeals to a much wider audience, attracting more investors, as businesses that incorporate a usage-based pricing model trade, on average, at a 50% higher revenue multiple premium over their counterparts.
But the benefits don’t stop there. Customers experience higher levels of satisfaction because they feel empowered and have control over their budgets and usage. It also gives them the flexibility they need to address their changing needs in real time.
Although UBP offers tremendous benefits to both the business and its customers, businesses should keep one thing in mind before implementing UBP into their pricing structure. Unlike subscription-based pricing, usage-based pricing does not offer as predictable of a revenue stream, since customers’ usage can vary each month. Despite these month-to-month revenues being less consistent, annual revenue should remain stable or increase.
Is it time to hop on the UBP bandwagon?
According to the latest OpenView report, adoption of usage-based pricing doubled in just four years from 2018-2022. And this trend shows no signs of slowing, as 21% of SaaS businesses that aren’t using usage-based pricing plan to launch or test this pricing model in 2023. In fact, data from the 2021 OpenView report noted that a quarter of UBP business models were introduced in the previous 12 months, concluding that “UBP will become the norm, not the exception.”
Businesses that want to retain customers and attract new ones must expand and change consumption options. They also must ensure they are supporting this with the technology and processes that enable them to do this properly, so they don’t compromise efficiency or customer experience. For example, automated features like data mediation built into the billing process mean businesses can rest assured they are providing customers with accurate invoicing information and avoiding costly mistakes.
Matt Ream is a Director of Product Marketing at BillingPlatform