As business software has developed during the past 30 years, the way in which it's paid for has also evolved.
In the 1990s, software applications tended to require large up-front purchases that usually had to be signed off by a senior executive. During the 2000s, this evolved into subscription models where line-of-business executives could enter into usage agreements and then terminate them if the applications were no longer required.
Now, in the 2020s, charging models are evolving once again. In many cases, applications run on cloud platforms, and customer usage can start with little (if any) upfront cost. The amount the customers pay for the software then increases as usage grows.
This user or consumption-based pricing model has some significant benefits. It allows resources to be dialled up (or down) as requirements change. It also allows a customer to match the resources being purchased with their actual requirements rather than needing to make predictions ahead of time.
Usage-based pricing also allows an organisation to take a ‘try-before-you-buy' approach to software selection. A new application can be made available to a small number of users, who can then check to ensure it meets their particular requirements.
The model also shifts the focus to software vendors. They become very committed to the success of their customers as this is the only way they will be able to grow their own business.
The adoption of usage-based pricing is growing quickly. As well as many new software vendors making their offerings available this way, several established players have also worked to shift from outright purchase or subscriptions to this new model.
Making the change
Five key steps need to be taken for a software company considering changing to a usage-based pricing model. They are:
- Choose the right usage metric: It's important to choose a metric that clearly communicates your product's value to prospective customers and how this will increase over time.
- Rethink your revenue playbook: Changing to this model will alter the way in which revenues are received. Take time to ensure your planning and processes can be aligned with this new income stream.
- Modernise your sales compensation structure: Sales teams will no longer have the same monthly or quarterly targets to meet, so compensation will need to be calculated over a longer period using a different approach.
- Help customers predict and optimise their spend: In many cases, this will be a new experience for customers, so take time to help them understand the approach and its impact on their spending patterns.
- Leverage data: Implement modern tools that can help estimate future customer demands so that the underlying infrastructure can be scaled to match.
This final step is particularly important as shifting to usage-based pricing will require a different way to estimate revenues. When customers take out subscriptions, the vendor knows with certainty how much they will be paying over the life of the contract.
With usage-based pricing, this is no longer the case. As a result, software vendors will need to develop new usage and revenue forecasting models that show how revenues will grow over time.
While many customers may follow a similar usage growth path at first, those paths are likely to diverge as the commercial relationship matures. Therefore, it will only be through careful monitoring of behaviour and spending patterns that accurate forecasts will be possible.
It's also worth a vendor taking the time to fully understand what impact its software is having on customers and over what period. If that software is resulting in a sustained increase in sales activity, for example, this will likely translate to increased usage revenues over a similar period.
The future of software
Because of the significant benefits to both software vendors and their customers, usage-based charging will likely become an increasingly popular approach in the coming years.
Taking the time to understand the implications of this shift will allow vendors to deliver products that closely match demand and customers to scale their resources as their requirements evolve over time.