Zuora
- Moving from boxed software to cloud-based subscriptions was a big change during the last recession.
- While that's still widely used, a new usage-based pricing model has quickly gained popularity.
- With another recession looming, experts say usage-based models will become standard.
When the Great Recession of 2008 hit, it proved to be a real opportunity for the tech industry to push a new business model: Instead of paying once for boxed software, companies like Salesforce, NetSuite, and even Google got their customers acclimated to getting billed as a monthly or annual subscription.
Now, a decade and a half later, the subscription model is the hallmark of the cloud-computing era. Incumbents like like Microsoft and Adobe and startups like Zoom all got on the bandwagon, making subscriptions the default way that many companies and consumers alike use software.
With another global recession looming, another change to the software business model is on the horizon, industry insiders say. Instead of charging one time for the software, or a monthly subscription, a new breed of tech companies is pushing so-called usage-based pricing, also known as consumption pricing.
"The best companies are saying, 'We want to have a mix of models that really accommodates all our different customers,'" said Tien Tzuo, the CEO of the subscription-billing-management company Zuora. "Different customers might want different things as well."
As the name suggests, the usage-based model sees customers only billed for what they use — no more, and no less. It's not exactly new: Cloud platforms like Amazon Web Services bill for the use of their cloud-hosted servers by the minute, and new-generation data companies like Snowflake charge for the data stashed on their platforms.
Experts predict the flexibility of this billing model will prove irresistible to customers, who are under pressure to stretch their dollars to the limit. That, in turn, will push companies large and small to at least explore the concept.
"If you think about the evolution of business models, it's always trended more and more towards being more friendly to the customer," Rishi Jaluria, a software analyst with RBC, told Insider. "It is very likely, in my opinion, that there will be more companies that are either on a consumption model or offer a consumption element to the model."
Usage-based pricing has drawbacks, but can ultimately pay off
The one drawback of usage-based models for the companies that offer them is a lack of predictability.
A company can make an informed guess about its next month's revenue based on the number of paying subscribers. But when you're paying based on consumption, a customer who uses the service a lot one month may not use it at all the next. That, in turn, leaves usage-based companies more susceptible to a downturn, since it's a relatively easy for customers to cut spending.
On the flip side, experts say that customers love that same flexibility, which could boost loyalty and overall usage.
In other words, the model forces companies to "earn customers' business each month," said Sanjiv Kalevar, a partner at the venture-capital firm OpenView. He says it's "the natural extension" of sending customers a bill every week, month, or year: "Why every month? Why not every week or every day, or every piece of compute?"
The flexibility also allows customers to feel like they're using everything they pay for.
"I think that it's important for providers to provide options to customers," the Gartner analyst John Santoro said. "So that when the customers become more price sensitive, they have options other than dropping the product entirely."
Hybrid-pricing models will become standard across the industry
While many analysts agree that usage-based pricing isn't going to be right for every situation, some believe that subscription pioneers like Salesforce may have to rethink their approach under the present circumstances. Its core software may not be billed by consumption, but it may find a future in going that route for additional services or tools that go beyond its existing model.
"I think that is a conversation Salesforce will have," RBC's Jaluria said. "Consumption models tend to lend themselves for now more at the infrastructure layer than the application layer, so it will take time, but I do think over time Salesforce will probably offer some sort of consumption-like element to their software, and customers will ask for it."
Ultimately, there will be a lot of hybrids between the two approaches, predicted OpenView's Kalevar. A company might sell its core product for a fixed recurring cost, and anything beyond that on a usage basis. That would give the vendors some predictability while also offering customers more flexibility, ideally landing on the best of both worlds.
"A lot of companies are choosing an in-between: between subscription and pay-as-you-go, what we call usage-based subscriptions," Kalevar said.
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