Are you paying for what you use?
This is a tricky question to answer. Whether you bought a 2-dollar pen or signed a multi-million dollar deal, this query hinges on the mind. Being a marketer, who decides on pricing as part of the marketing mix, this question intrigues me personally.
A 2014 IDC report* indicates 96% of enterprises admitted of wasting money on unused software / shelfware that accounts to 21% of investments. Pay for what you use or consume exist in few utility services such as ‘electricity, phone, gas, taxi, and hotels’ – with a rider of minimum quantity norms and slab based pricing. With the advent of cloud technologies and Internet of Things (IoT) that enable businesses to track usage, we need to have a clear consumption driven pricing mechanism.
In every sphere of life we pay for more and consume less. This article raises critical aspects of consumption driven pricing and seeks answers to questions such as (a) Are traditional pricing models (market driven, cost plus, value pricing) capable of addressing it? (b) How the current practices of volume pricing should change to address consumption? and (c) Is ‘pay as you go’ pricing cheaper than prepaid ones?
If you believe you should only pay only for what you use, reduce ‘shelf’ware, and increase consumption efficiency, please continue reading.
Inadequacies of traditional pricing models
(The need for a consumption driven pricing)
Pricing is a key ingredient in the marketing mix. Traditionally, the market driven pricing, cost-plus pricing and value based pricing are used by organizations to determine pricing. The market forces such as competition, the purchasing power, and supply-demand situations drives the market based pricing. The inside-out method of determining the costs and marking up to calculate prices are followed in the cost-plus and time & materials (T&M) pricing models. Value-based pricing is a pricing strategy that sets prices primarily on the value, perceived or estimated, to the customer and their willingness to pay (WTP).
None of these pricing models address the nature or quantum of consumption. Even the most disruptive businesses haven’t taken a shot at it. For example, Airbnb disrupted the hospitality business, though it did not question why a minimum booking is for a 24-hour day. According to American Hotels & Lodging Association (AHLA) about 41% of business travellers stayed just one night in a hotel. Some key questions around this statistics, would be,
- How many of us have stayed for more than 12 hours inside the room, during the one night stay? Then why the pricing is for minimum 24 hours?
- Do all the air flights or trains that we commute land by 12-noon? If no, why is there a 12-noon check-in? This reduces the consumption, as most travellers head out to their business activities once they land, as there is no way they could check-in by an early hour and relax a bit, before their meetings. This results in a late evening check-in, after the meetings, and an early checkout to catch the morning flight. In short, end up paying lot more than what is consumed. There are a few hotels that offer 24-hour checkout contrary to vast majority offering noon checkout.
- Does this pricing model help optimize the space availability, specifically in the cities that are short of hotel properties? If there is a business event or a social gathering, most hotels are sold out in no time. By blocking 24 hours per person / family, who eventually heads out to the event – most of the rooms remain unoccupied, though sold.
This example articulates how the current pricing model is neither mapped to the consumption need, nor does it solve a capacity constraint based on consumption nature. If we look at most other products or services, this pattern of pricing prevails. The traditional pricing models are not equipped to handle the consumption or simply negate this need.
Volume pricing in the ‘Consumption world’
(Need to evolve volume pricing methods)
The more you buy, the less you pay per unit, is an economic basis that is used by marketers for pricing products or services. The slab based volume pricing and/or ‘buy 2 get 1’ promotional pricing, follow this principle. Volume pricing experts often try to trigger the need after the point of satiation, by lowering prices, which goes against ‘consumption based pricing’.
The pay as you go model of the cloud world is hugely touted, as consumption driven. While it has its merits, most cloud product/service organizations offer annuity-pricing models** to collect full year payments in advance, making it a ‘Pay and then go’ model. Though the annual (volume) prices are lower than the monthly prices, it puts the onus of predicting the usage volume on the Customer, and thereby increasing ‘shelf-ware’.
Volume pricing is not present in some of the most quoted cloud business models. For example, an Uber ride costs same for a person who hires a taxi once a month, to another hiring everyday. However you see the market driven pricing that increases Uber price band by 1.2x or even 2x during peak demand time.
A couple of important questions arise:
- Base Price: Which is right ‘pay as you go’ or ‘pay and then go’?
- Consumption based pricing should ideally be paid post use, rather than paid on usage prediction that triggers shelf-ware.
- One could argue how a Safeway or Wal-Mart can follow this – and the new technologies such as IOT (Internet of Things+) that can track your refrigerator free space, can help address such pricing in near future.
- Volume price: A consumption based volume pricing should become a norm.
- Whether it is multiple Uber drives in a period, or frequented stays in Airbnb – as usage increases the price should decrease.
- There can be a periodic reset, say every quarter or annum, to avoid prices dropping below costs.
The extreme part of ‘clearance sale’ pricing often cleans up retail shelves but clutters consumers’ houses or stomach!
Is true ‘pay as you go’ pricing cheaper?
(Consumption driven pricing is sustainable)
A closer analysis of utility organizations’ pricing, and ‘pay as you go’ cloud models reveal consumption based pricing may not be cheaper per unit.
Moving away from a possession based model to shared models allows reduction in capital expenditure (Capex) and moves it to a recurring operating expenditure (Opex), thereby spreading the ownership costs over a period. Cloud companies who have operated on market-driven pricing, and focused on the anchor prices set by pioneers or competitors, often ignore the ownership and refresh costs – eventually struggling to make profits. Consumption driven pricing models will help mitigate the risks of organizations, by identifying the consumption needs, the infrastructure to support these needs, the volume of consumption – before arriving at the right price. This may increase the price per unit. However it will,
- Reduce the overall spend by customers, as it eliminates shelf-ware costs
- Prices can reduce as the quantum of consumption increases in a given period
- Improve sustainability by reducing wastes and inefficiencies – and allows genuine use of resources
- Increase customer satisfaction levels and thereby more willingness to pay
It is a win-win proposition for both (a) organizations in consumption economy to become profitable, and (b) consumers who end up paying only for what they use.
Summary of Consumption Pricing
(The right price)
Consumption is the new unit in the cloud world, and shared economy. It addresses the gaps of the traditional pricing models, and allows organizations to monetize right, and consumers to ‘pay for what they use’. The volume pricing methods evolve in the consumption driven pricing models, answering ‘when to pay’ and pay less with increased consumption. And while it may increase price per unit, will reduce the overall spend dramatically and improve sustainability of resources – a higher cause.
It is right for both the consumers and businesses – and fits the cloud era+. With new technologies such as IOT+, we can take the consumption driven pricing to most of the commodities that are still in possession based capex pricing.
We live to consume, and consume to live. And consumption driven pricing is simply natural.
Original edition published in CMO Council – Marketing Magnified, Mar 2016
*Source: The Software Budgets, Waste & Shifts in Software Licensing Report, IDC research 2014
**Source: Refer pricing chart in cloud product offerings such as Office365 or WebEx or Online Insurance offers
+ For more detailed impact of Cloud business models and IOT on marketing, read our Fluid Marketing white paper.