Stephen Hurrell's Analyst Perspectives

Subscription pricing models are no longer new. Many companies have experience with this pricing model even if there has not been complete adoption across their entire product and service offerings. Companies that use this model, or have spent time looking at the approach, understand the approach of a recurring revenue stream based on a repeating flat fee.

By 2025, over one-fifth of organizations will have part of their business conducted via subscriptions and recurring revenue rather than one-time sales as companies adjust business models to remain competitive.

This model is in heavy use within the digital economy - especially for software-as-a-service (SaaS) delivery models, for both B2B and B2C - and it is being adopted across more and more industries. But this model can lead to an unintended consequence. Because it encourages the maximization of initial revenue through incentivizing the selling or buying of the greatest number of units (of what is being purchased) to maximize that initial purchase value for the vendor, the buyer may find they have overpurchased. The downside of this is that, come renewal time, if the initial sale was oversold, then there is every likelihood of the renewal being downsized, if not cancelled. So why does this matter? If the vendor’s revenue projections incorporate a renewal at the initial value, that may result in an unanticipated downward adjustment at renewal. This also means an assumed run rate and resource allocation may not be enough to hit the revenue target and will require additional sales to make up the shortfall.

From the customer side, the desire is to effectively pay for only what is used. The seller’s approach to maximize initial revenue is potentially at odds with the customer’s intention to purchase only what they will use. As the impact of a downsized renewal is negative for the vendor, it suggests that a different approach should be used.

An alternative approach is to move to a “usage” pricing model, or perhaps less confusing, a “consumption” pricing model to differentiate against “user” models. This mode is prevalent in many different industries and markets and is most typical where there are countable individual transactions that can be priced and billed. Examples are how many miles have been driven, or how many credit card transactions were recorded. Unlike the typical sale that seeks to promote the purchase of the maximum number of units prior to deployment via value discounts or other incentives, the consumption model enables usage and value of the products or service to drive revenue growth. This satisfies the need for the buyer to align their perception of cost more closely with the delivered value, offering an opportunity for the vendor to develop adoption plans that work with the new customer to ensure sustained adoption. To a certain extent, these de-risks the overall financial exposure for the customer and allows for the buyer to work in conjunction with the vendor to develop adoption plans and get advice and input toward understanding how sustained adoption is achieved through much more than typical one-size-fits-all, feature-function training, but rather is linked to individual personas and the roles they perform.

From the vendor’s point of view, this will require a change of approach by sales and finance. Even in companies with a somewhat longer adoption of the subscription and usage-based business models, the de facto target is to maximize the initial revenue commitment by the prospective buyer. It would be against type to think more strategically with a view toward building a customer-centric sustained business growth model, where the impetus is on working with the customer to inform and advise as to how maximize the value the customer derives from the product for the initial users in order to demonstrate the value of expansion, either through more users or additional options for the initial user community, or both. From the vendor’s point of view, although reducing the potential initial revenue, this should be preferable to the potential for a large downsizing (or worse, cancellation) at renewal time. And it is an opportunity to actually be customer centric.

However, this model does not work if there is no way to count interactions, transactions or apply some other concept of measurement that enables the overall product or service to be divisible. Even digital products or SaaS applications are rarely developed with reducible divisibility in mind, hence the fallback to such items as user counts. And consequently, the risk for mismatched motivations in the buying/selling process.

For organizations, the recommendation is to have conversations with vendors to build a buyer journey that de-risks overall adoption and sustained-value delivery by structuring the buying contract to reflect a linkage between value and consumption, not necessarily number of users.

For vendors’ sales and revenue teams, it is an opportunity to build a relationship based on sustained growth potential over time rather than front loading the sales opportunity and assigning all the risk to the buyer.

For companies providing subscription management and billing platforms, there is an opportunity to partner with vendors to develop a mechanism by which they can move to consumption pricing.

For revenue management platform vendors, this is an opportunity to more fully develop functionality and messaging around building sustained growth among their customers.

Regards,

Stephen Hurrell