The Power of Usage-Based Pricing

August 17, 2018

MONTHLY ANALYSIS

The power of habitual usage

Modern consumers are experiential omnivores continuously seeking for better experiences. Delightful experiences built by technology companies set the level of expectations yet to be matched by the traditional sector, which is gradually evolving from a highly transactional nature of relationships to building addictive usage habits.

The culture of nurturing a habitual usage built a number of modern tech unicorns. A SAP study, explained by Mark Bonchek, Chief Epiphany Officer at Shift Thinking, and Vivek Bapat, SVP & Head of Marketing and Communications Strategy at SAP, states that the most successful brands focus on users – not buyers.

With some exceptions, traditional brands are purchase brands, and digital brands are usage brands. Purchase brands tend to focus on the moments of truth that happen before the transaction, such as researching, shopping, and buying the product. By contrast, usage brands focus on the moments of truth that happen after the transaction, whether in delivery, service, education, or sharing.

Usage brands are more focused on habitual, repetitive engagements rather than those of the transaction/barter category, which puts them closer to service providers and platforms than to product sellers.

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The SAP study found that usage brands have stronger advocacy, with individuals showing a higher preference for usage brands over competitors, not just in making the purchase but in the willingness to pay a premium in price. On average, the usage brand customers were willing to pay a 7% premium, were 8% less likely to switch and were >2X as likely to make a spontaneous recommendation of the brand.

Typically, at purchase brands, customer service and loyalty take a back seat to marketing campaigns and lead generation. Usage brands, by contrast, elevate customer service and loyalty from resource-starved cost-centers to key drivers of growth and profitability.

The strategic advantage of usage-based pricing

SAP emphasizes that companies looking to exploit the potential unlocked by core digital technologies need to make the shift in their engagement with customers – from purchase to usage. An analytical model of a supply chain developed by Frédéric Thiesse and Moritz Köhler, University of Leipzig, to compare usage-based pricing to a traditional scheme with fixed prices found that from a strategic perspective, the transfer of demand risk from the customer to the supplier implied by usage-based pricing might be used as a strategic tool for entering emerging markets.

In this case, researchers argue, usage-based pricing decreases the customer’s risk of unexpected demand fluctuations and, thus, lowers the barriers to invest in the supplier’s offering (in the study published by the University of Leipzig, in machines).

Today, the technological foundation necessary for the implementation of a usage-based pricing model is highly advanced: highly accurate and accessible sensory technology is available for ubiquitous deployment across industries.

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Source: An Analysis of Usage-Based Pricing Policies for Smart Products, Frédéric Thiesse and Moritz Köhler, University of Leipzig

Usage-obsessed businesses exploit the strongest force in one’s actions — the power of habit — to turn continuous engagement into continuous individual monetization through granular pricing. Usage-based pricing models allow for flexible consumption, slowly but steadily tying individuals to services and platforms. But more importantly, as we mentioned earlier, usage-based pricing model transfers the demand risk from the customer to the supplier, which might be used as a strategic tool to attract new prospects and to enter new markets.

When products are available on demand in smaller increments, and without a large up-front investment, more potential users will be willing and able to try them. For business customers, that means products designed to be purchased as vital infrastructure assets are reoriented as services. – Align price with use: Reducing up-front barriers with usage-based pricing, Deloitte

The company emphasizes that technological advances — particularly related to ubiquitous sensors, Internet speed, and cloud computing capacity — facilitate tracking, billing, and delivery for much smaller and more dynamic increments of use across a variety of customer contexts.

The granular monetization of a usage-based pricing model in action

One of the main financial benefits of a usage-based pricing model is in the number of service combinations a business can offer to increase revenue streams, explains Ed Sanville, Director – Implementation Management at Aria Systems, a cloud-based monetization platform for subscription services.

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Source: Aria

Other important benefits of usage-based pricing model include diminished barriers for use, decreased switching costs in the absence of lock-in, full amortization (accountability) of heavy users, and the opportunity to scale monetization alongside usage.

Influenced by the expanding adoption of advanced tracking and sensory technologies, usage-based pricing has found a way into a range of industries, including financial services.

Some examples include Stripe, which charges a flat percentage per successful card charge + an overage; Twilio, which charges per minute and per message sent, no flat fee; Autodesk, which charges per API used. While usage-based billing gives customers more flexibility and control over their spending, it can be more expensive for businesses per unit than committed volumes, requiring careful analysis and adoption only in the most appropriate, cost-effective scenarios.

Utility and telecom companies traditionally employed usage-based billing, and the approach gradually spread to the insurance industry and beyond by gig economy participants. Companies like Coca-Cola, Airbnb, Nordstrom, American Red Cross, Dell, Salesforce, and many more cross-industry mammoths have been relying on one of the providers of intelligent and complex communications systems as with Twilio, which utilizes a usage-based pricing model for messages, calls and more.

Every message sent, every minute of phone traffic or every authentication that is processed generates revenues for Twilio. – Lee Kirkpatrick, CFO, Twilio

Uber is probably a classic representation of the core transition happening today in consumer markets around the world — the usage-based pricing as a byproduct of transition from ownership to access (instead of building in-house infrastructure, for example, moving to Infrastructure-as-a-Service).

Ride-sharing companies like Uber and Lyft are changing the mindset of the consumer, making it more efficient and beneficial to pay for only what you use and when you use it, instead of bearing all the costs of owning a car. The same could apply for paying for a batch use of a service rather than for the precise period that the service is required for.

With the philosophy changing from you get what you pay for to you pay for what you get, usage-based pricing ties pricing to the value customers receive and consume.

Cloud services is an industry built on the cost-efficiency of usage-based pricing. AWS, for example, utilizes a pay-as-you-go approach for pricing for over 60 cloud services. It allows paying only for the individual services one needs for as long as the service is needed without requiring long-term contracts or complex licensing.

Not only does Amazon strongly believe in the cloud and in usage-based billing for the services it provides, but it also offers Amazon DevPay, an easy-to-use online billing and account management service that allows usage-based pricing and tiered usage-based pricing model implementation.

The true beauty of AWS is in the extreme granularity of pricing. AWS charges customers for the type of computing unit being consumed. For example, EC2 charges in cloud compute units. Getting even more granular, Lambda charges by the execution second, while S3 charges by the gigabyte of used disk space.

In the insurance industry, blockchain-powered real-time data flow from various devices opens an opportunity to automatically implement dynamic, customized pricing based on changing circumstances detected by sensory technology.

Progressive and Zubie collaborated on an industry-first telematics solution back in 2014 to deliver savings to consumers for their safe driving. Customers of Zubie’s connected car service started earning discounts on their auto insurance from Progressive. The partnership marked the first US partnership for an insurer offering a safe driving discount from data collected by a third-party connected car service provider.

At the end of 2017, Travelers launched its IntelliDrive smartphone app, which allows customers to better understand their driving habits and get auto insurance priced according to how they drive.

Customers who use the app and drive safely can save up to 20% and receive feedback that can help improve their driving and savings. To implement the IntelliDrive app, Travelers has partnered with TrueMotion, a provider of smartphone usage-based insurance technology.

Analysis of driving data from millions of trips by TrueMotion users showed that when drivers receive a score and tips about their actual driving behavior, they take steps to become safer drivers — an equally important and beneficial result for both insurance companies and end-users.

Usage-based pricing in the insurance industry is widely estimated to be financially beneficial for customers and carriers alike. To speed up the education and adoption, insurance carriers are also offering sizable discounts for participating drivers: Nielsen shares that consumers who take part are given an accumulating discount at each renewal, generally between 5% and 30% off their premium.

A case study by Protective Insurance Company in collaboration with D.M. Bowman and Geotab showed how telematics provides critical information on driver behavior, seat belt compliance, actual vehicles, and speed versus posted speed patterns. By combining telematics with company safety programs, D.M. Bowman saw a 20% reduction in accident costs. Telematics company Geotab also shares that in the case of business fleets, data collected from a telematics device can be used for accident reconstruction. When there is an accident, the telematics data can be used to understand the events that led to and followed the incident and determine potential liability.

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