The arrival of cloud computing precipitated a seismic shift in the software industry. It reshaped not just how software is built and delivered, but also how customers pay for it. The software industry largely shifted away from traditional perpetual and term licensing models to the seat-based subscriptions we know today.
Recently, a more subtle shift in business models has been quietly unfolding. Spearheaded by industry leaders such as Twilio in communications, Snowflake in data warehousing, and Stripe in payment processing, there’s a burgeoning interest in usage-based business models. This approach, where customers pay in proportion to their actual product use, has gained momentum alongside the AI boom, rekindling debates about optimal pricing strategies — it’s a fun time to be a pricing nerd.
The appeal of usage-based pricing for AI products is clear. Typically, users interact with AI systems by posing questions or providing prompts, triggering a comprehensive data analysis to synthesize answers. This is a very different use case from more static applications like video conferencing software or productivity trackers. Plus, usage-based pricing allows for low-cost or free initial engagement, helping to fuel the land-and-expand motion that has catapulted so many startups to success.
Still, there’s cause for circumspection before you decide to go all-in on usage-based pricing. In many cases, seat-based pricing still makes the most sense. Generally, seat-based subscriptions provide more predictable revenue streams, giving founders more consistency and improved business forecasting capabilities.
Conversely, consumption-based pricing can be capricious, fluctuating with changes in user demand. This exposes your startup to market vagaries, for better or worse. While customers might expand usage during prosperous times, they’re equally likely to scale back at the first sign of trouble. If this retrenchment coincides with broader economic downturns, the magnitude of revenue decline can be very big. An established company can stomach that sort of variability, but the same is not true for younger startups with limited customers and constrained balance sheets.
The good news is that your pricing model isn’t immutable. Companies should view their pricing strategy as a dynamic tool, evolving alongside their growth and market conditions. Of course, this shouldn’t be taken to an extreme; customers expect a degree of consistency.
The key lies in thoughtfully crafting a pricing structure that reflects your unique value proposition and market position, while maintaining the agility to adapt as circumstances dictate.
Originally published on Medium.