Consumption-based pricing models for software, pay-for-use, are growing in popularity. And it’s not just limited to pricing software services. From insurance companies to content services, pay for what you need, when you need it, is becoming the rule.
Taking a page out of an old pricing book used for decades by electricity and water companies, some software companies, like Amazon and Teradata, are using it to price their cloud services. So, is the time right for CRM companies to price software like cloud infrastructure or electricity?
New ideas are often born by taking what’s old hat and applying it elsewhere. From art to consumer products, innovators create something new by appropriating old ideas and recasting them with impeccable timing – right when that elsewhere is ripe and ready for it. In the case of cloud software providers, it happened naturally once those companies could deliver it like a commodity through fast internet lines. What people were buying was no longer a thing – since there was no CD to ship. Instead they were buying a pure service.
Yet today, CRM companies still sell their software as if the consumers were event planners booking hotel conference rooms. In this pricing model, the seller wins provided they pre-book enough of their inventory, regardless of whether buyers use the rooms. Since the consumer can’t perfectly forecast how many seats they’ll need, they hedge and often pay for more than they end up needing.
Once upon a time
Before the internet delivered acceptable speeds, software vendors peddled perpetual enterprise pricing, locking clients into ownership models with follow-on maintenance agreements. Like buying a car, the buyers forked out a large payment for the asset upfront, and then, for some stipulated period, usually 3 to 5 years, they locked in a service contract at a rate between 18% -22%. With the advent of software-as-a-service, subscription arrangements replaced perpetual models. From an accounting perspective, that meant expensing versus capitalizing, making CFO’s happier.
Yet the standardization on ideal accounting arrangements didn’t result in the harmonization of contract options, term timeframes, or pricing metrics, and didn’t lead to an ideal pricing model, certainly not for the CRM buyer. And presently, there’s still a plethora of pricing options that confuse both buyers and sellers. Buyers aren’t paying for what they need, and it’s hard to measure value.
Consumption, demand readiness, and value
Customers use some services steadily and other services intermittently. Take electricity service – it’s used every day, with consumers reaping benefits regularly. Tax software buyers, on the other hand, use it for just a few months out of the year. To get the electrical service, customers pay a flat connection fee, and then a per-unit charge each month based on consumption. With tax software, they pay a flat fee for unlimited use for the year. In both cases, the consumer just assumes the service will be available whenever they need it.
How should a consumer think about cost and value in these two situations? For tax software, buyers compare it to other alternatives, such as hiring an accountant. In terms of value, they rate efficiency, speed, convenience, and how much it might reduce their tax burden. For electricity service, assessing value is in the eye of the beholder (or perhaps the consciousness of the survivor), and ties directly to the Maslow hierarchy of needs. Some electricity flowing into a home serves basic needs, like keeping bodies warm; some powers security systems for safety; some enables virtual connection to others, serving the need for belonging, esteem, and self-actualization. Given this, how valuable is a kilowatt-hour of electricity to a consumer? Are all kilowatts created equal?
It quickly becomes philosophical and hard to measure this value, as we saw recently during the electrical shortage in Texas. If you’re freezing to death, you want warmth at any cost. So if you survive it, and then receive a bill for $17,000 for a few days of electricity, were you really willing to pay that much? And similar to urgent care services, in the moment of need, how do factors like competitive alternatives, consumerism, and switching costs play in, if at all?
CRM software users, on the other hand, don’t buy access to this software to save lives. As such, they have to assess value in other ways, by asking questions such as:
- Will our marketing programs become more effective?
- Will we streamline sales and service operations?
- What return will we achieve on this investment?
But even these expressions of value are hard to measure.
Measuring CRM value
Accurately measuring CRM software’s added value is not trivial. To do it, you’ll need a measurement system in place to count new outcomes and compare them to a baseline (control group). In that process, depending on the breadth and depth of the CRM package and your intended use (e.g., whether it’s for Marketing, Sales, and Service), you’ll need to answer detailed questions such as these:
- How much did response and conversion rates improve due to new marketing treatments?
- Were the improved rates directly attributable to the CRM’s marketing software?
- Are the service agents spending less time on calls?
- How much of the cost-saving is a direct result of using the CRM software?
- Did we reduce customer churn and improve loyalty?
- Was the sales automation software able to help us find better sales opportunities, shorten sales cycles, and/or streamline sales activities?
Answering these questions accurately will require careful planning. Large enterprises have constantly evolving CRM stacks made up of dozens of software packages (each implemented and upgraded at different times), making it difficult to coordinate multiple experiments while avoiding experimental contamination. But outcomes matter. As such, it’s imperative to do the hard work and set up the measurement systems. Otherwise, CRM vendors will lay qualitative claims when success happens, and run and hide when results are poor.
In a bold attempt to settle the attribution argument, some vendors, believing they have a secret weapon, are offering a fee-for-performance model (sometimes called “gain share”), charging based on the incremental returns enjoyed when their special sauce is added to the mix. And this approach requires an even more meticulous measurement and reporting system that both parties can agree to, with one of the parties (or a 3rd party) responsible for continuously administering that system.
Because the gain share approach is so complex, most CRM companies don’t offer this. Instead, they use several popular metrics, often mixed, as the basis for traditional pricing models:
|Metric||Metric type||Example of metric|
|Entity||Number of entities receiving the service||Pay by type of user, by seat, by tenant, by environment, by profile, by visitor, by contact, by customer, by prospect|
|Capacity||Amount needed/used||Number of service cases, amount of storage, emails sent, decisions made, events, interactions, API calls, or other compute units (e.g., Teradata Vantage Units[i])|
|Service type||Level of service given; features provided||By edition (standard or premium), by channel, by features offered, or application used|
|Term||Length of contract||On-demand, monthly, 1-year term, 3-year term, etc.|
Although businesses want to pay for use, they also want predictability for overall software costs, as budgets are annual. That makes it even more important to use models that accurately estimate use, charge within budget cycles, and true-up in a way that doesn’t shock finance and accounting. Hidden fees, add-ons, and excess use charges that surprise clients can be detrimental to long-term relationships.
Most importantly, buyers want value from use. To return value, the software must:
- Be easy to get up and running and support (setup costs, integration, etc.) – part of the total cost to use, often higher in the early stages of use.
- Be assessed along with other recurring costs (training, advanced analytics expertise, creative & support services) required to derive benefit.
- Supply measurable returns, and when compared to total costs, proven to furnish a high return on investment
Consider some of the main aspects to the price consumers are willing to pay for any service:
Meeting a Service Level Agreement (SLA) – Whether it’s how fast a pizza arrives, or a webpage loads, customers shop based on a level of service expected.
Availability at time of purchase – Will the service have capacity at the exact time needed? If so, what will the spot price be? For example, when shopping for a hotel room or airline seat, consumers face the tradeoff of whether to book early (paying upfront to lock in availability), or whether to roll the dice, hoping the price drops and the service is still obtainable. If demand is high and supply is low as the inventory approaches expiration, the price could be higher.
More is less – A volume discount lures clients to obtain more or commit to a longer contract term upfront, with the risk that some of the bought or baked in reserve will go unused. Here again, customers roll the dice when buying higher amounts of service units upfront (or even bundles of services) for a lower price-per-unit charge.
In a pay-for-use model, vendors need service meters, accessible to both parties (e.g., an electricity meter on a home) to measure consumption. Then, over some period, usually a month, the vendor counts the amount of service used.
And in terms of billing, the conversation might go like this:
“Let’s help you guess at how much you’ll need. For the first 12 months, we’ll bill based on those assumptions.”
“At the end of 12 months, we’ll look at actual use and if you’ve used more, we’ll true up… “
“Oh, and at that point, we’ll give you the choice to work the difference into a new monthly fee.”
If applied to CRM software, the focus shifts from the entity receiving the service (the user or contact) to the amount of service they consume. For the model to work, the service units must be understandable and closely related to outcomes. As an example, all parties will be able to easily understand a metric such as emails delivered. However, one like IOPS, which is tied to infrastructure consumption, will be too technical and obscure and should be avoided.
A pay-for-use pricing approach can work for CRM software and should be good for both buyer and seller. It’s fair and efficient if there’s a way to estimate upfront consumption, meter it, and if the unit prices are understandable. In terms of fairness, there’s certainly plenty of providers and competition in this market, with Trust Radius listing 261 companies as of this writing[ii]. And CRM vendors are in better shape to provide burstable services to handle surges in demand, as the cloud infrastructure they use becomes more elastic.
Indeed, from the onset, it seems enticing and comfortable for both sides. For the seller, it rewards them for finding more ways to expand the use of their software. For buyers, it removes intra-contract restrictions such as the number of users or channels. Yet at the same time, it does put the onus on the buyer to watch their use so:
- It stays within their assumed draw-down levels
- They aren’t surprised and can afford the true-up costs
Consequently, if CRM vendors adopt this model, buyers will need the discipline to use the services carefully, as they’re ultimately responsible for every service unit that flows. As Tom Bodett of NPR used to say for Motel 6, “We’ll leave the light on for you.” Although that has a heartwarming ring, remember, with a pay-for-use CRM pricing model, it’s the buyer that will pay for the service powering that welcoming light, so use your CRM electricity wisely.
[i] Teradata.com, https://www.teradata.com/Cloud/Pricing/Consumption-Pricing, 2021