Pay-Per-Use Business Model
Pay-Per-Use: Use of a product or service is metered, and customers are charged each time they use the service
How Pay-Per-Use Differs from Subscription
The pay-per-use model varies from the subscription model but you can see both at work in more evolved business model combinator companies. For example, I may pay a subscription fee to Amazon for my Prime account, but when I use AWS or Amazon Web Services, I’m paying per gigabyte of data processed or per load balancer hour.
The pay-per-use model does not assume a fixed monthly or annual fee; you pay what you use; whereas subscription typically has set pricing tiers and minimum commitments.
Pay-per-use co-exists with subscription-based pricing as another tactic to get people to try before they buy and monitor actual usage.
Pay-per-use is also called usage-based pricing or consumption-based pricing.
How Pay-Per-Use differs from Pay-as-You-Go
A variation of the pay-per-use model is the pay-as-you-go variation in which a customer with limited funds can pay for equipment like solar panels or mobile phones over time. Examples abound in the rural energy market. The company provider finances the purchase of the equipment, but ownership is transferred to the customer at the end of the repayment contract – which is different from pay-per-use in which ownership is not transferred.
Business Models in Use
Amazon Web Services | Autodesk | Heidelberger Druckmaschinen AG | Kaeser Kompressoren | Sigtuple | Car2Go | Stasis Monitors | Zebra Medical Imaging | Philips PACS | New Relic | Microsoft Azure | Rolls Royce Jet Propulsion
Pay-Per-Use Evaluator
Valuable to Customer
Benefits
- Pay only for what customers use, which helps when demand falls below expectations
- No upfront capital expenditures
- Transfers operational risk to the equipment maker who becomes responsible for keeping the machine running
Challenges
- High costs during frequent use periods
- The total cost of ownership is not always less expensive
- Customers may want expenses on the balance sheet
Key Performance Indicators
- Pay-per-use cost vs alternative
- Pay per (seat, customer, patient, user) delivers other financial, operational, or quality outcome
Valuable to Business Offering Pay-Per-Use
Benefits
- Value proposition clearly communicated around use value
- Disruptive market entry or market share move in a high margin category
Challenges
- Need to engineer a solution to deliver cost structure of pay-per-use (lower tech, component, or other costs)
- Have to figure out fixed vs. variable cost structure to determine per-use-unit profitability
- Unless well-engineered can suffer from unpredictable revenue
Key Performance Indicators
- Retention
- New User Growth
- Customer usage
When it Works Well
Simple distribution and billing processes
Pay-per-use works well when the service can be effectively metered. In the media business, pay-per-view has enabled the shift from standard broadcast technology to multiple cable channels.
For enterprise software companies, the shift to cloud-based computing models created the conditions for “pay-as-you-drink,” a change from prior business models such as upfront licensing, installation, and maintenance costs. SaaS or Software as a Service is deployed typically as a pay-per-use model, a subscription model, or a combination of both.
Billing systems and agreements must be simple to communicate and easy to bill, with customers authorizing an agreement that charges their account per use.
Ability to manage per-use costs
For software startups, particularly in the SaaS sector, once the initial minimum viable product is built, companies can scale revenue closer to the scale in costs required to deliver the service. Some SaaS companies prefer pay-per-use because the value relationship is made very clear to the customer, and they are able to prioritize feature and service development based on the customer’s expressed needs.
Low barriers to customer adoption
Because of low or no-cost startup fees, enterprise customers that typically take six months to a year to make a decision about enterprise software often leapfrog this decision and simply begin to try the service. Customers then increase their use based on the actual need of the company (vs. paying up front for licensing fees per seat).
Data-driven customer learning
Pay-per-use arguably gives the company more information about how customers use and value their products and services. Companies operating on pay-per-use can get greater feedback to refine their pricing and how they package products and services, to drive their profitability.
Challenges to the Pay-Per-Use Model
Unpredictable use and revenue
Because customers are only paying to use the service when they consciously think they need the service, revenue is less predictable than a subscription or licensing model.
May negatively backfire for frequent use customers
Pay-as-you-go is initially sold as a lower expense to a customer, with bill amounts being predictable and controllable. If not, then neither the subscriber nor the provider can budget effectively, and consequently, the subscriber pays a premium for bursting capacity.
Ability to flex without fail
Customers complain of being burned by pay-per-use models when they fail to flex up when the demand is required. Customers also run the risk of capacity shortage or brownout. The company offering pay-per-use must still operate with the strength of a public utility and be available.
Trends in Pay-Per-Use
The Amazon Capex-Opex Effect
Amazon Web Services (AWS) revolutionized startup costs for internet firms by granting access to server infrastructure on a pay-per-use model. The original value proposition: take what was once a large upfront capital expense and shift it to an operating expense, and pay as you scale. Expect other capital expenses to make this shift.
Connected Devices
Futurists envision the rise of internet-connected objects (IoT or the Internet of Things) will give rise to everything being available on a per-use basis because more easily controllable through sensors.
SaaS Combination Strategy
SaaS subscription-based companies have been experimenting with pay-per-use to get new customers on the hook and see how an organization uses the offering. Pay-per-use is often paired with the option to subscribe, or key features are revealed on a usage basis in addition to an underlying subscription fee.
Pay-Per-Use Mechanisms to Test
Pay-per-use is all about understanding your costs of goods sold and capital expenditures. Pay-per-use models become risky when you cannot engineer predictable customer use. Run a unit economics test to understand your breakeven point for the pay-per-use model.
Before You Consider Pay-Per-Use
- What is the cost per use to our business?
- What volume of use is required for us to break even?
- Determine the minimal offering that would be compelling enough to have the customer pay for the offering.
- Can you design an MVP that has high usage and engagement with a minimal feature set?
- Is there a user proposition that can be easily tested and implemented?
- Is the customer’s problem being solved in a better way with pay-per-use?
- Will the service usage generate enough income to cover the cost of hardware on our balance sheet in a reasonable payback period?
Testing the Model
- What is the total cost of ownership of comparable solutions?
- Arrange features, services, and benefits into key elements of your offer and have the potential customer arrange the elements of the larger solution in order of priority. Then take away the lesser priority elements until you determine what would make an MVP (minimum viable product).
- Determine the minimal offering that would be compelling enough to have the customer pay for the offering.
- Is the customer willing to share the data we need to power the MVP and future services?
- Can you design an MVP that has high usage and engagement with a minimal feature set?
- Is there a user proposition that does not require sign-off from IT or a long buying cycle?
More on Pay-Per-Use
Why We Never Sold Basecamp by the Seat, by David Heinemeier Hansson, Medium, 2017
Inside the Rapid Rise of Usage-Based Pricing, by Kyle Poyar Techcrunch, 2021
How the Internet of Things Will Change the Pricing of Things, By David Langkamp, Just Schürmann, Thomas Schollmeyer, Rolf Kilian, Amadeus Petzke, John Pineda, and Jean-Manuel Izaret, BCG, 2017.
Is “Pay-per-use”the future of manufacturing industries? An innovative business model may not live up to the expectations, Wolfgang Krenz and Daniel Kronenwett, Oliver Wyman, 2019.
Metered Services, by Margaret Rouse at Search CIO, 2015.
Pay-per-use Software Pricing? No Thanks! by Duncan Jones, Forrester, 2010.
It might be time to ditch the subscription model, by Ray Sobol, Techcrunch, 2012.
Software Licensing: Pay-Per-Use versus Perpetual, by Bao-Jun Jiang, Pei-Yu Chen, and Tridas Mukhopadhyay, at Carnegie Mellon University Tepper School of Business, 2007.
Robin Chase, Zipcar, and an Inconvenient Discovery, by Deborah Ancona and Cate Reavis, MIT Sloan Management Case Study, 2014.
Cloud Computing: A Value Creation Model, by David C. Chou, Computer Standards and Interfaces, 2015. (academic paywall)
Pay-per-use business models as a driver for sustainable consumption: Evidence from the case of HOMIE, by Nancy Bocken et al, Journal of Cleaner Production, 2018. (academic paywall)