What do premium toppings on a pizza (think: artichoke hearts, kalamata olives, bleu cheese, asparagus) have in common with AI-driven features of software products? They’re highly desirable to certain customers, and expensive to offer, potentially undermining the profitability of a product if not priced properly.
My family loves pizza. My colleagues are accustomed to hearing me draw analogies between this favorite food and the software business. Today, let’s take a nibble at how companies can monetize their products based on actual consumption, both to help protect revenue streams and to align the price charged with the value delivered to customers.
Consumption-Based Licensing Is …
Consumption-based licensing charges customers based on usage. Whereas traditional software licensing is established around fixed payments (for a seat or for a subscription), consumption-based pricing adjusts the price charged to reflect actual usage patterns and the expenses of offering the functionality.
Prevalent in industries where resource allocation (such as cloud services, including those required by AI) fluctuates, consumption-based licensing allows customers to pay for what they use, supporting efficient budgeting. As software-as-a-service providers look to grow the profitability of their SaaS, particularly for AI solutions with high computational costs, consumption-based licensing is increasingly prominent.
Consumption-based licensing delivers benefits for a software provider and its customers. It’s cost-efficient, only charging for resources that are actually used and allowing customers to closely monitor expenses related to software consumption. It’s flexible, supporting fluctuating demands and variable workloads. And it scales, allowing companies to adjust licensing up or down, without the financial worry of fixed-rate licenses.
Types of Consumption-Based Licensing
Multiple types of consumption-based licensing are available to deliver software functionalities that meet specific industry demands. Technology companies can determine what to offer, depending on the needs and usage patterns of their customers.
Options include:
- Pay-as-you-go (pay-per-use): With this straightforward consumption pricing model, users are billed for each unit of consumption, where costs align directly with usage (whether that’s the equivalent of a slice of cheese pizza for a single end-user or a dozen XL pizzas with all of the toppings for a party). This is a great way to monetize premium capabilities.
- Usage-based licensing: Users pay according to the specific services or resources they use. Metrics for determining usage may include API calls, compute hours, or data storage, for example. This can be offered via prepaid credits (metered tokens or elastic access), with a corresponding rate table that shows how many tokens are required to use a particular product or feature.
- Tiered pricing: Customers pay rates that correspond with predefined usage limits. When a threshold is exceeded, the customer pays the rate set for the higher usage tier. This provides flexibility as the customer’s usage grows and scales. Tiered pricing is often very appealing for organizations that have seasonal demand peaks or that require particular software functionality for occasional utilization spikes (meeting project-based or seasonal needs).
- Consumption-based billing with subscription: Hybrid approaches to software monetization are quite common. In this flexible model, it offers some predictability while also aligning with consumption, a base subscription is billed, then additional costs based on actual usage are added.
Effective Implementation of Consumption-Based Licensing
Software business success relies on a technology company’s ability to deliver an appropriately priced product that meets each customer’s needs. For many customers on most days, basic functionality (a plain cheese pizza, if you will) will be sufficient. But when they need advanced or unique functionality (extra cheese with loads of premium toppings—even pineapple!), aligning cost and value is important, both for meeting revenue goals and customer satisfaction.
To reap the benefits of consumption-based licensing, a technology company must implement it carefully. Accurate usage data is essential for illustrating what customers use and value (including particular features or storage and compute power) and pricing the product appropriately. Security and compliance initiatives must ensure that licensing terms and data security protocols, including those across departments or regions, are honored. Billing systems must be flexible enough to accurately represent varying consumption levels. Last but certainly not least, customers must have clear insights into their usage patterns and the functionality of the consumption-based models in order to be certain that the software meets their needs—and that they’ll come back for more.
