A few years ago, the subscription model was considered as the best pricing model for a long time. Compared to the classic purchase, where the customer acquires all the rights and obligations associated with the offer in a one-time transaction, the customer subscribes to pay a regular fee to use the offer.
The business models of the world’s largest companies by market capitalisation (e.g., Apple, Microsoft, Amazon) are partly based on subscription models, and for a good reason:
This ensures recurring revenues for companies and flexible access to services for customers without large one-time investments or expenses. Startups also tend to be more interesting for investors if their business model is based on subscriptions. Yet, alternative models can be effective as well.
Performance-based pricing models have been increasingly discussed recently. This is where the customer does not pay for the opportunity (subscription) or the activity (pay per use) but for the result of the use. For example, worth mentioning in the B2B area is Google Advertising (price per lead). The advantage for the customer is that the goals of the provider and those of the customer coincide (namely, to provide a high benefit), which is therefore perceived as particularly fair. The advantage for the provider is that customer-specific price acceptances can be better exploited because the pricing model can scale better.
From the perspective of classic value-based pricing, a pricing model is superior for the customer if it costs the customer as little as possible for as much benefit as possible. In this sense, performance-based pricing would be the “best” pricing model for the customer. But is this actually true?
What is the “right” pricing model?
The answer to this depends on the respective decision-making situation and the (price) motivation of the customer.
#1 The classic purchase
This pricing model applies to products that have a symbolic value that goes beyond their practical use and is linked to the possession of the product. The value of prestigious products such as cars, jewellery, and clothes, for example, results from the possession or the possibility expressed by the possession to afford the product. Other pricing models are possible but only allow the practical use, i.e. a small part of the total value, to be monetised.
#2 The subscription
This pricing model applies to products where customers do not know their exact needs in advance and at the same time have a high level of confidence that the provider will meet their needs. Subscriptions relieve customers because they do not have to weigh whether it is worth spending money on each use. Once the decision has been made, e.g., for a newspaper subscription or a streaming subscription, the provider is continuously obliged to establish usage routines so that the subscription is worthwhile from the user’s point of view.
#3 Pay per use
This pricing model applies to products where ownership has no symbolic value or would require high investment. They are used on such an irregular basis that customers with a subscription would feel that they are paying for something they do not need. For example, if someone only plays squash once in a while, they would rather rent a court for a certain time. This feels fairer than opting for a membership, although the latter could save money in the long run.
#4 Pay per performance
This pricing model applies to the same products that fall under the pay per use category. It even seems a bit fairer because it aligns the interests of the customer and the provider. However, the benefit must be clearly identifiable. Otherwise, there will be conflicts of interest in the billing process. Instead of charging by the minute (pay per use), a car-sharing provider can also charge by kilometre (pay per performance). From the customer’s point of view, this is even fairer because the customer does not have to pay for further use without the benefit (e.g., when stuck in a traffic jam).
The (price) motivation is decisive
As you can see, there is no one best pricing model. Which pricing model is suitable depends on…
… the type of benefit the product provides for your customers (e.g., practical, symbolic),
… the degree to which customers are willing to be involved in the purchase decision,
… the question of whether customers know and can articulate their needs,
… the (price) motivations of customers (e.g. predictability, fairness),
… the question of which price elements the customers pay attention to in their usage decision
This can often also result in a hybrid pricing model.
According to the GRIPS typology the decision strategy of customer types condenses some of these aspects. It thus gives indications of the adequate price model. Price Accepters are typically more susceptible to symbolic value propositions, so the purchase model is more suitable. Risk Avoiders want to be treated fairly and not pay for services they do not use, so they tend to feel more comfortable with pay per performance. Routine Buyers have a lot of trust in the provider and little desire to make decisions, so a subscription model is an obvious choice.
We observe time and again that young companies (understandably) focus intensively on their product and do not consider the issue of the pricing model until very late in the process. However, since the pricing model is decisive for the business model’s success, we recommend addressing the decision for the appropriate pricing model very early and intensively.