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Pricing and Packaging Paradox: Consumption, Subscription or Both?
There’s been a lot of conversation in The Circle lately around pricing and packaging. Many companies (especially SaaS and cloud services) are actively exploring a shift from a subscription-based pricing model to a consumption-based model, or hybrid of both, while others are looking to understand better the challenges and strategies for managing the transition. Whichever camp you’re in, this is undoubtedly an important decision as pricing continues to be both a crucial lever of financial growth and a tool for deepening customer relationships.
While the pros and cons of each pricing model are nuanced and very often company-specific, we recently convened the CFO|Circle to gain more clarity on what to expect when navigating a pricing model shift. In this peer-led conversation, we heard insights from Naeem Ishaq, CFO of Checkr, who served in previous finance leadership roles at Square and Salesforce. Naeem was joined by his VP of Finance, Todd Freedman, who is leading Checkr’s pricing and packaging strategy today. Both are battle-tested leaders who were willing to share their experiences and hard lessons learned.
When It’s Time to Reassess Your Pricing Model
Unless it’s explicitly clear that you’re losing significant revenue or customers, it can be difficult to identify exactly when it’s time to change your company’s pricing model. One thing is sure: pricing model changes can be incredibly complex and should be predicated on more than just financial metrics.
The best place to start is by examining a pricing model shift’s impact on your most valuable asset: your customers. Because pricing is so inextricably tied to the perceived value of your products and services, customer preferences should be the key driver in any pricing model decision.
“Don’t force your customers down an unnatural path. Take the time to understand how they perceive the value of your product or service, how they budget for it internally, and how it’s used day-to-day.” – Naeem Ishaq, CFO @ Checkr
Start by gathering intel in a discovery phase, both directly and indirectly. In addition to user surveys and direct customer conversations, leverage insights from your Sales team since they are on the frontlines of those pricing conversations. You’ll also want buy-in from your leadership team and board members, but it’s critical to remember that the “north star” of this decision is to identify what is best in the long-term for your customers.
If you don’t have the internal bandwidth or resources, consider engaging an external consultant like McKinsey or Simon Kucher & Partners that specializes in pricing and packaging strategy to do much of the legwork for you.
Choosing the Right Pricing Strategy
Upon initial discovery, some companies may find that a wholesale switch between a subscription and consumption model doesn’t make sense. Perhaps the marginal costs of the pricing structure become too high at a certain usage level, or it becomes too difficult to track and recognize revenue accurately.
This is why many companies are pursuing a hybrid pricing model, which combines both subscription- and consumption-based pricing elements. For instance, you might offer consumption-based pricing but with an annual fee or a minimum volume or commitment. Tiered subscriptions that offer discounts for higher usage are also a common consumption-subscription blend, particularly for companies that want to test their customer’s reaction to a pricing shift.
Whichever model you decide on, be sure it aligns with your customer’s preferences and your existing cost structure. Suppose you plan to offer various customizations on your pricing. In that case, you’ll want to ensure that the structure always reflects the value of your products and encourages greater usage, but also that the structure is cost-effective and easy to implement.
“When you have pricing that’s fundamentally disconnected from the cost structure, you can wind up with unforeseen consequences.” – Naeem Ishaq, CFO @ Checkr
Start Planning Early
According to Naeem and Todd, if you’re planning on rolling out a new pricing model, know that it can take roughly six months to a year to roll out fully. Any less and you risk frustrating and losing customers; any longer and it becomes more challenging to get all of your customers on board. Be sure to take extra care of your larger customers and accounts, who may need additional time and handholding to transition to the new pricing model effectively.
Establishing Internal Alignment
Along those same lines, bake in plenty of time to establish internal alignment on the new pricing model as it will impact almost every business area – from sales and accounting to customer support and marketing.
A particular focus should be placed on your Sales team. Moving between a subscription and consumption model will change how your team sells to prospective customers and potentially change their incentives. For instance, a consumption model that awards commission on hitting certain quarterly volume targets might incentivize your Sales team to focus on securing bookings rather than actualized revenue. Conversely, a pricing model shift might allow your Sales team to generate greater revenue opportunities, either through more variable pricing structures that incentivize customer usage or by rewarding commission on upsells. Again, the key comes down to working directly with your Sales team to help them understand how to make your new pricing model work best for them and ultimately for their customers.
Having the Right Systems and Infrastructure in Place
Of course, the success of all of this work hinders having the right internal systems, processes, and tools. There’s a lot that goes into rolling out a new pricing and packaging model, from updating your pricing across your marketing materials, generating contracts, billing automation, and revenue recognition. Be prepared to make a sizable investment in your internal operations over the course of several months or even years.
“One of our large company initiatives this year is to spend more time investing in our billing infrastructure. Really it’s about re-architecting the backend of all of our products to get us the information and visibility we need not just to invoice correctly but to be able to report back on a product-by-product basis.” – Todd Freedman, VP of Finance @ Checkr
Suppose you don’t have the infrastructure or engineering resources to build a homegrown solution. In that case, you might choose to cobble together different solutions, like Salesforce CPQ for pricing generation, Netsuite for ERP, Klarity for contract generation, and Captivate IQ for commission tracking. There are many different options out there but just be sure that whatever you end up going with ultimately leads you closer towards standardization across your system. You’ll want to continuously test and monitor the performance of your infrastructure and identify any bottlenecks.
Financial Planning and Reporting
Last but certainly not least, transitioning to a new pricing model will dramatically change the way you measure and ultimately report on financial performance. Particularly if you’re moving from a subscription to a consumption model, metrics like ACV (annual contract value) and ARR (annual recurring revenue) will be replaced with metrics like incremental user growth, net/gross revenue retention, and net usage. This might cause some consternation among your board or investors at first given the perceived difficulty to forecast accurately; however, you can provide assurance by focusing on measuring predictability as well as possible.
When forecasting, if you’re transitioning to consumption or hybrid pricing there is a need to move from a deterministic model to a probabilistic one. In other words, there is a shift to a focus on customer behavior trends more so than input variables that affect revenue.
As you plan your transition, it is worth taking the time to define the metrics that matter most to your key stakeholders and the company as a whole. This allows you to develop the right internal processes and models used to create predictability in your revenue models and pricing strategy.
Have more questions about pricing models and other related topics? Apply to join The Circle and gain access to curated content and conversations with a community of growth stage CFOs across 200+ private companies.