Revenue models are changing

By the end of 2021, it’s expected that 30% of $1 billion-plus firms will have a significant digital portfolio. Twenty percent of that number is expected to stand up digital divisions purely dedicated to launching disruptive products. And by 2025, over one-fifth of organizations will conduct part of their businesses via subscriptions and recurring revenue in order to remain competitive. They’re moving away from the one-time sales model and integrating recurring revenue into their offerings.

“What is happening is we’re seeing a shift in recurring revenue models and adoption of them. [And this means] there’s a benefit for both the buyers and the sellers. As a buyer, you’re only paying for what you can get. As a seller, it’s giving you predictable revenue,” says Brian Dingman, VP Solutions Engineering at BillingPlatform.

Things are changing and even though the Subscription Insider community is familiar with subscriptions, subscriptions are just the tip of the iceberg. By 2025, it’s estimated that 75% of enterprise software providers will offer a consumption- or transaction-based pricing model in their portfolio. This is a huge increase from the 35% of organizations in that industry who already do this.

The following are eight different pricing constructs that can help expand recurring revenue in companies. While all of these models are different, they are no purely distinct; overlaps occur. And  all models have pitfalls.

Subscriptions

This recurring revenue model is one that most people are familiar with. To illustrate this point, the average household has nine subscriptions. If you pause to count how many you have, it’s likely you’ll find you have around that number too. They add up quickly!

We’re all familiar with subscriptions a charging method that enables merchants to bill customers automatically on a fixed schedule for a specific product or service. Some of the benefits of subscriptions for companies include:

• Selling products and services to create steady, predictable revenue
• Offering customers the ability to use products and services rather than own them
• Aligning price to value by user type

Many times, subscription offerings come with a freebie, like a free week or month of service, that usually takes place at the beginning of the subscription. Dingman points out, however, that some B2B businesses are offering the freebie near the end of the subscription. This is problematic for businesses, however, because it’s incredibly hard to monetize.

Consumption

This recurring revenue model is one a subscription can morph into when there is more complexity within the business’ offerings (i.e., more than just a strict subscription offering). This style of revenue model rates and bills based on the usage of a product, anything from clicks to minutes to downloads. This model is also known as “pay-as-you-go.” Some of the benefits of a consumption model are:

• Competitive advantage due to lower price of entry
• Additional revenue created on top of a subscription model
• Customers pay only for what they use

General consumers see this type of billing model every month when they pay their water, gas or electricity bills. However, most companies don’t sell in pure consumption data models like utility companies. Still, creating volume-based or tier-based pricing is how usage data is monetized and then combined with other pricing models. 

“If you plan to do any kind of consumption pricing, you need mediation. Mediation is essentially loading that usage data into the billing system for rating and taxation,” says Dingman.

Very few subscription management solutions on the market handle meditation; usually it requires a third-party product.

Dynamic pricing

As Dingman says, “This is what I like to refer to as the ‘Holy Grail’ for pricing.”

Dynamic pricing is calculating a price for a good or service based on complex formulas that take multiple conditions or attributes into account. It’s essentially a custom pricing structure. A great example of this style of pricing structure is a parking garage that offers different rates based on the level of capacity or a ride share service that raises rates as demand increases. Some benefits of dynamic pricing are:

• Unlimited flexibility in pricing and packaging
• Offering exact pricing that’s fair and logical

Dingman sees this model a lot. This model can be tricky when companies seek to provide a unique offering to their customers, and they think they can do it through their pricing structure. Sometimes companies get lost in the process of pricing, rather than focusing on what they’re selling.

The good news is businesses don’t have to have a custom billing structure in order to do dynamic pricing. Automation and third-party solutions can support companies in integrating or streamlining dynamic pricing.

Hybrid pricing

The flip side of dynamic pricing is the hybrid pricing model. In this model, companies charge for physical and digital goods that sometimes include other services. What’s unique about this recurring revenue model is that it always involves hardware. Pivot irrigation is an example of this model. Customers can buy or subscribe to use the irrigation equipment; they pay for the software that runs the machines; and finally, they pay for the maintenance of the machines and software. Some of the benefits of the hybrid pricing model are:

• Combining one-time, consumption-based and á la carte pricing models to create different packages and bundles
• Providing best of subscription- and usage-based pricing models: the predictability of revenue from subscriptions and the upside of consumption of usage-based

It’s important to know there are very specific ways that accounting categorizes hardware within industries. Whether you sell it or lease it and how it’s used will affect the accounting side of the business and may affect whether a hybrid pricing model will work or not.

“There are subscription management services out there that have no concept of a one-time charge,” says Dingman.

This is important if your business is considering offering more than straightforward subscriptions.

Consolidated invoicing

This concept is and isn’t a pricing model. Here’s why: Consolidated invoicing has two definitions:

1. Combining multiple subscriptions or purchases from a customer onto a single invoice for a set period of time

and

• Consolidating invoices from multiple child accounts that roll up into a parent account

Most simply, there are child accounts whose invoices are all rolled into a single, parent invoice. The benefits of this consolidated invoicing include:

• Easy access to parent/child relationships within a company that gives insight into total sales, profits, churn and more, across the company in one place

However, this concept becomes complex when 1) businesses have child accounts with their own invoices; 2) contractual rates that are set at the parent level and flow down to the child accounts; and 3) volume-based discounting across different divisions globally.

This leads to more complicated pricing constructs, all of which can be approached from different angles, like pricing and invoicing. According to Dingman, it’s important to note that this is the breaking-off point for most customers from their ERP. This happens because ERP solutions don’t have the ability to handle account hierarchies and the billing requirements associated with them. Usually, customers will seek a third-party billing solution at that point.

Revenue commitments

This recurring revenue model allows customers to pay a flat rate for a set amount of services (regardless if they use them in full or not) for a discounted rate. This model is most often seen in “minimum commitments” where a customer guarantees to pay X amount of dollars over a set period of time for one or more services. The benefits of revenue commitments include:

• Discounted rate for the service(s) for the customer
• Predictable revenue stream
• Protection against revenue decline or underperforming accounts

One of the issues with annual commitments that is often seen in this model is that, from a revenue recognition perspective, you can’t recognize the consumption of [the good or service] until it occurs, says Dingman. This causes revenue to be less predictable and causes accounting issues — as many systems struggle with this type of revenue accounting.

A solution to this issue is to sell at a monthly level instead of an annual level. This allows for easier accounting and more predictable revenue throughout the year. Additionally, if usage dramatically inclines in one of these commitments, you may be left “holding the bag” as Dingman put it. Ensuring flexible contract modifications, allowing for an out, is important.

Partner arrangements

Like consolidated invoicing, partner arrangements are more of a construct rather than a traditional pricing model. This system provides companies the flexibility to define various billing arrangements, which could be with a reseller, distributor, partner or through a marketplace. This model is designed to allow a business to go to market with other entities. The benefits of partner arrangements include:

• Utilizing partners as another channel to sell products and services to increase revenue potential and automatically settle commission
• Utilizing bill on behalf model
• Utilizing marketplace model

All of the abovementioned relationships are very common, which is why this system may make sense for some companies. Additionally, this model takes into account commissions, which fall under accounts payable. While all of this processing can be done manually, automating it with software will save time and money as well as prevent mistakes.

Prepaid credits

This recurring revenue model offers customers and prospects a prepaid balance for a specific product or service valued with a specific monetary value and the ability to draw down over time. This can be done through promotions, discounts, vouchers and other methods. The benefits of prepaid credits include:

• Incentivizing customers to use more products and services as a way to increase revenue and loyalty
• Incentivizing prospects to become customers
• Flexibility in discounts and promotions

This model can become complex to manage when there are multiple vouchers running concurrently on an account that must be drawn down in an intelligent way for accounting. Additionally, Dingman has noticed an interesting trend in the cloud services industry.

“Companies are not just allowing you to buy credits for their product, but they’re actually selling their products for credits. So, if something costs $200, they’re selling it for $200 in credits now. It’s kind of like a virtual currency; it’s something that’s pretty novel. I’ve seen it at two or three companies now and it’s something to keep an eye on and something to think about,” says Dingman.

Companies don’t always have to sell products or services for a dollar amount; they can sell them for a credit. This lends particularly well to the current rise of cryptocurrencies across the global market.

Choosing the right recurring revenue model

When it comes to implementing a recurring revenue model, companies have many options. But choosing the right one for your business requires consideration of how you want to move into the future, keeping pace with changing technology and customer demand. All of these models can support the expansion of revenue and growth within your business, if you know how to use them.