Initially pay-per-use was the default revenue model in only a few industries, such as utilities (electricity, phone). But in recent years it has been spreading to industries that you would not have expected such as software and even automotive. The pay-per-use business model often combined with a subscription models are now common in these industries.
The economic benefits pay-per-use offers to consumers will make it a successful business model in more industries. Innovators who understand how to apply pay-per-use and subscription business models to their industry can be ahead of their competition […]
Once upon a time …
Do you remember the times where most software would cost you an arm and a leg? A hobby photographer buying a decent DSLR for $898 was only half done shopping. You’ll be quit another US $999 for the photo editing software (Adobe Photoshop CS6 extended version 2012). A too steep barrier for many people, missed sales for Adobe and even for the camera manufacturers.
But things have changed quite dramatically in recent years. Software is another industry where creative pricing models have emerged. Many start-ups were offering pay-per-use or its cousin, monthly subscriptions. This has put incumbents under pressure. And the big players have followed. Now you can get an Adobe Photoshop license from $10-$23 per month. This appears to be a more suited revenue model for a product that requires constant updates (service packs, etc) in any case.
Pay-per-use has been the forever pricing model in some industries. You name it: utilities (gas, water, electricity, landline phone). You pay a fixed access fee plus a variable fee for what you consume. Mobile phones offer you the choice between different size packages. One package may include 500 minutes talk plus 2 GB data per month. You lose what you don’t use. Things are very similar when you look at internet service providers.
You will find this combination of a monthly subscription model with a per-per-use charge on top in many other industries now.
Pay-per-use business models for durable goods?
Extending the pay-per-use business model to the software industry was enabled by the wide penetration of the internet and increasing bandwidth. Like utilities, software could now be distributed cheaply everywhere through the ether. You have large scale distribution at low transaction cost and improved protection against piracy.
But things get more interesting when it comes to durable goods, say cars. Until we have a Star Trek-like “replicator,” you can’t just send them through a data pipeline. And yet the pay-per-use pricing model has found its way into this market.
I am not talking about rental cars. Yes, they have existed for a long time. But ask yourself why are they are located near airports? Mainly because they are used by business people or tourists. The reasons are obvious: they are too expensive to rent, too time-consuming to pick up and only available for full days.
This makes them unattractive for most people. A situation where both lose the provider as well as potential consumers. On most weekdays (and even more so on weekends) you will see tons of rental cars collect dust on the rental car yard while at the same time some poor bugger curses having to carry their groceries home in the rain.
Zipcar: Pay-per-use cars
The economic benefits of car-sharing are obvious given that “it costs an average of $8,558 per year to own a car in the U.S., but each vehicle is used just 4 percent of the time.”
One of the first attempts for car sharing had been endeavoured in the 60s in Amsterdam but has ultimately failed. The right technologies were too expensive and too unreliable to establish a viable business model.
A good 35 years later the technology landscape had changed and the window of opportunity had opened. In 2000, Zipcar was one of the early-movers (and one of the biggest ones despite not having the first-mover advantage) to apply pay-per-use to cars.
Location-specific wireless technologies, GPS and a number of other technologies helped solving the challenges. “Zipcar would never be possible without technology. Robin Chase, former CEO and co-founder Zipcar.”
The challenges to tackle
An important first step to establish the new business model to the automotive / personal transportation industry, Zipcar had to overcome a number of challenges. Let’s have a look at some of them and Zipcar’s solutions.
- Challenge: How do you get your durable good to the pay-per-use customer? Would you expect them to go to the airport to pick up a car for 2 hours, then return it and get home by public transport? On the other hand positioning the car in many locations adds new challenges. You would require additional offices (infrastructure), hire additional staff for those offices and so on. Not exactly a low cost base.
- Solution: Zipcar is in selected cities and there only in targeted areas. Their cars are in clusters close to potential customers, e.g. around university campuses close to students. The cars are spread across different streets in the surrounding area. The cars are picked up from and dropped off at fixed parking spots without any supervising staff. A mobile app will show you all cars available near the customer’s location. You can reserve cars in advance or book available cars spontaneously.
- Challenge: Picking up keys, having to refuel, providing personal details, determining usage and other tasks make transactions prohibitive. It would waste the customer’s time and cost the providers too much in staff. “I would never be able to provide you a car for an hour if the transaction cost was anything” Robin Chase, former CEO and co-founder Zipcar.
- Solution: The payment scheme is similar to utilities, an annual membership fee plus pay-for-use (automated transaction). The customer receives a membership card which is used as keys to the car and to identify the user. Users need to refuel when it drops below 1/4 of capacity.
- Challenge: Car share providers have to solve a number of other problems related to the condition of their asset, such as theft, damage, cleanliness, etc.
- Solution: You may have already guessed that the cars are tracked via GPS. They can be remotely shut down. These are only two security measures without which insurance costs would be prohibitive. Additionally, there are also clear protocols around cleanliness, and technical issues. These are designed in a way that they use the customer for the reporting (rather than staff) and transfer accountability to the (likely) originator of the problem.
How to get started?
Is pay-per-use for your company’s products? Zipcar’s business makes sense. It provides economical benefits and addresses new market segments. It avoids large upfront payments (or taking up debt) and the subsequent depreciation losses. It is useful for student and others that can’t afford (or don’t like) to buy a car. In space-constrained cities like Singapore the taxes can easily triple the purchase costs of a car. In other cities parking costs
These type of circumstances can be a starting point for innovation ideas. Is there anything similar in your industry? Could you address new market segments or exploit inefficiencies with a pay-per-use model?
Once you identify such a starting point innovation tactics can help you elaborate the details of your idea.
Once you have the solutions best-suited for your innovation idea / industry you can take the next step. Pay-per-use opens new market segments. But it also comes also with some risk. A pure pay-per-use for example can cause higher volatility in revenues. It may as well risk cannibalising you own, more premium or revenue-generating offerings.
This will spook your CFO and CEO or whoever is the decision maker. You can alleviate risks by combining pay-per-use with a monthly or annual subscription fees with pay-per-use. Starting with your non-premium offering could also be very wise. This bodes also well with the fact that pay-per-use is economically more suited to the lower end of your customer base.
Pay-per-use business models will work well where you can allocate the cost of developing and delivering the service/product to the customer well.
And additional benefits
Once you remedy the risks, you can start pointing out the growth opportunities. The obvious one is to capture new customer segments because of the lower cost of entry and capture market share from your competitor.
But there could be more benefits. Pay-per-use and subscription models lend themselves better to incremental feature-adds, scalable product offerings and faster product-development loops. This can offer great insights, rapid feedback on which new features customers value (and which ones not).
With this comes a significant reduction of risk in your R&D endeavours. Imagine Microsoft invests a billion dollars into the next version of Windows to find out it flops (not unheard of).
For companies that are willing to take the challenge, this can significantly accelerate the organisational learning curve. You can reduce R&D risks and costs by stopping investing in low-value add functions. CFOs will appreciate the better returns on R&D investments and reduced risks.
When to start?
Established companies may want to trial pay-per-use on one of their new non-premium offerings. If you are a premium brand in your industry this will help you gain experience with this pricing model. This experience will be invaluable when you get attacked from other companies using pay-per-use.
If a pay-per-use model means a lower profit margin for your company, there will be significant organisational resistance to this innovation tactic. You will likely need a senior executive of your company to be the sponsor of this project.
If there is an economic benefit for some customer segments, then it is certain that someone will come up with this pricing model. Waiting until others force you to take this profit model seriously, would be the worst starting point.
If you are at the less premium end of your market you can be the first-mover on this business model. For new entrants and smaller companies this payment model is a real opportunity to capture new customer segments and enter the market from the lower end.
The power of innovation tactics!
We have touched three very different industries in this article and yet there were profound similarities. These industries had to solve the same same set of problems to make pay-per use business models work. I have mentioned the distribution, the transaction and asset management as an example. You can solve other challenges in a similar fashion by comparing across industries.
These examples show the power of innovation tactics. Innovation tactics will show you which challenges are key areas to focus on. Without knowing the challenges you will struggle to come up with a convincing proposal. It will also increase the risk of your ideas failing when trying to realise them.
If you look at the industries covered in this article you will see that the technologies are – understandably – different. However, it is striking that on a business level the challenges are so similar.
Take action now & boost your innovation skills
Even a 5 minute brainstorm will help trigger your subconscious thinking and broaden your horizon for bigger, better ideas over time. Copy & paste to your note taking software and jot down what comes into your mind.
- Which offerings of your company may be suited for a pay-per-use business model? Consider all your products & services (not just your main ones).
- How can you solve the key challenges for your product/service associated with this pricing model?
Learn more now
There are many overlaps between Zipcar’s and Uber’s value proposition. But Uber is based on the powerful platform business model. I am comparing both companies here. While you are at it, take the time now to advance your innovation knowledge further:
If you are interested in Uber, here is a must-read article on their business model (this article ranks #1 on Google across several keywords):
This article by Murat Uenlue is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
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