Five pricing models implemented through billing

Summary

Billing is the point where undifferentiated transactions have their price determined. The pricing models used can influence both the success of the biller's sales and the complexity of the billing process. In common with many billing functions, similar pricing solutions are implemented and successful across a range of businesses and industries.

How much is that?

A key decision each business must make is how much it will charge for its product or service. Businesses selling one product may choose one model, or differentiate their pricing solutions by customer group. Businesses offering more than one product may construct combinations into bundles that are further differentiated by their pricing model.

Flat Rate

This is the simplest approach to pricing that applies the same rate to each transaction or charge regardless of who the customer is, and ignoring previous transactions performed. Collection and storage of historical data is not required since the correct price can be obtained by applying a rate to the information contained within the transaction itself. Flat rate pricing with its linear relationship (use more, pay more in a constant ratio) forms a comparison point against alternative models.

Examples of businesses using flat rate pricing include tollways or bridges applying the same charge for each journey / crossing across their customer base. There may be a different rate (price) applied to different customer segments or (say) vehicles, but the rate does not depend on other aspects of their 'consumption'.

Charge more per unit the greater the quantity consumed

An alternative to applying the same rate for all consumption is to increase the amount charged as a penalty or a form of persuasion. This model can be used to reduce the customer's consumption for products and services that are in short or limited supply. Two examples are utilities that charge for water or electricity consumption. In drier climates, water is a relatively limited resource that cannot be easily 'manufactured' to cater for increased demand. Water utilities persuade people to limit their home and garden consumption by making it expensive to use large quantities. Similar reasoning applies for electricity utilities since power stations are expensive to construct, and deferring the demand saves the expense of new construction.

In the example above, governments may regulate that a quantity of water/electricity, representing an 'average' household, is supplied at reduced rates. This social policy ensures the community has access to an acceptable minimum of essential water/electricity whilst allowing excessive consumers to pay a higher rate.

Both tiered and threshold algorithms may be used to determine the rate for higher consumption, but only the tiered algorithm will preserve the lower rates applied to the earlier consumption.

Charge less per unit the greater the quantity consumed

Businesses such as telecommunications and information providers (e.g. music, reports) are more interested in encouraging higher consumption than penalising it. These businesses offer each additional unit of consumption at a lower price to encourage higher spending by their customers. Often these businesses sell a product or service that has a high fixed cost to produce (digital reports) or maintain (phone networks) but a low cost to supply additional copies (report downloads) or support use (phone calls).

Encouraging higher use helps these businesses cover their costs. Businesses subject to economies of scale, especially those selling information products, can achieve highly profitable revenues through encouraging higher consumption of products that are essentially 'free' to reproduce and distribute.

Bundled prices

Bundles are collections of products and/or services offered to customers at a lower price than the sum of each item offered separately. Even if customers don't need or use all its components, customers may find enough value in the bundle to purchase at its higher price. The components in the bundle undervalued by the customer can still provide benefit since the customer may optionally use them 'for free' (since they are already paid for). Without the bundle, customers would only spend a lesser amount of money on the specific components they valued.

By grouping many products and services and charging less for them, the bundle's reduced price helps bind the customer to the biller and reduces the benefit to be gained by the customer from purchasing each product or service from another provider. If the customer 'breaks' the bundle they are likely to have to spend more money than currently incurred.

An example of a bundle is a telephone company that offers discounted rates when a customer purchases all their fixed, mobile, cable TV and/or internet services from the same company. The discount for the increased business is reduced or removed when the customer stops their service and spends with other providers. Bundles increase the complexity of billing in this case because the individual services (and their pricing) must be billed as well as the bundled combinations (with their different prices).

Another example is the Cable TV 'basic' package bundle where a number of channels are provided for a fixed rate per month. Whilst not every customer loves all the sports, news, movie and kids channels, each customer finds enough value within their interests to warrant the ongoing cable TV purchase. In this case, bundles reduce billing complexity since the alternative is to allow each customer to purchase their particular choice of channels. The tracking and reconciliation of channel combinations would be complex for a 100+ channel cable TV business when compared with a small number of bundled offerings.

Quantity discounts can provide the same benefits as a bundle. Businesses offering DVD rental by subscription (e.g. borrow 3 at once for $21/month, 4 for $25/month, 5 for $27/month) allow customers to self-select the number (bundle) of DVDs appropriate for their home. This example also has elements of differential pricing outlined below.

Differential Pricing

Differential pricing tries to collect different amounts from customers for the same (or similar product or service) based on their willingness/ability to pay and their perceived value of what is being offered. The classic example is an airline seat that conveys a passenger from point A to point B. The product is the same, but the ticket conditions allow the airline to charge a premium to business passengers (who need to purchase tickets at short notice with the ability to change flight times) and discount to tourists (who purchase weeks in advance and are locked in to specific flight times). This helps the airline extract the most revenue from each flight from a wider range of customers.

Billing can be used in a similar manner to charge different amounts for products and services by applying different conditions to their offerings. Example include:

Utilities might charge higher monthly access rates for their power / gas / water connections if restoration and maintenance were performed with a higher priority.
Tollways could construct offerings that charge customers less for journeys performed in off-peak hours (when customers might choose to use side roads instead) if the customers were charged more for peak-hour journeys (when each additional car adds to the congestion).
Stock market quotes offered live at a premium price, and at a reduced rate for quotes delayed by 15 minutes.
Digital Rights Management: offerings could be constructed with different combinations of rights charged at different prices.
Telephone companies offering phone services which trade-off the monthly access fee against the cost of phone calls - the higher the monthly fee, the lower the call costs. (Note: A competing pricing choice (using an earlier model) would charge customers who make high volumes of phone calls (e.g. businesses) a cheaper rate for their monthly access.)

Tags: Billing, Pricing models