Usage Based Pricing : An Case of Service Unbundling

Consider a service with limited and uninventoriable capacity serving a large number of users with different usage patterns. Limited means, capacity at current investment levels that cannot be increased without new investment. Uninventoriable means that the capacity exists only for the duration and cannot be carried over to the next period. There are  two common ways to price such a service, 

1. Flat or Subscription Pricing: Users pay a flat subscription fee for a period and consume as much as they want. As long as the usage patterns are distributed with a vast majority of users with below average consumption, the marketer will make profit. For example, Cable TV. Subscribers can watch any number of hours for a flat fee.
   
2. Usage Based Pricing: Users pay for exactly how much they use. As long as the marketer an unbundle their service into measurable units and has means to meter the usage, they can price the service based on usage. For example, Water supply. The water meter measures exactly the number of gallons used and people pay for ust that amount.

 Hal Varian and Jeffrey MacKie Mason  wrote a FAQ on Usage based pricing in the context of Internet pricing models. They compared Usage pricing to Flat (or Subscription) pricing models. Their work discusses Internet pricing, but is relevant to unbundling in general. In a broader context, Usage based pricing is an instance of Unbundled pricing, the marketer prices their product/service to reflect  the usage cost and a user of this product/service pays only for what they use.

The unbundling described here is on the extent of usage of a service and not on the multiple components.  In the next few posts I will discuss the advantages and issues raised by Hal Varian and Jeffrey Mason and the relevance to Unbundled pricing.