Pricing is one of the most important decisions a software platform can make. Which side of a multi-sided market to charge, how much to charge, and in what form are never-ending questions faced by Industry Cloud providers. These platform pricing decisions influence participation rates and must evolve as any multi-sided market grows.
The question of what form the fees should take is a particularly interesting one. Should participants pay access fees (typically annual fees) to be able to use the system or just usage fees as they use the system. In economic terms, an access fee plus a usage fee is called a two-part tariff. If you remember your college economics, you will recall that two-part tariffs can be favorable, especially if there are many different types of customers with uncertainty about their true levels of future demand (e.g., health clubs). (I think behavioral finance will also, some day, show that there are psychological advantages to two-part tariffs as well.)
Today’s Wall Street Journal reminded me that two-part tariffs are a pricing mechanism in even mundane industries. My favorite example of two-part tariffs is Costco, which charges a membership fee for access (and actually checks to see if you have the card) as well as a usage fee in the form of an admittedly razor-thin margin on the merchandise they sell.
Today’s article about Costco makes two salient points:
- Membership (access) fees for the last fiscal year were $2.3 billion and nearly three-quarters of Coscto’s annual operating income!
- During the last three fiscal years, Costco’s 10% increase in its membership fees accounted for 30% of per share earnings growth.
Costco has a membership renewal rate of almost 90% (higher among businesses), so this fee seems secure and perhaps inelastic. What would be really interesting to know is what percent of members are like me and pay the membership, but rarely shop there!