Spigot Pricing

Mainstream Names for This Strategy

1. Freemium
   • Definition: A pricing strategy where a basic version of a product or service is offered for free, but users must pay for premium features, advanced capabilities, or higher usage limits.
   • Examples:
     • Spotify offers free streaming with ads but charges for ad-free premium accounts.
     • Dropbox provides free storage but charges for more capacity or team collaboration features.
2. Usage-Based Pricing (Pay-As-You-Go)
   • Definition: A pricing model where customers pay based on how much they use the service. The initial price per unit or tier is low to encourage adoption, but costs rise as usage increases.
   • Examples:
     • AWS (Amazon Web Services) charges based on compute hours, storage, or bandwidth, making it affordable for small users but expensive for heavy users.
     • Utility companies (e.g., electricity providers) charge a small base fee but increase costs for higher levels of consumption.
3. Loss Leader Pricing
   • Definition: A strategy where a product or service is sold at a loss (or at a very low price) to attract customers, with the goal of making money on complementary or incremental purchases.
   • Examples:
     • Video game consoles (like PlayStation or Xbox) are sold at a loss, but companies make money from game sales and subscription services.
     • Printers are priced affordably, but ink cartridges drive up revenue over time.
4. Land-and-Expand Strategy
   • Definition: A business strategy where companies "land" customers with a low-cost or free offering, then "expand" revenue by increasing usage or selling more features over time.
   • Examples:
     • SaaS companies like Slack or Zoom often start with a free or low-cost plan for small teams but monetize larger teams or enterprise features.
     • Salesforce offers basic CRM tools, upselling advanced analytics and integrations as organizations grow.

How "Spigot Pricing" Works

1. Attraction Through Low Initial Costs:
   • Offering a low-cost (or free) entry point ensures a large number of users adopt the service quickly. This builds market share and brand loyalty.
2. Encouraging Heavy Usage:
   • The product or service is intentionally designed to incentivize more usage. For example:
     • A cloud storage service may offer 5 GB for free, knowing that users will likely exceed this limit and pay for more storage.
     • A streaming service may offer a free trial to hook users with their content library.
3. Revenue Expansion Through Upselling and Scaling:
   • As customers scale their usage, they naturally pay more. Some companies also upsell premium features, higher service tiers, or additional add-ons.
4. ARPU Growth Over Time:
   • Heavy users become the primary contributors to revenue. While many users may stay on the free or low-cost tier, the most engaged customers drive up ARPU.

Examples of Spigot Pricing in Action

1. Spotify (Freemium Model)
   • Free users listen to ads but can upgrade to premium plans for unlimited, ad-free music streaming.
   • Revenue grows as free users convert to paid plans and as existing users explore family or higher-tier plans.
2. AWS and Cloud Computing (Usage-Based Pricing)
   • Startups may begin with minimal usage, but as their businesses scale, their cloud service needs (e.g., storage, computation) increase, driving up costs.
3. Mobile Apps and Games (Freemium)
   • Free-to-play games like Fortnite or Candy Crush generate revenue through in-app purchases for virtual goods or additional content, especially from heavy players.
4. Telecommunication Plans (Tiered Pricing)
   • Internet providers offer low-cost plans with limited data but charge significantly for overages or higher-tier packages.

Why Companies Use "Spigot Pricing"

1. Market Penetration:
   • Low-cost or free offerings attract a large customer base, making it easier to dominate the market and outcompete rivals.
2. Behavioral Economics:
   • Once users are onboarded and use the product heavily, they’re more likely to upgrade or pay for additional features because of increased reliance on the service (psychological "sunk cost").
3. Scalability:
   • Companies can start with low-cost users but scale revenue as those users grow or consume more of the service.
4. Network Effects:
   • A large user base enhances the value of the service for all users, attracting even more customers (e.g., social networks like LinkedIn).

Risks and Challenges of "Spigot Pricing"

1. Over-Reliance on Heavy Users:
   • A significant portion of revenue may come from a small subset of users, making the company vulnerable to churn.
2. Sustainability Concerns:
   • Offering free or low-cost tiers can be expensive if customers don’t upgrade or scale usage quickly enough to offset costs.
3. Customer Backlash:
   • Incremental pricing increases (e.g., exceeding usage limits) can lead to dissatisfaction if perceived as unfair or opaque.
4. Competition:
   • A free or low-cost model is easy for competitors to replicate, leading to price wars.

Conclusion