Willingness To Pay Founder Explains AI Pricing Challenges
AI costs are driving down profit margins for many companies, with 1% of users accounting for 50-75% of total AI costs. This disparity highlights the need for more nuanced pricing strategies.
Original reporting · saastr.com
Original: “The Double Hockey Stick: Why 1% of Your Users Now Drive 75% of Your AI Costs, and What Figma, Clay, and Higgsfield Are Doing About It”
Read “The Double Hockey Stick: Why 1% of Your Users Now Drive 75% of Your AI Costs, and What…” at SaaStr →How this was written. Voyager Commercial wrote this article with a language model from SaaStr’s reporting (model: @cf/meta/llama-3.3-70b-instruct-fp8-fast); it describes that reporting rather than adding to it. The original, linked above, is the full story.
Key points from SaaStr’s report
- AI costs can drive down profit margins for companies, with a small percentage of users accounting for a large proportion of costs.
- The value that customers derive from a product can vary greatly, following a power law distribution.
- Companies need to implement pricing models that take into account the varying value and cost of different customers to manage costs and capture more value.
- Tiered pricing, usage limits, and other mechanisms can help companies manage costs and increase revenue.
- The 'sticks dance' process can help companies navigate the complex relationship between cost and value curves.
Ulrik Lehrskov-Schmidt, founder of Willingness to Pay, has spent a decade studying pricing strategies. He recently developed a model to explain the unique challenges posed by AI pricing, which he calls the 'double hockey stick'.
According to Lehrskov-Schmidt, the value that customers derive from a product can vary greatly, with some customers getting significantly more value than others. This variation follows a power law, where a small percentage of customers account for a disproportionate amount of value.
In traditional B2B companies, flat pricing models often hid the issue of uncaptured value, as every customer cost roughly the same to serve. However, with the introduction of AI, a new cost curve has emerged, which can lead to significant losses if not properly managed.
Lehrskov-Schmidt's team has worked with numerous high-growth AI companies, and they have consistently seen that a small percentage of users drive a large proportion of AI costs. In some cases, just 0.1% of users can account for over 75% of total AI costs.
This disparity between value and cost can lead to unprofitable customers, where the cost of serving them far exceeds the revenue they generate. Lehrskov-Schmidt cites the example of a company where one customer was spending 380 times more in tokens than they paid in revenue.
To address this issue, companies need to implement pricing models that take into account the varying value and cost of different customers. This may involve introducing tiered pricing, usage limits, or other mechanisms to manage costs and capture more value.
Lehrskov-Schmidt's team uses a process called 'the sticks dance' to help companies manage their cost and value curves. This involves segmenting users, setting usage limits, and gradually introducing 'brakes' to reduce costs and increase revenue. This article is based on reporting by SaaStr.
Questions and answers
What is the 'double hockey stick' model?
The 'double hockey stick' model refers to the two curves that emerge when considering the value and cost of AI-powered products, with a small percentage of customers driving a large proportion of value and cost.
How can companies manage their cost and value curves?
Companies can manage their cost and value curves by implementing pricing models that take into account the varying value and cost of different customers, such as tiered pricing, usage limits, and other mechanisms.
What is the 'sticks dance' process?
The 'sticks dance' process is a method used by Lehrskov-Schmidt's team to help companies manage their cost and value curves, involving segmenting users, setting usage limits, and gradually introducing 'brakes' to reduce costs and increase revenue.
