Although cloud computing often bills itself as the simpler choice for consumers, the reality of cloud pricing schemes is far from straightforward. These days, there are two principal options for cloud pricing models, each with their own internal subdivisions and specifics.

For one, there’s the flat-rate SaaS (software as a service) business model, where customers pay a recurring charge to access applications hosted on a third-party server. This may be a single price for the entire business, a price that’s charged per user, or a tiered pricing model for the benefit of companies with different sizes and needs.

On the other hand, there’s the pay-as-you-go model, in which customers are charged a small fee each time that they use the service. This dynamic pricing model is typically preferred by companies offering infrastructure and platforms, like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud Platform. The exact fees charged may vary based on a variety of features, including storage, bandwidth, compute use, and server requests.

The problem with the flat-rate pricing model is that it doesn’t accurately reflect how people use software, just like the legacy on-premises solutions before it. Using flat-rate SaaS pricing as a customer is like purchasing a gym membership. If everyone with a membership suddenly became a faithful gym-goer, the extra costs of repair and maintenance would quickly become uneconomical for the company. Instead, gyms count on the fact that for every “power user,” there are many others who essentially subsidize the lower cost of membership by not using the facilities as much (if at all).

Unless you’re a juggernaut in the industry like Salesforce or Microsoft, the days of the one-size-fits-all pricing model are on the wane. Paying $150 per user per month, no matter what the use case or how often the use, is a gross oversimplification that simply isn’t appealing for price-sensitive customers who don’t want to pay too much for their software.

As the number of cloud providers continues to expand, organizations want finer-grained control over how much they spend on cloud computing from their IT budgets. The future of cloud computing pricing models lies not in the existing flat-rate SaaS approach, but one that gives consumers the most flexibility and choice: the micro value software economy.

The History of SaaS

The premise behind the SaaS business model has been around since the mid-20th century, when you could pay the owner of a computer to use the mainframe during a given time slot. This time-sharing agreement allowed smaller businesses and educational institutions to have access to a computer on an as-needed basis, without making a massive capital investment up front.

In its current incarnation, SaaS is more than a decade old, dating to around the turn of the millennium. Two factors are largely responsible for the (re)birth of SaaS in the 2000s. To begin with, this era saw rapid technological developments in fields ranging from the Internet and mobile phones to web browsers and APIs, all of which are essential components of SaaS.

Secondly, the first major modern SaaS companies, Salesforce and Concur, both broke into public consciousness around this time: Salesforce was founded in 1999, and Concur went public in 1998. Breaking from the prevailing paradigm, both companies focused on providing valuable services that met business needs—customer relationship management software and travel and expense software, respectively—over the Internet.

The Internet has given birth to countless niche markets residing in the long tail. Before, companies usually had to orient their products to have as much mass appeal as possible, with advertising channels to capture this mass appeal. Avenues like prime time television were the most important forms of advertising, with businesses spending millions to get their message in front of as many eyeballs as possible.

These days, however, it’s easier than ever to monetize smaller public groups with a narrower focus. If you want to sell lizard potion to 32-year-old female lizard lover, you can—and if you cater to your customers in the right ways, you can make a fortune doing it. Thanks to the Internet, we’ve entered the age of mass specialization and micro-channel advertising.

The Evolution of Cloud Computing Prices

In essence, the pay-as-you-go cloud computing model represents a further evolution of the software pricing structure for customers’ convenience. Companies once had to spend thousands of dollars on expensive software licenses without regard to which applications were being used, or how many employees were using them.

Because this was needlessly wasteful, however, the SaaS model quickly gained popularity, allowing businesses to select the services they wanted and the number of users à la carte. Companies’ software budgets went from being a capital expenditure to an operational expenditure, giving them greater flexibility and convenience.

Now, an even more efficient pricing model is emerging: the “AWS” cloud economics model, in which customers pay only for the software and infrastructure that they actually use, at the times that they’re using them. The days of having to engage in complex negotiations with the vendor just to use an application are over.

Rather than signing a contract that locks you into a relationship for an extended period of time, the API becomes its own contract. Paying a tiny fraction of a cent per API call is an appealing prospect for companies who have problems understanding exactly what it is they’re getting for their money. With the micro value service economy, it’s simple: The price of the service scales proportionally as usage increases. When it’s used, you pay; when it’s not, you don’t. SaaS promised this, but API monetization strategies are actually delivering it.

The next pricing revolution is happening now, thanks to the rise of AWS and other IaaS (infrastructure as a service) companies. If you only need a CPU, a function, or a bucket of memory once a night, once a month, or once a year, then you should be charged for that amount of usage and no more.

The micro value service economy is the instantiation of the perfect long tail in economic theory. By giving users the ultimate control over their operating costs, it will make flat-rate SaaS pricing look as unappealing as SaaS made owning your own software and servers did.

Cloud Computing and Price Discrimination

While micro value economics is already here for cloud computing, there are still inefficiencies in its pricing models today. For one, many cloud companies that offer the pay-as-you-go model charge the same rate for all services, no matter how much a customer uses that service.

The next stage of the micro value service economy will be price discrimination: charging different prices to different customers for the same product. Companies use price discrimination based on a number of different factors, including the quantity consumed, the time of use, and the customer’s demographics. For example, a coffee shop may give customers a free cup of coffee after they’ve already purchased 10 of them, or an airline may charge more for a plane ticket during the holiday season.

Behind the practice of price discrimination is the economic concept of elastic demand. If you want to go on vacation, for example, you generally have a degree of flexibility as to when you can travel. On the other hand, if you want to go home for the holidays, you need to travel within a restricted range of dates—in economic terms, your demand is more inelastic.

Another example of price discrimination is offering discounts for students and senior citizens, both of whom typically have lower income, and so have more elastic demand. On the other hand, business travelers have highly inelastic demand because they travel when and where their employers ask them to. As a result, companies like airlines and hotels offer “business travel” services at higher prices, even if they're the same as or similar to their standard offerings.

So what does this all mean for cloud computing prices? As mentioned above, they’re already trending toward greater efficiency by allowing users to pay only for what they consume. It’s very possible that once more and more cloud providers migrate to the pay-as-you-go model, companies will begin to adopt price discrimination as a way to distinguish themselves and attract new customers.

Eventually, the market may become so efficient that cloud computing unit economics will have prices just as sophisticated as airline tickets. Cloud providers will use complex price discrimination algorithms, based on API calls, to determine the price of their services for different customers, times, and quantities of data.