AI: price models do not acknowledge high variable costs

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Forecasts for generative artificial intelligence disruption are hampered by the lack of clarity around pricing. AI excitement has lifted software-as-a-service stocks from last year’s slump. But how can AI be a multitrillion-dollar market if customers pay little to access AI-enhanced services?

When Salesforce launched AI Cloud in June, it did not raise rates. Box does not charge for AI services. Microsoft’s bet on start-up OpenAI has lifted its share price to a record high. So far, however, the sharp rise in share prices has not corresponded with a jump in AI-driven sales and profits. In the last quarter, Microsoft’s revenue rise was driven by gains in cloud computing.

For software companies adding AI capabilities, there are two options: employ a freemium model and then price services at low rates to encourage high take-up, or charge premium rates that reflect the costs involved.

AI hype suggests the first strategy is unnecessary. But how should premium rates be fixed?

GitHub priced its AI Copilot services at $19 a month per person for businesses. Microsoft went further, opting to charge an extra $30 a person per month. This means the premium service is twice as expensive as the cheapest version of Microsoft 365. It is a fair starting point. If a fifth of Microsoft’s Office 356 enterprise users opt to pay for Copilot, Mizuho estimates an annual $9bn revenue rise, equal to an extra 3 per cent.

This sort of increase is welcome, if not transformative. Microsoft’s new office software with AI features gives users the chance to create PowerPoint presentations more easily and parse emails and other documents quickly. The challenge is convincing customers that AI is not just a productivity enhancement but an essential service.

If companies succeed in doing that, there is one further danger to consider: AI services require high compute costs and are expensive to provide. Raising per person subscription rates means higher recurring revenue. But if customers use AI tools more than expected, then charging a flat rate will weigh on future margins.