Does Usage-Based Pricing work for Your SaaS? -
According to an OpenView survey, in 2023, the majority of SaaS companies will use or planning to use price-based usage, which they define as "a pricing system that allows customers to purchase the product based on the extent to which they utilize the product."
Usage-based pricing (UBP) (also known as consumption pricing is determined by the usage of a specific measure, for example, gigabytes of storage utilized or the amount of API calls that are made over a period of time.
The method of pricing SaaS products is super current, but that doesn't mean it's the best fit for most companies.
Here's what I think in the simplest way:
The emergence of UBP is gaining popularity as a alternative to an older problem price must accurately reflect value on both sides. UBP helps to better align the value of a deal so both buyers and sellers perceive the transaction as honest.
However, this doesn't mean that it's the right choice for everyone -- and actually, you may be already using an earlier version of UBP.
Seat-based price (SBP) isa measurement based on usage. The question for you to consider is: is the amount of people who use (or seats) the most strongly connected metric to significance?
- Don't get sucked into the use of UBP as a solution looking to solve a problem. As you think about pricing, you should be focusing on one thing: is pricing viewed as fair.
In this piece, I'll break down my thoughts on usage-based pricing and the best way to determine if it's worth investigating for your company.
Why is UBP trending?
SaaS pricing can be difficult to improve. The main reason for this is that it has very little limitation. With high gross margins and few technical constraints, products have the potential to be wildly creative in their pricing and packaging, in ways isn't the case in other industries.
SaaS is also a emerging industry. We're still in the early stages of ideation around pricing packaging, pricing, as well as the sales model. Innovative companies are developing rapidly, not just on their products, but also in the ways they monetize. In many ways, we are in the very starting point, and using usage-based pricing is an easily accessible method of pricing.
It's all thrilling, however it means that, with fewer restrictions and tested best practices, we can quickly get caught by the "next major trend."
So why is UBP "the the next biggest thing"?
Like many trends, usage-based pricing is popular with the recent success stories that play on the idea of pricing fairly. The consumers, whether business or private, need to feel like they are paying an appropriate price. In the world of SaaS, customers are making the decision to renew their subscription or permit a monthly cost. However, fairness is not a one-way street. SaaS providers should also be compensated fairly in exchange for the benefits they provide, and in most cases this is the case as the product continually improves and usage by customers increases. The creation of a pricing structure that optimizes for fairness -- in both directions -is an essential element for SaaS pricing. To do that effectively, the metric upon which your pricing is based needs to be as close to what customers perceive as value as possible.
If it is done properly, UBP accelerates you toward the answer. It's crucial to understand, however, that alignment to value is not the only consideration when coming up with an ideal pricing measurement that's linked to value. Two aspects you have to optimize:
- A linked pricing metric that is as close to value as possible (the Fairness Principle)
- Your pricing should be as easy and as easy to forecast as possible
The extent to which you weigh one versus the other is contingent upon a myriad of variables including your market and what your competition is making, the average price as well as the type of product you sell and the preference of your buyers. It usually requires time to determine the ideal balance between your products and market There aren't any quick fixes. Continuous testing is the only proven way to be successful.
Most of the time, when you read or hear anything regarding UBP is that it's promoted as an alternative to pricing based on seat which is the dominant sales model for B2B SaaS businesses.
(But regardless of the fact that more companies are trying out other measures and pricing strategies seating-based pricing remains stillthe most common B2B pricing model.)
But one of the biggest reasons that UBP is trending is because there are some significant positive stories of success in the recent IPOs of companies using this model, such as Snowflake, Twilio, and Agora.
The success stories of these companies are fascinating but they should not be replicated blindly. Consider the core factors behind why UBP work for certain firms by asking three simple questions in order to take the insights from the experience so that you are able to use them in your personal scenario:
- What is the price metric correlated with the value perceptions of customers?
- How is the degree of complexity (or simple) of their business model affecting their sales and renewal process? Do they slow down or accelerate it? Does it make it easier or harder?
- How is their pricing model placed in comparison to other competitors? Is it unique or similar? What are the pros and cons?
What do the UBP Success Stories Have In Common?
It's simple to study companies that have successfully gone to the public market with massive valuations, and want to pattern match to find things you can use for your business.
But there are a couple points that all these businesses have in common that make usage-based pricing particularly beneficial for them. And before assuming that UBP is the right choice for you, you'll want to see whether your business is a good fit for these characteristics.
1. The Model Lends Itself To An Usage Metric Measurable
The most successful UBP firms all use one primary price metric like:
- Snowflake: Compute and storage use
- Twilio: Amount of phone numbers used and lengths of calls or messages delivered
- Agora Live stream or call messages or lengths
They can easily be tracked and estimated by their customers. It is a common reality - if your prospect can't easily forecast how much they will pay, you are making your prospects' ability to purchase from you much more difficult. This is especially true of applications for enterprise where expenditure is required to be budgeted.
2. The Success Stories Tend To Have Long-Term Time Horizons
Another important commonality of effective UBP models: the goals are a long-term view. This model allows businesses to do things during the initial or growth stages of the company with a focus on the long-term goal of maximising value.
As an example, the more innovative B2B product types often make use of UBP to charge very little in the first year or two with a customer and show their value and earn buy-in. In time, as that company grows, so does the ARPU, or average revenue per customer (ARPU) as well as profit margin.
Although usage-based pricing IPO successful stories are impressive, they don't do justice to those initial years of deal when they probably left money in the bank because of a traditional pricing model. Ultimately, that value is growing with time, and that's why we see an astronomical increase in net dollar retention rates.
However, businesses operate with very distinct time horizons that they operate within. You must determine which is best for you as well as your company first. If you're financing projects with cash flow, it's possible that you don't have the chance to move to a longer term time horizon.
Is UBP Worth Investigating For Your Company?
If you're thinking about UBP, it means that you're re-evaluating the metrics you're using to determine the price of your products.
Instead of restricting yourself to metrics that usually are in the UBP group, I'd suggest you to simply consider what your ideal value metric or metrics might be - begin there.
It might be seats It could be megabytes, or even minutes. Perhaps an approach that is more tidier with bundled features would work well.
Assessing the primary and subsidiary value metrics you use for pricing and packaging is one of the primary growing levers that you have If you're questioning your pricing model then you're on the right track. But pause if you consider UBP simply because of its positive or negative publicity in the market.
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