Does Usage-Based Pricing work for Your SaaS? -

Aug 19, 2022

Based on the findings of an OpenView survey, in 2023 the majority of SaaS companies are using or planning to use usage-based pricing, which they describe as "a pricing system that allows customers to pay for an item based on how much they use it."

Utilization-based pricing (UBP) -- or consumption pricing is determined by the use of a particular metric, such as gigabytes of storage utilized or the number of API calls made -- over a period of time.

This way of pricing SaaS services is very trendy right now, however that doesn't mean it's the optimal choice for every company.

Here's what I think briefly:

-- UBP is being touted as the alternative to an older issue that pricing must accurately reflect value -- for both sides. UBP will better coordinate value so buyers and sellers can see that the price to be honest.

But this doesn't mean that it's the right choice for everyone -- and actually, you may have already been using a particular variant of UBP.

- Seat-based pricing (SBP) isa measurement based on usage. One thing to think about is: is the number of users (or seats) the most strongly connected metric to worth?

- Don't get sucked into using UBP as a solution looking for a problem. As you think about pricing, focus on the one aspect: is pricing viewed as fair.

In this post I'll share my thoughts on usage-based pricing and how to decide whether it's worth a look for your business.

SaaS pricing is tough to improve. The main reason for this is that the fact that there are no limitations. With high gross margins and little technical restrictions, goods are able to go crazy in their pricing and packaging in ways isn't the case in other industries.

SaaS can also be a young industry, and we're just beginning to get into the nascent phases of conceiving pricing packaging, pricing, and selling models. Companies that are innovative are advancing quickly, not only in the design of their products, but also in the ways they monetize. In many ways, we are just at the starting point, and using usage-based pricing is an affordable way to approach pricing.

This is all very thrilling, however it means that, with fewer restrictions and tested best practices, we can quickly get caught up in the "next big thing."

Why is UBP "the the next major trend"?

As with many other developments, the usage-based pricing model is popular with the recent successes that build on the idea of the concept of pricing fair. The consumers, whether businesses or individuals, want to feel like they are paying a fair price. In the realm of SaaS consumers are making the decision to renew or when they accept a new monthly fee. Fairness should be considered in both directions. SaaS providers should also be compensated fairly in exchange for the benefits they provide Most of the time, this is the case with each improvement in the product as well as the usage of customers grows. The creation of a pricing structure which is fair -- in both directions -is an essential element of SaaS pricing. To do that effectively, the metric upon the basis of your pricing must be as similar to your customers' perception of value as it is.

If it is done properly, UBP accelerates you toward the answer. It's important to recognize, however, that alignment with value is not the only factor when it comes to coming the perfect price metric that is linked to value. There are two considerations that you have to optimize:

  1. The metric of linked price is as close to its value as is possible (the principles of fairness)
  2. Your pricing should be as easy and easy to calculate as is possible.

The extent to which you decide to weigh one against the other depends on many factors such as your marketplace, what your competitors are performing, their average price, product type, and the preferences of your customers. It generally requires time to determine the right balance for your product and your market There aren't any quick fixes. Constant testing can be the only proven method to achieve success.

The majority of the time whenever you hear or read regarding UBP, it's positioned as an alternative to pricing based on seat that has long been the predominant sales method for B2B SaaS businesses.

(But regardless of the fact that more companies are testing different measures and pricing strategies seating-based pricing is currentlythe the most popular B2B pricing model.)

However, one of the primary reason why UBP is trending is because there's been some huge successes in recent IPOs by companies using the UBP model, including Snowflake, Twilio, and Agora.

The success stories of these companies are fascinating but shouldn't be blindly copied. Think about the underlying factors making UBP perform for particular companies by asking three questions that help you abstract the lessons from the experience so that you are able to apply them to your own scenario:

  1. What is the price metric related to customers' perception of value?
  2. What is the degree of degree of complexity (or simplicity) of their approach affecting the renewal and sales process? Do they slow down or speed it up? Will it make it simpler or harder?
  3. What pricing structure is positioned relative to their competitors? Is it unique or similar? What are the pros and cons?

What are the most successful UBP stories have in common?

It's not difficult to find firms that have succeeded in going public with huge valuations and are looking to pattern match to discover what you can apply to your own business.

However, there are a few of things that most of these businesses have in common which make UBP particularly beneficial for their needs. Before you decide that UBP will be right for you, you'll want to see whether your business exhibits these qualities.

1. The Model lends itself to An Usage Metric Measurable

Successful UBP companies all have a primary pricing metric, like:

  • Snowflake: Calculation and storage usage
  • Twilio: Number of phone numbers used, call lengths or messages delivered
  • Agora Contact or live stream lengths , or messages that are sent

These metrics can be easily monitored and estimated by clients. It is a common truth - if a potential customer can't easily forecast how much they'll spend they will pay, it makes your prospects' ability to purchase from you far more difficult. This is especially true of enterprise software where spend needs to be budgeted.

2. The Success Stories Tend To Have Long-Term Time Horizons

A key feature of the success-oriented UBP models: the goals are far-sighted. The choice of this model permits companies to take actions during the initial or expansion stages of a company with a focus on long-term value maximization.

In particular, newer B2B product types often make use of UBP to set prices that are very affordable for the initial year or two of a relationship with a customer and thus prove the value and gain customers' buy-in. Then over time, as the company expands and expands, so do the ARPU, or average revenue per customer (ARPU) as well as profit margin.

Though usage-based pricing IPO successful stories are compelling, they undersell the first deal year when they probably left money at the end of the tunnel because of a traditional pricing structure. The truth is that this kind of value has been getting better with time, and this is the reason we're seeing an astronomical increase in net dollar retention rates.

But businesses have very different timespans they operate within. You must determine the best option for your and your company initially. If you're funding other projects using cash flow there's a chance that you won't get the opportunity to shift into a more long-term time horizon.

Is UBP Worth Investigating For Your Company?

If you're considering UBP It means you're re-evaluating the metrics you're using to determine the price of your goods.

In lieu of being confined to metrics that typically fall into the UBP camp, I'd urge you to think about what your ideal value metric or metrics could be. begin there.

The number of seats could be as low as a few, it might be megabytes, or even minutes. It could be that the more structured approach using bundles of features is the best.

Analyzing the primary and the subsidiary value measures you employ for packaging and pricing is among the primary growing levers that you have -- so if you're questioning your pricing model You're on the correct path. But pause if you find yourself considering UBP just because of the popularity or the hype surrounding the marketplace.

Live Interview with Kurt Smith on Pricing Strategies to Combat Stagflation

Join us for an live discussion with Chief Product Chief Executive Officer Kurt Smith about pricing strategies to take into consideration in markets that are volatile. RSVP to learn more.

Kurt Smith   Kurt Smith leads the Product team where he focuses on the market and development of products to offer an exceptional e-commerce experience for the global software companies partnered with . Prior to joining, Kurt was an operating principal at Accel-KKR Consulting , and he received an MBA in the Wharton School at the University of Pennsylvania in Strategic Management.