Usage-based pricing (UBP) is increasingly a must-have for SaaS businesses. According to a survey of almost 500 SaaS businesses conducted by Maxio, The SaaS CFO, and RevOps Squared, almost four in five SaaS operators now use UBP or plan to start doing so soon.
That’s a giant leap: as recently as last year, Open View reported that just 45% of companies had adopted usage-based models. So why is UBP such a big deal—and how can SaaS leaders make sure they’re implementing usage models in the right way for their business?
Mastering monetization
The first thing to understand is that pricing models, such as usage-based pricing or subscriptions, make up just one piece of your company’s monetization strategy. And, of course, your monetization strategy is just one aspect of your broader go-to-market (GTM) strategy, which also encompasses areas such as organizational structure, budget allocation, and more.
Finding the right monetization mix expands your pathways to growth. Expansion isn’t just about winning new customers; it also means driving growth by retaining and upselling to existing customers.
Your monetization strategy consists of the following elements:
Your acquisition model, or how you acquire customers (product-led vs. sales-led)
Your pricing model, which tracks how your product is sold (subscription vs. usage-based pricing)
Your pricing strategy, or the amount you’ll charge (premium vs. competitor-based vs. penetration pricing)
Your billing model, covering billing methods (self-service vs. invoice), frequency (monthly vs. quarterly), and contract terms (up-front vs. in arrears)
Your payment methods, or how your customers pay (credit cards vs. ACH)
With so many moving pieces, monetization creates operational complexity. To succeed, all these different components have to work together in harmony. Companies that master this can optimize for enduring growth while also pivoting their monetization strategies quickly to adapt and endure in uncertain times.
Usage-based pricing is a great example of both the challenges and opportunities that companies encounter as they adapt and evolve elements of their monetization strategy.
Why usage-based pricing?
What’s driving the big shift? It’s partly pressure from investors to diversify revenue streams: if you can offer both UBP and subscription options, why not do both? That, in turn, is based on the idea that usage-based pricing is generally perceived as a good deal by buyers, especially in comparison to legacy models such as per-seat pricing. Companies hate paying for things they don’t use, and UBP is specifically designed to ensure your customers only pay for the services they use.With usage-based pricing, 80% of customers report better alignment with the value they receive, according to Bain & Company research.
What’s often overlooked, though, is just how great UBP can be for the vendor, too. That might sound contradictory: if you’re selling conservatively, based on what the customer actually uses, aren’t you leaving money on the table? Not necessarily. Nearly half of software companies using it say it has helped them acquire more customers, and two thirds say it’s helping them increase revenue with existing customers.
True, legacy pricing models can capture more revenue up-front, but they can also make it harder to drive organic growth across an organization—and if seats go unused, you could face awkward conversations when it’s time to renew the contract.
One of the biggest strengths of usage-based pricing is that it allows vendors to move away from chasing seats and reduces the likelihood of people sharing accounts or logins. It tracks the work customers actually do with the product and, because that activity is perceived as high-value by the customer, you’ll find they’re much happier to pay more and expand their usage over time.
Among the software companies with the highest valuation multiples in 2022, those offering usage-based pricing (Snowflake, Datadog, and MongoDB, for example) on average earned 10 points higher revenue retention from existing customers, as measured by net dollar retention (NDR).
Usage-based models also tend to be packaged in ways that allow for natural graduation between tiers. For example, if you use price-per-transaction (the most common variable, used at 32% of SaaS companies surveyed) you can create transaction tiers that naturally move customers into higher-tiered plans as they grow. By giving customers clarity upfront, in other words, you get to cement a relationship that deepens and grows over time.
Challenges and opportunities
Of course, adopting a usage-based model brings some challenges.
The first is you might need to evolve your SaaS metrics to align with your new pricing model. As Ben Murray of The SaaS CFO recently noted, traditional lifetime value (LTV) calculations only account for one revenue stream. This is a headache for companies with hybrid models that encompass a blend of subscription, usage, and even one-time fees—and while it’s a solvable problem, it’s one you shouldn’t ignore.
Second forecasting is a significant challenge for SaaS companies transitioning into new pricing models. Almost a third of companies surveyed use historical trends to develop their usage-based ARR forecasting. That’s hard to do if you’re just launching and don’t have solid historical data, especially because SaaS usage tends to be seasonal. One solution is to stream usage data in real-time, rather than batching it in weekly or monthly blocks, giving you more granular insights that enable more accurate forecasts over time.
Finally, you’ll need the right FinOps infrastructure to implement usage-based pricing effectively.That means ensuring your usage-capture and billing/invoicing systems are robust and flexible enough for both initial testing and subsequent evolution of pricing model and variables.
Usage tracking is key to optimizing customer activation, engagement, and ultimately retention. Real-time visibility into usage, and projected billings are a must-have to avoid invoicing surprises. The tight, seamless integration of the product usage capture system and the invoicing system should be considered and implemented early in the UBP journey—but companies that use crude internal invoicing systems will struggle to deliver this critical support.
Flexibility starts with FinOps
At Maxio, we firmly believe SaaS companies should make re-evaluating their monetization strategy at least in sync with their fiscal year planning process.
A robust monetization strategy includes a collection of different moving parts, each of which can be fine-tuned independently, but each of which affects every part of the whole. And this system needs to continually evolve based on changing market conditions, competitive pressures, and new entrants as companies plan where and how they are going to grow in 2023 and beyond.
That’s certainly the case when it comes to your pricing model. Whether you opt for subscriptions or usage-based pricing—or, increasingly, a mix of the two—you need to be able to rapidly and reliably retool your entire monetization and GTM apparatus to ensure you’re optimizing for best results.
Get in touch with Maxio today, and learn how we can help you operationalize usage-based pricing.