Is Usage-Based Pricing Right For Your SaaS? -
According to an OpenView study, by 2023, the majority of SaaS businesses will use or expecting to test the concept of usage-based pricing. They describe as "a pricing strategy that allows users to purchase a product according to the extent to which they utilize the product."
Utilization-based pricing (UBP) -- or consumption pricing -- is determined by the usage of a specific metric, such as gigabytes used in storage or the number of API calls made -- for a certain period of time.
The method of pricing SaaS products is super current, but that doesn't mean it's necessarily the optimal choice for every company.
This is my opinion briefly:
-- UBP is gaining popularity as an option to the old problem that pricing must accurately reflect value for both sides. UBP will better coordinate values so that buyers and sellers perceive the price to be reasonable.
However, that doesn't mean it's right for everyone -- and in fact you might already be deploying a variant of UBP.
Seat-based pricing (SBP) isa measurement based on usage. One thing to consider is: is the number of users (or seats) the most closely connected metric to worth?
- Don't get sucked into using UBP as a way to solve for a problem. When you are thinking about pricing, you should be focusing on one thing: is pricing viewed as acceptable.
In this post I'll go over my thoughts on usage-based pricing and the best way to determine if it's worth investigating for your business.
What is the reason UBP is trending?
SaaS pricing is tough to improve. One primary reason is there are very few limitations. Because of the huge gross profit margins, and few technical constraints, products have the potential to be wildly creative with their pricing and packaging in ways aren't seen in other industries.
SaaS can also be a young industry, and we're only in the beginning stage of thinking about pricing packaging, pricing, as well as the sales model. Innovative companies are developing quickly, not only in the design of their products, but also in how they make money. In many ways, we are at the beginning of the new era, and the use-based pricing is an affordable way to approach pricing.
This is all very exciting, but it also means that, with fewer limits and tried-and-tested best practices, we can be easily swept by the "next major trend."
Why does it matter that UBP "the the next big thing"?
As with many other trends, usage-based pricing is a catchy name with recent success stories that play on an existing concept -- pricing fairly. Consumers, whether they are business or private, need to be sure that they're getting a fair cost. In the realm of SaaS the customers make that decision every time they renew or permit a monthly cost. But fairness cuts both ways. SaaS companies should also be compensated fairly for the value they deliver Most of the time, this value grows when the service is continually improved and the customers' usage expands. Designing a pricing model which is fair -- in both directions -- is a fundamental tenant in SaaS pricing. For this to be done effectively, the metric upon that your pricing model is built needs to be as close to your customers' perception of value as possible.
When done right, UBP accelerates you toward the answer. It is important to realize the fact that alignment with value isn't the only factor when it comes to coming to a perfect pricing metric that is linked to value. There are two considerations that must be considered when determining the best price:
- Linked pricing metric as closely to value as possible (the principles of fairness)
- Make your pricing as simple and easy to calculate as is possible.
The degree to which you decide to weigh one against the other is contingent on many factors such as your marketplace and what your competition is performing, their average price, product type, and the preferences of your customers. It typically takes time to find the right balance for your product and your market There aren't any solutions. Continuous testing is the only proven path to success.
Most of the time, whenever you hear or read something regarding UBP is that it's promoted as an option to pricing based on seat which is the most popular sales strategy for B2B SaaS companies.
(But regardless of the fact that more companies are testing different metrics and pricing models, seat-based pricing remains currentlythe the most popular B2B model.)
But one of the biggest reasons that UBP is trending is because there have been some major successes in recent IPOs of companies using the UBP model, including Snowflake, Twilio, and Agora.
The success stories of these companies are fascinating but shouldn't be blindly copied. Instead, think about the core factors behind why UBP be successful for specific businesses by asking three questions that help you abstract the lessons away so you can best use them in your personal scenario:
- How does their price measurement correlated with customers' perception of value?
- How is the degree of complexity (or simple) of their business model affecting the renewal and sales process? Can it affect the speed of renewal or accelerate it? Does it make it easier or more difficult?
- What pricing structure is positioned relative to their competitors? Is it unique or similar? What are the pros and cons?
What Do Many UBP Success stories have in common?
It's easy to look at businesses that have gone public with huge valuations and want to pattern match to find things you can apply to your own business.
But there are a couple aspects that the majority of these businesses have in common that makes usage-based pricing effective for them. If you're unsure if UBP is the right choice for you it is important to determine if your company also is a good fit for these characteristics.
1. The Model lends itself to A Measurable Usage Metric
Successful UBP businesses all share one primary price metric such as:
- Snowflake: Compute and storage usage
- Twilio: Number of phone numbers used and lengths of calls or messages delivered
- Agora Contact or live stream lengths , or messages that are sent
These metrics can be easily measured and interpreted by clients. This is an often overlooked reality - if your prospect isn't able to predict easily what they'll pay, you are making the process of buying from you much more difficult. This is especially the case for business software, where spending needs to be budgeted.
2. The stories of success tend to Have Long-Term Time Horizons
Another important commonality of success-oriented UBP modelsis that their goals are far-sighted. This model allows businesses to do things in the early or even expansion stages of a company with a focus on the long-term goal of maximising value.
For example, more novel B2B services typically use UBP to price very low for the initial year or two of a relationship with a customer and thus show their value and earn buy-in. As time passes, this company grows as does its ARPU, or average revenue per customer (ARPU) as well as profits margin.
Though usage-based pricing IPO successes are compelling, they undersell the first deal year in which they likely left money in the bank as a result of a conventional pricing structure. Ultimately, that value is catching up in recent years, and that's why we see only astronomical net-dollar retention rates.
However, businesses operate with very distinct time horizons that they operate under. Be sure to determine which is best for you and your company first. If you're financing other projects with cash flow, then you may not have an opportunity to change towards a long-term horizon.
Is UBP Worth Investigating For Your Company?
If you're contemplating UBP, it means that you're reviewing your value-based metrics you're using to price your product.
And instead of limiting yourself to metrics that normally are in the UBP camp, I'd urge you to simply consider what your ideal value metric or metrics could be. begin there.
This could mean seats or minutes, gigabytes or gigabytes. It could be that the more structured approach using bundled features would work best.
Examining the primary and secondary value measures you employ for packaging and pricing is one of the most important growing levers that you have and, therefore, if you're wondering about the pricing you're using, you're on the right path. Be wary if you find yourself considering UBP solely because of its success or hype in the market.
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