Usage-based pricing The model almost looks like cheat code – it allows SaaS companies to acquire new customers more efficiently, grow with those customers as they succeed, and keep those customers on the platform.
Compared to their counterparts, companies with usage-based pricing trade at a multiple premium of 50% of revenue and see 10 percentage points better net dollar retention rates.
But moving from pure subscription to usage-based pricing is almost as complex as moving from on-premise to SaaS. It opens up the addressable market by lowering the buying barrier, which then requires finding new ways to acquire users on a scalable basis. It more closely aligns payment with a customer’s consumption, which impacts cash flow and revenue recognition. And that creates less predictability of revenues, which can lead to a decline in procurement and legality.
SaaS companies exploring a usage-based model should plan for both go-to-market challenges and operational challenges ranging from pricing and sales clearing to invoicing.
Selecting the right usage metric
There are many potential usage metrics that SaaS companies could use in their pricing. Datadog’s fees are based on hosts, HubSpot uses marketing contacts, Zapier prices per task, and Snowflake has compute resources. Choosing the wrong usage metric could have disastrous consequences for long-term growth.
The best usage metric meets five key criteria: value-based, flexible, scalable, predictable, and achievable.
- Based on value: It must align with how customers derive value from the product and how they see success. For example, Stripe charges a 2.9% transaction fee and therefore increases directly as customers grow their business.
- Flexible: Customers need to be able to choose and pay for their exact scope of use, starting small and growing as they mature.
- Scalable: It should increase steadily over time for the average customer once they have adopted the product. There’s a reason cell phone providers now charge based on GB of data rather than minutes of talk – data volumes keep increasing.
- Predictable: Customers must be able to reasonably predict their usage in order to have budget predictability. (Assistance may be required during the sales process.)
- Feasible: It should be possible to monitor, administer and control use. The metric should track the cost of providing the service so that customers do not become unprofitable.
Navigate the company’s legal and procurement teams
Corporate clients often seek price predictability for annual budget purposes. It can be difficult for traditional legal and procurement teams to focus on an unspecified cost purchase. SaaS providers need to be creative with different usage-based pricing structures to provide business customers with greater peace of mind.
Twilio customer engagement software offers greater discounts when a customer agrees to use it for an extended period. AWS takes it a step further by allowing a customer to commit up front, but still pay for their usage as they go. Data analytics firm Snowflake allows customers to roll over unused usage credits as long as their commitment for next year is at least as large as the previous one.
No one wants to see a shock expense when they unknowingly exceed their usage limit. It’s important to design thoughtful overrun policies that make customers feel in control of how much they spend.