As the shift toward usage-based pricing (UBP) continues to gain momentum in various industries, including SaaS, companies are unlocking new opportunities to drive incremental revenue. The 2023 State of Usage-Based Pricing Report from OpenView Advisors showed that 61% of SaaS companies use some form of UBP (i.e. a hybrid pricing strategy or pure UBP), with a further 21% expected to test a UBP model in 2023 or later. But usage-based pricing isn’t for everyone. We recommend reading “Is Usage-Based Pricing Right for My SaaS Business?” by Todd Gardner, managing director of SaaS Advisors Ltd and a SaaS finance and valuation thought leader, before making the decision to implement any usage-based pricing models.
Once a business does make the choice to shift to UBP or a hybrid pricing strategy, what should they be trying to achieve? We consider three goals to be paramount:
This article delves into five popular examples of usage-based pricing models that can significantly enhance your pricing strategy. When it comes to implementing UBP, there are numerous approaches to consider, and the optimal choice may differ depending on the company. Our team has extensive experience guiding customers operating across a range of industries and setting up bespoke UBP models, providing us with a distinctive insight into the diverse pricing strategies employed by successful companies.
In hybrid pricing, companies mix some aspects of usage-based pricing into traditional pricing models. Pricing might be per seat or based on feature-based tiers, but there are usage limits involved as well. These could be “hard” limits at which usage is limited (unless you upgrade to a higher tier) or thresholds which define a usage allowance, above which overages are paid.
Hybrid pricing models are actually the most common form of UBP: according to OpenView, 31% of SaaS businesses are utilising usage-based subscriptions and 15% are testing usage-based elements. This far outpaces the 15% of companies with a largely usage-based pricing model.
The beauty of a hybrid pricing strategy is that it combines the familiarity of traditional models with a mechanism for capturing more revenue from heavy users, in a way that feels fair to the end customer.
Hybrid pricing can be complicated to bill for, as it combines elements of different models and often has more factors deciding the end price. Companies using a hybrid strategy will need to ensure pricing is clear to customers so they know what they’re paying for and how.
In this type of model, the cost to the customer is based on how much they consume of the resource, i.e. their usage levels of the product. This UBP strategy is typically seen lower in the stack, where the product is either:
The pricing model feels fair and easy to understand: the end customer knows there is a significant cost on the vendor’s side and that the price they pay scales with usage to compensate for this.
The challenge with linking prices to resource consumption is its simplicity. There is a trade-off to consider between keeping pricing simple – ideally just a single metric – and more closely aligning cost with revenue, which would enable more predictable margins.
The third usage-based pricing or consumption pricing example is linking the price customers pay with the impact on their business. A simple example of this model would be in the field of payments. Companies like Stripe, Paddle and GoCardless all price based on a share of revenue
In these cases, your pricing is closely linked to your customer’s success – meaning mutually assured positive results. If you get the strategy right, your service becomes something that “pays for itself”; the customer doesn’t mind paying you more, because higher costs are associated with successful outcomes on their side.
The custom pricing used for larger accounts can quickly create complexity with this model. It can also be detrimental if you don’t choose the right value metric for your company.
Other examples for this strategy link to a clear revenue proxy, or activity linked to revenue generation. Hubspot prices are based on contacts and leads. Twilio uses the number of communications. ThoughtRiver uses the number of legal documents processed by machine learning contract review services.
Volume-based discounts are another form of usage-based pricing. There are a variety of ways to offer these discounts:
The underpinning idea among any volume-based discount is the same – to reward customers who use more with declining marginal costs of use – and this tends to be viewed positively by buyers. In other words, the more you use, the cheaper it gets. It’s like the opposite of the principle of diminishing returns.
SaaS businesses using this model have to strike the right balance. If you discount too far or don’t create limits, then heavy users may create profitability issues.
In this example, companies reduce the variable price for usage if a customer commits to a certain level of spend.
Gaining more certainty and predictability around cost. By committing to pay a minimum amount, customers get more predictable costs and reduced rates. Their spend will be at least the minimum amount, but this also gives them a big usage allowance, and if they exceed it their marginal cost is low.
Addressing concerns of the buyer and getting more predictable revenues themselves. It also allows them to bring cash forward, as the customer pays the commitment in advance of usage.
As with the volume-based discounts example, SaaS companies have to strike the right balance here. Commitments are highly valued, especially in times of economic uncertainty, but the discount can’t be too large to outweigh the benefit of a longer contract.
Usage-based pricing – in all its forms – is quickly becoming more common among SaaS businesses, and we predict a vast majority of companies in the software space will be using hybrid pricing or full UBP pending updates to their product or business model in the next several years. By tying their success to the success of their customers, companies deploying UBP will see this strategy incrementally drive revenue and create lucrative, sustainable business relationships.
m3ter’s Pricing Operations Platform powers every variation of usage-based pricing by integrating usage data, applying pricing, and generating error-free bills in real time for companies at all stages of growth. If you’re ready to simplify your deployment of usage-based pricing, set up some time to talk to our team.