As the shift toward usage-based pricing (UBP) continues – both in SaaS and other industries as well – companies are unlocking new opportunities to incrementally drive revenue. According to Vista Point Advisors, 37% of SaaS companies in the Fortune 5000 already utilize UBP. Our own survey of SaaS companies found that 73% have deployed UBP or are actively assessing the model. But usage-based pricing isn’t for everyone. Todd Gardner, the managing director of SaaS Advisors Ltd and a SaaS finance and valuation thought leader, recently wrote a guest post for our blog titled Is Usage-Based Pricing Right for My SaaS Business? We recommend reading this post before making the decision to implement any usage-based pricing examples.
Once a business does make the choice to shift to UBP, what should they be trying to achieve? We consider three goals to be paramount:
In pursuit of these goals, there are a variety of ways to implement UBP, with the “best” option varying by company.
Here are five of the most popular examples of usage-based pricing:
This UBP strategy is typically seen lower in the stack, where the product is either:
In these cases, 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 because of 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 your costs with your revenues, which would enable you to maintain predictable margins.
The second usage-based pricing example is linking the price customers pay with the impact had on their business. In these cases, your pricing is closely linked to your customer’s success – mutually assured positive results.
If you get this 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.
A simple example of this would be the field of payments. Companies like Stripe, Paddle, and GoCardless all price based on a share of revenue. (There can, however, be some complexity that accompanies the custom pricing used for larger accounts.)
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. In other words, the more you use, the cheaper it gets. It’s like the opposite of the principle of diminishing returns.
In this example, companies reduce the variable price for usage if a customer commits to a certain level of spend.
What’s the benefit on the customer side? They gain more certainty around cost. By committing to pay a minimum amount, they get reduced rates; this means their spend will be at least the minimum amount, but this gives them a big usage allowance, and if they exceed it their marginal cost is low.
The benefit for the vendor is in 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.
In a hybrid pricing model, 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 throttled (unless you upgrade to a higher tier) or thresholds which define a usage allowance above which overages are paid.
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.
Usage-based pricing – in all its forms – is quickly becoming more common among SaaS businesses, and we predict most companies in the software space will be using UBP or at least hybrid pricing models in the next 2-3 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 is the metering and pricing engine for SaaS. Software companies use our data infrastructure solution to deploy and manage usage-based pricing, in all of the forms listed above or any other type of UBP.
If you’re ready to simplify your deployment of usage-based pricing, set up some time to talk to our team.
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