For SaaS businesses, product profitability is an increasingly urgent question.
In the face of strong headwinds for the technology sector, finance teams are under pressure to refine their unit economics and maximise returns on a customer basis. One of the most effective ways to achieve this is usage-based pricing (UBP) - this aligns what the customer pays with the value they derive from the product, making revenues more resilient.
However, practical implementation of usage-based pricing puts significant pressure on financial and billing teams from an operational perspective. For businesses planning to scale, managing the complex workflows to measure usage and create a bill requires a high degree of data sophistication.
Here we examine the opportunities and pitfalls of usage-based pricing as well as how finance teams can mitigate the challenges involved.
What has powered the growth of recurring revenue models is the simple subscription – one of the most common pricing practices in SaaS. For my part, I spent over eight years developing solutions at one of the early leaders in the field – Zuora – which allowed businesses to manage subscriptions, plans, customers, and payment objects and combine them as needed.
These have been successful for a reason - customers like them. They’re simple to understand and reassuringly predictable. And all that is required from a billing perspective is a recurring payment with associated entitlements that runs on a monthly basis. Operationally, this can be run with a simple finance stack and minimal manual intervention.
More sophisticated processes - including UBP - add complexity which may go beyond the capabilities of your existing systems. This leaves finance teams balancing competing incentives: what will generate the best return from customers vs. what can be implemented practically, particularly for fast-growing, sales-led organizations.
By examining the challenges involved in UBP, however, we can also set criteria for solving these issues.
UBP requires incorporating two worlds of data: 1) usage data, based in your platform; and 2) commercial information such as accounts, products, deals, plans, and pricing from your CRM. For billing, these data sets need to be combined and the outputs delivered into your finance stack, from which you generate invoices, manage collections, recognize revenue, and generate key metrics.
The practical challenge for UBP is that you need to calculate what goes on the bill for every customer, every month. This involves manual work: recording usage data for every customer and then bringing it together with their pricing to calculate the amount.
In the absence of a specialized system to manage this, businesses attempt workarounds.
Some use a spreadsheet. This involves engaging the engineering team to set up delivery of key data to an analytics database from which you can export and then combining that data with pricing in a spreadsheet.
As a business attempts to scale, this gets more difficult.
Customer volumes: While manual workarounds via spreadsheets and calculations can work when you have 10 customers, they become unwieldy when you have 100 or 1000.
Pricing complexity: Building an in-house system can be a possibility if your pricing is simple, totally standard, and not likely to change. If you’re applying the same numbers in the same way for every customer, then you can build a single system and run it on repeat. But if increasing pricing sophistication is playing a role driving your growth, you’re likely to be introducing elements such as different tiers, different prices for different territories, or volume-based discounts, or conditional elements. Not to mention the likelihood that your sales team will want to use specific pricing or structures for individual customers..
This leads to serious challenges for your business:
Lost time: Working manually, it can take days (or even weeks) to finalize billing and send invoices to customers, extending time to cash and harming your customer experience.
Wasted resources: Your finance team loses time to billing every month, raising your costs and distracting you from other priorities.
Human errors: Human systems produce errors, even with the best of intentions. This hurts you either way – under-billing loses you revenue while over-billing undermines customer trust.
Inflexibility: Brittle systems are unable to accommodate broad pricing innovations proposed by Product teams, or respond to Sales’ reasonable requests for variations and private pricing deals that they believe will drive customer acquisition and revenue growth.
So, manual usage-based pricing is a non-starter. Some may try to build a more involved custom solution, but this takes away valuable development resources from your core product and requires regular updates every time you change your pricing. So for most businesses, building a custom solution is not a practical option. Quite apart from the fact that these projects are slow, expensive, and risky, here it’s just unnecessary.
What’s needed is a solution that can fill the gap between customer, platform and pricing systems, and the finance stack – removing undifferentiated heavy lifting from your financial team and making billing operations automated, scalable and efficient. We’ll cover the practical steps of implementing usage based pricing properly in our next piece, so you can avoid the pitfalls from the start.
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