Pricing is one of the most tumultuous—and critical—parts of any SaaS business. Just ask Kyle Poyar, the Operating Partner at OpenView, who has made a career of it.
But many companies have made the switch to usage-based pricing over the years for several reasons, with a big one being that it's super appealing to customers.
Pay only for what you need, and nothing more? Talk about an offer that can’t be refused.
If you’re considering moving to usage-based pricing, you’ve come to the right place. In this post, we’ll uncover the pros and cons of usage-based pricing, top considerations before switching per Kyle’s advice, and more.
What is usage-based pricing?
Before we jump in, let’s get clear on the definition of usage-based pricing.
Usage-based pricing is a SaaS pricing model focusing on consumption. Customers are charged on a “per-use” basis.
In other words, they’re only charged for what they use—nothing more and nothing less.
Traditionally, SaaS companies have adopted a seat-based pricing approach, which has become the industry standard, says Kyle:
“I think the biggest thing is to contrast [usage-based pricing] with what it’s not,” says Kyle. “We’re used to thinking about SaaS companies as subscription businesses that charge based on seats or based on how many folks logged into [your] software. That’s the classic Salesforce model. It’s in everyone’s head when they think of SaaS.”
With usage-based pricing, companies can learn so much more about their customers and how they use your products:
“Usage-based pricing is starting to take metrics around how folks are engaging with your product and whether or not they’re successful and incorporating that in how you monetize,” says Kyle. “To me, the key thing is it’s not just defaulting to seat-based subscriptions.”
Leading SaaS companies like Snowflake, Stripe, and Plaid (as well as companies across the tech stack) use usage-based pricing as it offers a best-of-both-worlds scenario for both the company and customers.
Stripe’s pricing, for example—coupled with reassuring copy—is both simple and transparent.
Customers know how much they’ll be charged with Stripe’s integrated model, or they can choose to build a customized package that’s as unique as their business.
The pros and cons of usage-based pricing
More SaaS companies are considering usage-based pricing in recent years—with adoption rates doubling in just four years.
What’s more, as of 2021, 45% of SaaS companies say they have usage-based pricing, which is up a whopping 34% from 2020.
So why the spike in adoption? And, what are the potential drawbacks of usage-based pricing?
Let’s look at a few of the pros and cons of this pricing structure.
The pros of usage-based pricing
🙌 It’s a win-win for you and your customers
Usage-based pricing ties your customers’ success to your company’s success. In other words, as your customers grow, you grow.
“With a usage-based model, the customer makes the decision really every day whether they're going to log in and use your product,” says Kyle.
“And so you have to win them over, literally every day. Everyone has to start playing a role in customer success across the organization. You even start to see businesses like Snowflake or AWS have sellers stay with accounts, and are only compensated when their accounts actually use the product. So sellers are motivated to drive customer success and usage.”
Plus, by tying the price paid with the value received, a powerful dynamic is created between companies and their customers.
“Some companies will do things like say, ‘Hey, you're going to get an annual allotment of usage—almost like a gift card. There'll be no overages, and if you spike one month you don't have to worry about some unforeseen usage fee.’ It gives the customer time to ramp up their adoption, and that way, if they end up using the product more than they initially expected, they're just doing an early renewal,” says Kyle.
And the numbers don’t lie: SaaS companies with usage-based pricing see a 38% increase in forecasted growth YOY compared to the broader SaaS index.
Plus, many customers appreciate that they only need to pay for what they use.
💰 Boost your overall net-dollar retention
SaaS companies with usage-based pricing see a 9% increase in net-dollar retention compared to those with other pricing strategies.
“What I tend to find is that most usage-based businesses actually have above average net dollar retention rates,” says Kyle. “When I've looked at public companies, the average net dollar retention rate for usage-based companies has been about 120%. For traditional subscription tiers, those companies see about 110%. For these companies, not only does a usage model act like it's recurring, but your current base of usage-based customers is actually generating compound interest year in and year out. It's a more valuable revenue base than a traditional subscription company.”
The cons of usage-based pricing
🔮 It’s difficult to predict revenue (and cash flow)
Traditional subscription or seat-based pricing allows for a clearer understanding of cash flow compared to other models. With usage-based pricing, things get more challenging…and confusing.
“Businesses become less predictable. If you don't have this committed, upfront contract, folks could churn. If you're not able to say, ‘Hey, we're going to generate this much revenue for the next year,’ it's hard for you to do things like predict what headcount you need to support the business or how much funding you want to raise or how much you're going to plan to burn,” says Kyle.
This level of uncertainty may not be right for every business (there’s something to be said for predictable revenue and cash flow!).
The solution? Kyle says usage-based pricing requires running your business differently:
“Even large public companies struggle with this. If they've got customers with no history of usage, it's really hard for them to forecast what revenue is going to look like that year. They end up taking a conservative approach. I think of it as: managing a usage-based business is different from a traditional subscription company.”
3 Big considerations when switching to usage-based pricing
Changing up your pricing structure is a huge undertaking. There’s a lot to think about, and there’s a lot at stake for most companies.
Here are a few points to think about before making the switch.
#1: Your customers and finance team want the same thing
Even with the flexibility of usage-based pricing, customers still want predictability.
Building that into your customer experience—by way of using calculators in the sales stage and monitoring what their usage looks like from implementation to rollout—will not only put customers at ease, but it helps your team add clarity to financials.
Plus, because your customers’ success is tied more closely to your success, it’s critical your team has a pulse on their growth in some way.
“I think the more connected finances are with go-to-market teams and your customers, the better. That helps you understand what's really unpredictable. For example, you don't know if your customers' business is going to take off or shut down, but you can have pretty good confidence around it [based on what your numbers are telling you]."
#2: Data will become a critical part of how your finance team operates
There’s no question that data plays an important role in any SaaS business, but with a pricing structure that offers less certainty (in terms of revenue optics), it’s all the more important for your finance team to have access to customer data.
Understanding how different cohorts of customers are using your product along with seeing what factors contribute to an account growing or shrinking will become a big part of your finance team’s responsibilities.
“The other great thing, from my standpoint, is that data is actually really helpful to make sure you're targeting the right customer,” said Kyle. “You have good visibility into whether that customer is going to churn or take off.”
“So your finance team can actually become a much more strategic operator inside of a business. But it requires getting really good granular usage data at a historical level across your accounts and having folks with a data science background that can be looking at that data continuously.”
#3: Billing infrastructure should not be an afterthought
Lastly, when switching to usage-based pricing, how you choose to structure your billing should be a priority.
“To have that really good usage, metering and billing infrastructure needs to be put in place. And I think, historically, that's been challenging for a lot of the top software companies,” says Kyle.
“There's now an industry of emerging startups, some extremely well-funded, that are solving this problem. They're treating it as a data infrastructure problem, first and foremost, which I think is the right way to look at it for a usage-based business. The great news for companies at an earlier stage or just thinking about usage-based pricing is that you don't have to build this from scratch.”
Subscript helps you make sense of your SaaS data
Managing data is difficult for any SaaS company. And as finance teams continue to lean into data as companies scale, having a pulse on company analytics is mission-critical.