Usage-based pricing (UBP) has been a trending topic over the past few years in B2B SaaS. More often than not, when the topic of pricing comes up, usage-based pricing does as well. In short, usage-based pricing means a company picks a price model where price scales as product usage scales. Put simply, the more you use it, the more you pay.
Various studies have indicated that at least 16% SaaS companies primarily have a usage-based pricing model, and 45% SaaS companies incorporate a usage-based pricing component. Usage-based pricing advocates often point out that companies with usage-based pricing models grow 38% faster and have 18 pp higher net revenue retention than companies that don’t employ that model. It’s easy to understand the allure.
At the same time, the recent performance of publicly listed SaaS companies calls the use of usage-based pricing as a universal solution into question.
So, should your company adopt a usage-based pricing model? In general, if customers who start using a product more get more value, usage-based pricing makes sense. Isn’t that all SaaS companies, you may ask? Not exactly. Some SaaS products derive value from providing continual access to information, protection against breaches, certainty that a problem can be solved, etc. In other words, the value is more binary – “Am I protected against a breach? Yes”. You provided value by solving the customer’s pain point.
The other thing to think about is that usage-based pricing can also be a double-edged sword. Usage-based pricing is often put in place when there’s a tendency for customers to start using a product more, and you want to make sure you capture all that value. So when usage-based pricing is deployed with a world-class product that customers love in a market of expanding budgets, it further catalyzes the company’s growth. However, if customer satisfaction starts dipping, strong competition emerges, or budgets tighten, down-sell and churn can appear quickly with more rapid negative financial consequences. Sometimes predictability is worth leaving some money behind.
Think of usage-based pricing as a tool that can increase your upsell, but also increase your down-sell. It can be a powerful tool to drive high expansion revenue, but if a product isn’t core to a customer, it can also leave a company exposed to down-sell or churn. By experimenting, you’ll therefore learn if it helps you drive higher net revenue retention.
So to the hands-on stuff: how do you know if usage-based pricing is appropriate for your particular SaaS company? Use these six primary questions as guidance when you begin to evaluate whether this is the model for you:
- Can value be broken down into a unit of usage?
Customer value must scale with the chosen metric that measures usage. If you can measure your product by the amount of data processed, API calls made, contacts stored, tests sent, products shipped, or a similar type of metric, you’ve likely passed this test. But be mindful: this might not be the only value customers perceive. Combining usage- and license-based models is therefore a common solution.
- Is the unit of usage easy to understand?
The value metric should be easy to understand for both company and the customer. If it’s easy to understand, it’s easy for a prospective customer to estimate the price. If it’s hard to understand, your sales team might spend an extra sales call per process to explain the pricing scheme.
- Is the unit of usage easy to predict and measure?
The measurement method should generate unequivocal results, and the usage metric should also be easy to predict. Your customer’s finance team will have an easier time budgeting you as a vendor and less likely to disagree about a specific billing amount.
- Is it easy to implement and onboard the product?
If it’s time-consuming or labor-intensive to implement a new product, usage-based pricing alone is less attractive. This is a situation where a combined license-based and usage-based model can make sense.
- Is it hard to get rid of the product?
In an era of continually expanding budgets, usage-based pricing greases the wheels to accelerate upsells. In an era of contracting budgets, usage-based pricing can increase down sells. Companies are likelier to retain software that serves a critical need, contains uniquely valuable data or insights, or is deeply embedded into daily processes.
- Does the product category accept usage-based pricing?
In some product categories, usage-based pricing is already the norm. In others (especially in industries still adapting to cloud-hosted, subscription-based models) usage-based pricing can still feel foreign. Infrastructure SaaS and other solutions deep in the technical stack have largely shifted to usage-based pricing. Traditional enterprise software has not. And SaaS solutions at the forefront of digitalization, where software replaces pen and paper, generally do well to choose the business model their customers are most likely to adopt.
Pricing is an extremely complex topic, and it’s important for companies to really understand the strategy they decide to implement for their business. I’ve delved deeper into the topic in a series of articles on the Oxx website. You can read more about the theory behind usage-based pricing here, and you can find an even more extensive deep-dive into the practical applications of the model here.
And at SaaSiest 2023 in Malmö, April 18-19, I’ll also be hosting a session on the good, the bad, and the ugly of pricing and look forward to seeing you there!