Okay, I know—‘should every SaaS business have a usage-based pricing strategy?’. The question posed in the title of this article might seem exaggerated at first.
But Boston-based VC firm OpenView Partners published its 2021 State of Usage-Based Pricing Report in November, and due to the way software buying is evolving, its findings suggest this exaggeration may be our reality before we know it.
The results show that a usage-based pricing method—which also includes pay-as-you-go pricing and subscription pricing based on usage tiers, as well as traditional consumption-based pricing—is quickly becoming more mainstream. In fact, 45% of nearly 600 respondents report that their businesses use it. That number is up by nine points from just a year prior and is only projected to climb over the next two years.
Usage-based or value-based pricing is already one of the more common pricing strategies, but why is it having such a moment in the spotlight?
Let’s take a look at how SaaS and other subscription businesses are tackling usage-based pricing and how to decide whether it’s right for your business.
Why the market is demanding usage-based billing
As mentioned above, software buying has evolved in the last 30 years. In the 1990s, software infrastructure was hosted in a data center and required an up-front purchase at a higher price.
Today, however, much of the software world is in the connected cloud and is much more affordable. With many providers offering an entry-level plan at a low price or even a freemium model, customers can start on a free version of the software with the option of switching to a premium pricing tier later, as usage grows.
For modern customers that like the idea of flexibility, usage-based may be the best pricing strategy. And B2B customers, in particular, enjoy that a usage-based model allows the software to scale with them, without requiring them to renegotiate their contract as their usage grows.
This lowered or mitigated barrier to entry is particularly attractive to startups or smaller businesses that may not have as many resources available. It also helps you, the software vendor, set the basis for a land-and-expand growth strategy.
Kyle Poyar of OpenView Partners explains, “The usage-based pricing model allows a customer to start at a low cost, attracting more customers to get started while still preserving the ability to monetize a customer over time because the price is directly tied with the value a customer receives.”
So what does this market shift mean for the pricing strategy?
Quick and widespread adoption. Of those usage-based businesses featured in the OpenView report, 24% had implemented this pricing in the past twelve months. Looking to the future, 79% of businesses expect to have fully implemented—or at least be experimenting with—some usage-based pricing by the end of 2023.
When does usage-based pricing work well?
There is room for some nuance in the usage-based pricing conversation. Not every pricing strategy works well for every business. Some business models may see better success employing other pricing strategies—this is when knowing your customer demographic and having a well-defined ICP (ideal customer profile) come in handy.
- If your target customers aren’t savvy tech buyers and require a simplified purchasing experience, a traditional software pricing model may be a better choice.
- Similarly, if customers are sensitive to variable costs and are likely to feel the ‘taxi meter effect’—that is, rein back their usage to ensure they pay a low price—consider sticking to a simpler model or penetration pricing strategy or experimenting with hybrid pricing.
- Finally, if usage of your product is highly variable or if you have many one-off use cases, it may be better to stick to a flat fee.
However, there are, of course, many cases in which usage-based is an effective pricing strategy for both your business and your customers. This might be the case for your business if:
- as discussed earlier, your target customers prefer the flexibility that comes with only paying for what they use,
- usage of your product can align directly with your customers’ success outcomes, ensuring a high perceived value, or
- your product has a high usage rate once it’s been adopted.
If your competitors are already charging their customers based on usage and having success with it, it may be time for your business to follow suit. And if those competitors are all still following more traditional pricing strategy examples but your customers seem keen on adapting to a new pricing structure? Consider becoming a disruptor in your space and pivoting to a usage or value-based pricing strategy.
The pros & cons of a usage-based pricing strategy for SaaS businesses
If you’re looking to scale quickly, the usage-based pricing method is a competitive pricing strategy to facilitate this.
With 55% of businesses not incorporating any usage-based pricing whatsoever, per the OpenView report, those that do may find the pricing strategy to be a competitive advantage that allows them to outperform their peers. According to the same report, 41% of businesses achieving 100%+ ARR growth had a largely usage-based pricing model.
Further down the road, as this pricing strategy becomes more widely adopted, it may be the differentiator that allows you to stay in business.
Manav Khurana, Chief Growth Officer for data analytics platform New Relic, predicts value-based pricing will become the necessary standard in the SaaS industry as businesses prioritize customer success. He writes, “Forward-thinking software companies will continue to embrace this model as true vendor partners. Those that don’t evolve risk seeing an erosion not just of their top-line growth, but in customer trust and loyalty as well.”
It’s not a magical strategy guaranteeing instant success, though. Usage-based billing has its drawbacks, too.
Firstly, it means billing your customers in arrears, rather than upfront, for your service or product. This may be a problem depending on the size of your business and its cash flow. Not only does it mean you won’t get paid as quickly, but you also run a higher risk of customers not paying.
It also makes it more difficult for your business to predict future revenues since customers won’t necessarily be paying the same fee each month. Of course, you can still make rough predictions based on historic usage, but there’s always the chance that a customer’s consumption needs might drop unexpectedly at any point.
Is usage-based billing right for your subscription business?
On average, 98% of SaaS businesses see positive results from making changes to their core pricing strategies. And while it’s not necessarily the best pricing strategy for every business model, value-based pricing could be an asset to your business.
If you do choose to move forward with a usage-based pricing strategy for your subscription business, you need the right tools to help you put it into action. A modern, adaptive subscription billing software offers catalog flexibility that enables you to efficiently experiment with any SaaS pricing strategy under the sun.
So, whether you want to get ahead of the competition and switch entirely to a consumption model, diversify revenue streams by offering hybrid pricing, or stick to your current tried-and-true pricing model, your agile billing platform is your competitive advantage.