7 Reasons Usage-Based Pricing is the Future of SaaS

Apr 21, 2021

If you haven't heard the words 'usage-based pricing' lately then you probably need to check your Zoom settings. Usage-based pricing is the talk of the enterprise SaaS town.

It’s helped several high-profile SaaS organizations boost revenue growth, increase adoption, and significantly reduce user churn: the holy trinity of SaaS KPIs.

Does this mark the end of the subscription model or seat-based pricing? Not entirely, but over the next five years, most SaaS companies will adopt some form of usage-based pricing in a hybrid approach.

What is usage-based pricing for SaaS?

Usage-based pricing is a go-to-market model where your customer pays based on how much they use your product or service. It’s also known as consumption-based pricing, pay-per-use pricing, and pay-as-you-go pricing.

Usage-based pricing encourages new users to poke around and discover use cases without worrying about price. If they get hooked on your product and want to increase usage, their spending goes up and you share in their gains.

It’s a win-win: no complicated pricing or tiers to get in the way of your customer's success or your businesses' growth.

Usage-based pricing is:

Sharing in your customer’s success.
Scaling your revenue with usage.
Lowering (or removing) the barrier to use your product.

Usage-based pricing is not:

User-based pricing, seat-based pricing, or subscription-based pricing.
It’s how we’ve billed utilities since the invention of the power meter.
Only for infrastructure software companies like AWS. Applications like Hubspot, Slack, and Shopify have all seen great success with the model.

Why all the excitement around usage-based pricing now?

Kyle Poyar of OpenView Partners has been openly very bullish on usage-based pricing since the end of 2020.

Poyar points to SaaS powerhouses like Snowflake and Twilio that have seen great success with this pricing strategy. These companies are outpacing competitors, growing faster, and keeping more customers. But you don't need >$100 million ARR to benefit from a usage-based pricing model.

For the mature SaaS company, usage-based pricing could be your ticket to breaking through a growth ceiling. For the fledgling startup, usage-based pricing could speed up trial and adoption.

Whether you're big or small, a UBP model will motivate your team to help customers derive more value from your product or service — as long as you determine how to incentivize the correct behavior. But that's not the only reason VCs are so hot for usage-based pricing.

1. Break through your growth ceiling

You can only sell so many seats, so many add-ons, and so many services before your revenue growth hits a bump in the road.

Consider Hubspot. Before introducing usage-based pricing, their net revenue retention was nearing 70%. But when they introduced a usage-based model that charged for every lead, that all changed.

Hubspot recognized that customers who gained value from their platform wouldn’t stop using it. With the new model, as customers generated more leads and more business, Hubspot shared in their success. Soon, Hubspot’s NRR returned to near 100% levels, and the company was back on IPO trajectory.

On top of growing value from their existing base, Hubspot gave users who were previously boxed out by price the opportunity to experiment and even fall in love with their platform. And if you've met Hubspot fans, you'll know they really do love that platform.

2. People will love your product (even more)

If more people can use your product, more use cases will be uncovered.

SaaS companies like AuditBoard generate as much as 10X the number of users on a usage-based model versus their previous subscription model. That’s ten times more users finding new use cases, deriving real value, and informing your product roadmap.

In some cases, an account’s usage will not increase in tandem with its user base's growth — and that’s okay. Usage-based pricing increases your volume — and in the process — your chances of landing an account that loves using your product.

3. Investors see the value

It would be safe to assume that investors are wary of usage-based pricing. It’s risky, makes revenue unpredictable, and even volatile.

But the numbers tell a different story.

Public usage-based companies like Snowflake, jFrog and Datadog are growing faster (32% vs. 26%), retaining more revenue (131% vs. 122%), and trading at a higher revenue multiple (24.8x vs. 17.7x).

It appears emerging SaaS players have caught wind of usage-based pricing — or their backers are pushing them in that direction. In a 2021 SaaS pricing survey by OpenView Partners, 42% of seed-stage companies said they follow a usage-based pricing model.

Could this signal market dominance for usage-based pricing in the future?

Only time will tell, but it certainly seems likely.

4. Usage-based pricing IS value-based pricing (if executed well)

Value-based pricing is the hallmark of a SaaS organization with a clear POV on strategic pricing and monetization.

A value-based approach is when you set your price based on the perceived value that customers stand to gain from your product or service.

If value pricing is the gold standard of setting the optimal price, usage-based pricing is the vehicle that will get you there.

To achieve value-based pricing under a usage-based model, you must identify the right usage metric. Ask yourself:

Does the usage metric align with the value of my product?
Can the usage metric be measured? How easily?
Is the usage metric predictable within reason?

5. More SaaS companies are making the switch

If your competitor switched to usage-based pricing, would you follow them?

At AWS, that metric is capacity. At Twilio, it's API calls. At your company, it will be something similar that's valuable, measurable, and predictable.

In a 2014 survey by Pacific Crest, 23% of SaaS companies used a usage-based pricing model. This past year, a study from OpenView Partners put that number up to 39%. Another study by Forrester and GoTransverse found that 72% of SaaS companies planned to try a usage-based model.

Those who succeed with a usage-based model may attract more funding, more customers, and more talent. SaaS companies with usage-based pricing include Datadog, Twilio, AWS, Snowflake, Stripe, Slack, and Hubspot — to name a few.

6. Usage-based pricing for SaaS is the fairest way forward

Today, your high-usage customers may think your service is cheap while your low-usage customers believe you're expensive.

That was certainly the truth for Zocdoc. They were charging doctors — no matter their scale or usage — a $3,000 flat rate to access their healthcare marketplace.

Zocdoc’s churn was creeping higher with every quarter. Low-usage customers didn’t see the value, while high-usage customers were squeezing value. Zocdoc needed to refine its approach to monetization or risk losing its growing customer base. Usage-based pricing was the answer.

Once Zocdoc made the switch to usage-based pricing, their churn dropped by 50%. Now that light users could afford to stay, Zocdoc could turn their attention towards nurturing and educating them to get the most value from the platform.

With the right nurturing, support, and a bit of luck, a low-usage customer could flourish into one of the company’s most valuable customers.

7. You’ll future-proof yourself

As your SaaS becomes more powerful — be it through machine learning, automation, or AI — your customers will need fewer users to derive value. At that point, you can take your approach to monetization in two directions.

Stick with a user-based or subscription model and increase your price every few months to reflect the increase in value per seat.
Or introduce usage-based elements into your pricing plan. Dial-in the correct usage metric and optimize every few months.

Usage-based pricing may seem like a hassle to put in place, but when done correctly, the long-term benefits can outweigh the short-term pain.

How to Prepare Your Sales Team for Usage-Based Pricing

Usage-based pricing will change the way you sell. Sales teams will shift their focus to closing faster and working with CS to expand usage. In a completely Product-Led model, sales reps may not even touch a customer until their usage has reached a certain level.

"Usage-Based Pricing will become a costly headache for SaaS organizations that don’t promote visibility in their sales compensation processes."
‍Justin Lane, VP Professional Services - Forma.ai

Knowing this, you’ll have to build an incentive plan that rewards expanded usage without delaying compensation. That means forecasting models will be imperative to success. And without the right sales compensation software, the sales performance department is about to get very loud.

Is usage-based pricing suitable for your SaaS?

Due to changing consumer preferences, outstanding numbers from public companies, and pressure from VCs, usage-based pricing will become the default go-to-market strategy (if it hasn't already) for many SaaS organizations. The rest will integrate some sort of usage-based model into their subscription pricing.

With all this buzz, you could be forgiven for thinking that usage-based pricing is a cheat code for greater SaaS profitability. It's not.

When executed correctly, usage-based pricing can certainly help SaaS organizations to increase revenue, but the work involved in implementing UBP to the standard required should not be underestimated.

If SaaS leaders do not prepare their sales operations to manage the complexity and variability inherent in a usage-based pricing model, UBP can quickly become a drag on revenue and an area of significant financial risk and uncertainty for the business.