Implementing usage-based pricing doesn’t guarantee you’ll see increase profits. Without proper planning, it could even rapidly eat through margins.
Making the switch to a usage-based pricing model in a SaaS organization raises numerous financial and operational risks, which we have helped our SaaS partners circumvent. We share our learnings on that process in this detailed guide for Sales Ops leaders.
This article is an abridged version of that guide, which you can download using the form below.
Why All the Fuss About Usage-Based Pricing?
The last decade saw the rapid growth of some enormous software companies that all seem to have one thing in common: Usage-Based Pricing (UBP).
Naturally, this has got the VC world buzzing. SaaS executives worldwide are being asked, “Can we make Usage-Based Pricing work for us?”
The answer is ‘yes,’ but there lies the danger. Most companies will approach this as a simple pricing change, but this is an organizational change.If you run a SaaS organization, usage-based pricing will almost certainly become part of your go-to-market strategy in the next five years. #saas #strategy Click To Tweet
In particular, the way sales incentives were calculated in the past won’t work with a usage-based model.
Margins will be seriously impacted if organizational leaders make the switch without proper consideration of how incentives and compensation fit within this radically different structure.
Is Usage-Based Pricing Really the Future of SaaS?
Why all the fuss around UBP now? In a word: profits.
The best performing public SaaS companies in recent years were all Product-Led Growth companies with UBP models.
The combination of greater revenue at scale but a similar (and slightly better) gross margin means that investors value these businesses at a significant premium over their peers: up to 20-40% more.
You might think the nature of the UBP model would give most VCs sweaty palms — but that’s far from the truth.
72% of companies who are not currently using a usage-based model plan to do so within the coming years.
The Danger of Switching Your SaaS to Usage-Based Pricing
The risk for established SaaS organizations is switching to a usage-based pricing model without preparing their sales operations and incentive compensation plans to work with it.
“Usage-based pricing will become a costly headache for SaaS organizations that don’t redesign their sales compensation process.”Justin Lane, VP – Professional Services, Forma.ai
Designing incentives and sales compensation for sales teams working in a UBP model is very different from a traditional subscription or seat-based pricing structure.
In a subscription-Based Pricing model:
• You know the price and the customer pays upfront
• You know the ACV value of the sales deal. Even if it’s month-to-month, you still have a predictable income.
• You know the booking date of the deal.
In a usage-based pricing model:
• All bills are in arrears.
• You don’t know the ACV value of the sales deal. Even estimates based on lookalikes will vary over time.
• You know the booking date of the deal.
Fully integrated customer usage data is critical to leveraging usage-based pricing.
Customer usage data must be accurate, timely, and aligned — particularly your incentive compensation solution — in order to successfully leverage UBP in a SaaS organization
Most SaaS organizations will need to completely redesign their sales operations to get anywhere close to the agility required to execute usage-based pricing.
There are four typical areas of weakness in SaaS sales operations that need addressing:
Even enterprises that use the latest sales performance management software to ‘automate’ find that they’re surprisingly limiting. Then, out come the spreadsheets to calculate that SPIF anyway.Most SaaS organizations will need to completely redesign their sales operations to get anywhere close to the agility required to execute usage-based pricing. #saas #salesops Click To Tweet
The problem is these solutions are only highly flexible once. The first time you set them up, they can do pretty much everything. But whenever that automation or comp plan needs tweaking, the whole system needs reprogramming.
For usage-based pricing to have a positive impact on profitability, sales comp. and operations processes need to be highly flexible and customizable at every level — down to the individual.
The increased resource-load and complexity that comes with leveraging a usage-based pricing model will magnify existing inefficiencies in your current compensation process. That could eliminate any benefits found in a usage-based pricing model.For usage-based pricing to have a positive impact on profitability, sales comp. and operations processes need to be highly flexible and customizable at every level. #saas #salesops #spm Click To Tweet
All large enterprises struggle with expensive inaccuracies in their sales compensation process. Salespeople will rarely report an overpayment but always report an underpayment.
If extrapolated onto a usage-based pricing model, where contracts are infinitely more variable, these inefficiencies get amplified. That could curtail any increase in profits that SaaS organizations may find by leveraging a usage-based pricing model.
Usage-Based Pricing Requires a New Sales Incentive Strategy
Compensation makes up a large portion of an organization’s expenditure; anywhere between 10%-50% of overheads.
Sales performance teams don’t have the ability to measure the effectiveness of their incentives plans, let alone audit them thoroughly.
“Agility without governance is chaos.”Nabeil Alazzam, CEO – Forma.ai
Many sales operations teams have little idea how effective their plans are at driving revenue. Worse still, they often can’t audit them to see how they have been abused or manipulated over the year. This would be total chaos with usage-based pricing added to the mix.
Incentivization is intended to tie individual performance to organizational goals. Switching your SaaS organization to usage-based pricing means a radical change in organizational goals, which means incentives, individual targets and quotas must also change.
How to Prepare Your SaaS Sales Operations for Usage-Based Pricing
If you run a SaaS organization, usage-based pricing will almost certainly become part of your go-to-market strategy in the next five years. But making the switch–or even a partial switch–isn’t just a simple pricing change.
Integrating Usage-Based Pricing in your Go-to-Market strategy will require a complete reorganization of your sales team.
Here are the steps we advise you to take before they make the switch to usage-based pricing.
- Validate and display your sales data
- Invest in real admin automation
- Test incentives strategically and often
- Build a knowledge bank of sales performance and incentive data
It’s no coincidence that the organizations we point to when talking about the benefits of UBP are mostly data companies. They appreciate the importance of real-time, reliable data and understand how to deliver it. Most SaaS organizations are nowhere near this level of data agility.Leaders of SaaS organizations be warned: switching to usage-based pricing requires a significant overhaul of governance and data management processes. #saas #strategy #governance Click To Tweet
Switching to usage-based pricing requires a significant overhaul of governance and data management processes.
The Decision for Sales Operations Leaders
The decision SaaS leaders must make is a tough one.
Either heavily invest in building the internal expertise and tools required to support usage-based pricing. Or outsource that data processing and administration function to a reliable, cost-effective partner.
To learn more about successfully adding usage-based pricing to your SaaS go-to-market strategy, download the full guide below.