Usage-Based Pricing vs. Subscription Pricing for SaaS
It may seem like usage-based pricing is just another pricing model, but integrating it into your go-to-market strategy requires a fundamental shift in organizational mindset and processes.
Here are the key differences to help you decide if implementing usage-based pricing is the right investment for your enterprise.
Usage-Based Pricing is Operationally Different from Subscription Models
Remember when every startup wanted to be Uber? Or, at least the “Uber” of something?
Uber had an ambitious vision and the technology to back it up. Their pricing model was nothing special, but part of their success is that it worked well and still does. Many venture capitalists even consider it the gold standard in go-to-market strategies for the modern SaaS enterprise.
The beauty of Uber’s pricing model is that it aligns price to usage — unlike fixed pricing or subscription pricing. It’s beautifully simple. Naturally, many of today’s SaaS companies want to make the switch to Uber-style pricing, or as it’s more commonly known, usage-based pricing (UBP).
More specifically, SaaS companies want to meter their services and charge per-use in the same way Uber charges based on miles traveled and time spent on the road.
On the surface, UBP might seem like a small change for your enterprise to make, but it affects everything about an organization — from salaries and incentive compensation to planning, auditing, and customer service delivery. It’s not just a pricing strategy. It’s an entirely new business model.
Why All the Fuss About Usage-Based Pricing?
UBP is helping SaaS heavyweights like Snowflake, jFrog, and Datadog grow at an accelerated rate.Integrating usage-based pricing into your go-to-market strategy requires a fundamental organizational shift in mindset as well as processes. #ubp #saas #pricing Click To Tweet
Analysts estimate that public SaaS companies with UBP models are growing revenue at 32% per year compared to the 26% SaaS industry benchmark.
Investors also see the long-term growth potential of the model. It’s part of why UBP organizations are valued at a 24.8x revenue multiple, compared to their non-UBP counterparts at an average of 17.7x multiple.
Moreover, VCs are favoring startups with the model and pushing others to make the switch. In a 2021 SaaS pricing survey by OpenView Partners, 42% of seed-stage companies said they follow a consumption-based pricing model.
The surge in UBP interest can also be attributed to the rise of product-led growth (PLG, for short) — an approach where the product or service itself is the primary driver of growth.
Roles and Departments Have Different Roles with Usage-Based Pricing
With subscription-based pricing, sales reps are encouraged to close on the biggest deal possible. With UBP, that’s often no longer the desired behavior.
SaaS companies with UBP are expected to generate 23% more revenue growth than industry benchmarks
Analyst Consensus Estimates for FY 2021-2022
When UBP is paired with PLG, sales reps are no longer involved in the prospecting or ‘initial’ sale — that job is taken care of by the product itself. UBP lifts the barrier to entry, be it through a freemium tier or free trial, and PLG invites new users to take themselves on a test drive of your product.
When users don’t have a sales rep guiding them through your product, your customer experience becomes the one thing that will make or break the account.
If a prospect shows promising consumption, only then will customer operations, success teams, and account managers step in to increase account value by providing more hands-on guidance.
Subscription Pricing is Contract Centric, Usage-Based Pricing is Customer-Centric
PLG and UBP succeed because their go-to-market models are inherently customer-centric — the company doesn’t grow if they can’t help customers increase usage.
The best way to increase usage is to demonstrate tangible value with:
- A great product with use cases that drive proven results
- A user experience that delights customers.
Under a UBP and PLG model, your teams in sales, customer ops, and product are all aligned to crafting the best possible customer experience — because your success depends on it.
The improved customer experience and stronger early-stage relationships under UPB will welcome more brand evangelists to your platform and higher revenue retention. Remember Snowflake? Their S-1 showed an NDR of 158%, nearly 30% higher than the industry benchmark.
Customer experience should always be a priority, no matter your pricing model. But, subscription businesses will tend to lean on marketing value upfront to land contracts and put customer experience on the backburner.
UBP keeps your organization laser-focused on customer experience.
UBP Shifts Cost Control to the Customer
To recall the Uber analogy, why pay for a cross-town joyride when you’re only going around the corner?Subscription Pricing is contract centric. Usage-Based Pricing is customer-centric. #saas #strategy #cx Click To Tweet
Subscription businesses are more likely to push customers onto larger contracts than they need. This is great for your bottom line, until the renewal period rolls around and the customer realizes they haven’t used your product enough to justify the price. They don’t stick around long after that.
Usage-based pricing models shift cost control to the customer. That fundamentally changes how they use your product compared to when charged a flat rate or subscription.
Instead of binging your product — and in the process hamstringing resources — UBP customers only use what they need at that time. You can see this thought process play out in real-time in the Snowflake product demo.
Every time a Snowflake user wants to access data on the platform, they’re met with a menu of warehouse sizes to choose from, ranging from small and cheap to extensive and expensive. Like a brunch crew deciding on UberX, UberXL, or Uber Black, Snowflake users select the database size that fits their needs in real-time.
The shift away from “binge” usage to “sip” usage will encourage customers to use your product more strategically. But, it may mean your revenue is less predictable. That can be mitigated with a tiered UBP model where every incremental tier unlocks more usage.
Sales Planning and Compensation is Simpler with Subscription Pricing
Sales performance management under a UBP model can get complicated very quickly. Here’s how:
- Commissions are more variable since revenue is more variable.
- Salespeople typically don’t impact contract value until after the ‘potential customer’ begins using the product and the account has reached a particular value.
- More teams (customer operations and success) are directly tied to revenue growth and should be compensated fairly with commission or bonuses.
- Customers are paying arrears, which can be an issue for companies with a tight cash flow.
Given the increased complexity that comes with UBP, organizations need to ensure usage data is accurate, timely, and aligned — but more importantly — is integrated into your incentive compensation software. They’ll also need to ensure that they can demonstrate how billing works to the satisfaction of enterprise customers with more stringent accounting and procurement processes.
Successful implementation of usage-based pricing requires dedicating resources to curating and validating your data. To avoid massive drain on resources, enterprises need to automate sales compensation and performance admin as much as possible.
With accurate data and the right incentive compensation tools, SaaS businesses that want to leverage UBP can manage the complexities of compensation and demand planning while realizing the immense benefits of UBP.
Are subscription pricing and usage-based pricing compatible?
Not all enterprises should make the switch to totally usage-based pricing. As examined here, there are positives and negatives sides to both. Usage-based pricing is significantly more complex and risky to execute, so integrating it into your go-to-market strategy should be considered a fundamental reorganization of the business.
Usage-based pricing is most certainly compatible with subscription-based pricing, and most organizations would benefit from stacking them, despite the additional complexity.
Revenue and operational leadership should assess the suitability of their current administrative processes, and experiment with usage-based pricing on product lines or small sections of customers to determine if making the full switch to usage-based pricing would be beneficial for their organization.