December 14, 2021
Much has been written about the increased transparency and customer satisfaction associated with usage-based pricing models compared to seat-based or tiered subscription plans. Still, many companies, particularly in the early stages of product delivery, are intimidated or hampered by the difficulties of building an internal metering service and instead elect to divide features and capabilities into tiers or levels and charge on a subscription basis. Billing is simplified as no metering is required and the only variable to consider is the number of users at each price when creating an invoice. This prioritizes getting a monetizable product to market over maximizing customer satisfaction and value over the long term, however most companies aren’t going to notice any negative impact right away - after all, when the revenue comes flowing in each pay period, it’s tough to complain. Particularly for startups who are growing revenue from zero, it is easy to become complacent and not question if another strategy would accelerate growth or reduce churn. As long as growth or profits are being shown, few companies are about to mess with their meal ticket to implement a completely new pricing model.
This turns out to be shortsighted and detrimental to the long-term prospects of the business. Examining SaaS IPOs from 2019 through the first half of 2021, vendors employing a usage-based pricing model increased their market capitalizations by $10.4 billion on average from IPO to present day, while vendors employing a subscription-based model increased by an average of $6.1 billion. This represented average growth of 143% from IPO for usage-based vendors, while subscription vendors grew by only 83% over the same period. Since its public listing in 2019, the most successful subscription-based company (Zoom) has grown its market capitalization by 500%. This is impressive in a vacuum, but pales in comparison to the most successful usage-based vendor (Cloudflare) which has grown by over 1066% since its listing in the same year. Of eight SaaS companies to show market cap growth over 200% since public listing in 2019, five employ a usage-based pricing model while only three are subscription-based. We want to discuss these financial benefits and some organizational benefits associated with offering your application or service on a usage-based pricing model.
Subscription-based plans provide natural cut-off points for users. Each time an organization reaches a point of considering the next tier up, it becomes a new sale with new value demonstration and cost justification needed. Further, if a tier or subscription doesn’t include all the functionality that an organization needs but the next tier includes too many features that will go unused, it is natural for that organization to shop around and find a vendor that will meet their needs without paying for as many unused features. In this case, the sales organization is constantly challenged to upsell and demonstrate the value of next-tier functions in order to simply prevent churn. Contrast this with a usage-based model where the full functionality is exposed to customers from the beginning. In this case, the sales teams can engage with their customers in a less transactional manner, creating deeper partnerships built around advising on how to best leverage the product. This also eliminates natural attrition points in the customer lifecycle. As long as the solution scales according to the organization’s needs and the pricing is transparent and reasonable, it’s less likely that the customer will churn without requiring successful upselling efforts by the sales organization.
The usage-based model further reduces the demand on sales teams as it shortens the sales cycle and doesn’t typically require such extensive price justification up front. It lends itself well to a “land and expand” strategy, where the solution is brought in to solve a specific problem and its success in that area drives future adoption for new use cases; the vendor simply needs to remain involved in a customer success/product expert capacity to drive increasing adoption (aka upsales). This can open up new revenue streams based on services and support, as well as free up resources from the sales organization that can be dedicated to net new customer acquisition.
With real-time meter data showing how each customer is using a platform or application, sales teams are equipped with the most granular usage data to inform the promotions, deals, and solutions recommended. Customers can easily correlate the cost of service with the value realized, and the ease of value demonstration lends itself to evangelization inside and outside the company, driving growth from adoption via the network effect. It sends a message to customers that the company is completely confident in the product, saying “we won’t get paid if you don’t adopt the solution and see value.” The low barrier to entry from the lack of per-seat payment/up-front ownership combine to enable the product to be the primary growth driver for the vendor, while sales and marketing contribute to a lesser extent.
Having access to usage data from the metering and billing system provides essential visibility to product adoption and usage trends that can inform product development and iteration to maximize value and utility for customers with each subsequent product update or release. In a subscription model, there is no imperative to develop a metering service, so the organization lacks the same level of visibility to usage and adoption to inform product development. The subscription model doesn’t lend itself as naturally to a product-led growth strategy, as sales and marketing efforts are still the primary forces driving adoption and upsales.
Still the trend of usage-based pricing adoption increasing steadily with new companies (i.e. Confluent, DoubleVerify) going to market with the UBP model from the start, while more established vendors (i.e. New Relic, Oracle) are looking to transition to the model either completely or as a step function. In 2019, four SaaS companies went public with a usage-based model; in 2020, this figure increased to six, while so far in 2021, 11 companies leveraging a usage-based pricing model in part or full have gone public. For established vendors looking to transition to a usage-based model, the journey usually begins with new products or capabilities priced on a usage model from first release before transitioning legacy products over time. As we’ve written about before, the fundamental capability that must be in place before implementing any pricing or billing strategy is the metering infrastructure. Once this is in place, it is simple enough to define meter events and a pricing plan to charge for an application or service based on usage. As you consider pricing and billing, the ability to forecast revenue from meter data to optimize pricing strategy to identify the most profitable course of action becomes essential. Read here how Amberflo addresses this need with our Price Modeling capability. Connect with us here to set up a demo and discuss how your organization can benefit from a usage-based pricing model.