subscription-based pricing is dead: smart saas companies are shifting to usage-based models

The process of acquiring software has undergone a significant transformation. The traditional approach, where leadership selected software solutions based on IT infrastructure or key performance indicators, is becoming less common. Today, employees are increasingly influencing software purchasing decisions and directing their managers toward specific choices. This shift explains the growing prevalence of usage-based pricing among Software-as-a-Service (SaaS) companies, including prominent examples like Datadog, Twilio, AWS, Snowflake, and Stripe.

This pricing structure enables customers to begin using the software with minimal upfront investment, reducing obstacles to adoption. Simultaneously, it ensures a pathway for sustained revenue generation, as costs are directly correlated with the benefits the customer derives from the product. By removing restrictions on user numbers, organizations can explore diverse applications of the software, fostering greater long-term adoption and maximizing customer lifetime value.

Although a complete transition to usage-based pricing won't happen immediately, considering current trends in the software industry – such as automation, artificial intelligence, and APIs – the value of a product typically isn’t linked to the number of users accessing it. Usage-based pricing is poised to become essential for effective monetization strategies going forward. Below are four crucial recommendations to assist companies in achieving $100 million or more in Annual Recurring Revenue (ARR) with this approach.

1. Land-and-expand is real

Pricing structures based on actual usage are now prevalent throughout the entire technology landscape. While initially introduced at the infrastructure level – exemplified by companies like AWS and Azure – this approach is gaining significant traction for products delivered via APIs and application software, spanning infrastructure, middleware, and applications.

A common concern is that investors might disfavor usage-based pricing due to the absence of long-term subscription commitments from customers. However, investors generally view this model favorably, interpreting it as evidence that customers are actively deriving benefit from the product and are not simply paying for unused software.

Indeed, companies employing usage-based pricing are currently receiving increased positive attention from investors. These businesses are being valued at a revenue multiple that is 50% higher than that of their competitors.

Investors are particularly enthusiastic about the synergy between usage-based pricing and the land-and-expand sales strategy. Examining recent IPOs, seven out of the nine with the strongest net dollar retention rates utilize a usage-based pricing model. Snowflake, notably, demonstrates exceptional performance in this area, achieving a net dollar retention rate of 158%.

2. Pick the right usage metric

Implementing a pricing structure based on usage introduces distinct challenges for both market entry and ongoing operations. It’s crucial to thoroughly consider the usage-based value metric – the fundamental unit used to calculate a customer’s cost. Numerous metrics could potentially inform your pricing strategy, including factors like customer scale, consumption levels, number of users, or other relevant criteria.

Ensure the metric you select demonstrates consistent growth across your customer base, effectively conveys the benefits of your product, and offers customers a clear understanding of their expected costs. Remember to prioritize five key characteristics: alignment with value, adaptability, scalability, predictability, and practicality.

Here are some examples of usage metrics employed by established companies: Attentive, a platform for personalized text messaging, bases its pricing on the quantity of SMS messages sent. Snowflake, a data platform, utilizes compute resources and data volume. Datadog, a cloud application monitoring and security solution, charges based on the number of hosts monitored and the gigabytes of data ingested or scanned.

For many thriving startups, average customer usage tends to increase consistently over time. However, not all metrics are equally suitable for pricing models.

3. Compensate reps for ongoing customer growth

The customer experience with a usage-based model frequently differs from that of conventional software. Employing a product-led growth strategy can streamline the initial onboarding process for users. Following successful implementation, the sales team can then focus on securing long-term contractual agreements.

Customer success teams are also crucial for fostering sustained engagement and product adoption. It’s vital to structure sales compensation plans to avoid hindering these efforts and to ensure alignment with overall company objectives. Many companies utilizing a usage-based approach enable their sales representatives to benefit financially from increases in customer usage following the initial subscription. This encourages reps to prioritize securing the first subscription efficiently, while ensuring customers are provisioned with the appropriate level of service. When customers achieve positive outcomes, it benefits all parties involved.

Sales professionals should concentrate on rapidly finalizing agreements and subsequently allowing usage to increase organically. Incorporate a component into their compensation that is tied to actual usage metrics after the initial implementation period.

4. You can’t predict your best customers

Revenue models based on usage are inherently less stable in their projections than those relying on subscriptions. Consequently, substantial investment in both technology and personnel is crucial to accurately anticipate customer consumption patterns.

Expect to take calculated risks – and some of these will yield exceptionally positive results. When revenue is tied to consumption, a strong emphasis on predicting that consumption is essential. Remember that finance and accounting teams preparing for an initial public offering approach forecasting as a sophisticated data analysis undertaking. These teams thoroughly examine key revenue indicators at both the group and individual customer levels.

Ultimately: Prioritize delivering an excellent onboarding process for every new user, irrespective of their starting expenditure.

Prepared to grow revenue to $100 million or more?

Currently, even established subscription-based businesses are integrating a component based on consumption into their pricing structures – examples include Salesforce, Box, and Zoom. Leading SaaS organizations such as Datadog, Twilio, AWS, Snowflake, and Stripe have already demonstrated success with this advanced approach to software pricing.

When considering this for your own company, begin by assessing if a consumption-based model aligns with your product. Every instance of product utilization should result in a beneficial outcome for your customers, with your revenue growing alongside their achievements. Should this model prove suitable, carefully select the appropriate usage metric – dedicate sufficient time to this choice and remain adaptable to modifications as your business expands. Ultimately, anticipate the need for development; many companies required bespoke solutions to address the operational complexities inherent in their unique consumption model, spanning areas like billing and sales incentives.