Playbook: Scale to $100M+ ARR with a Usage-Based Pricing Model
Software buying has evolved. Long gone are the days of executives choosing software for their employees based on IT compatibility or KPIs.
Employees now find their preferred software products and start using them, usually for free. Then they tell their boss what to buy.
This is why we’re seeing more and more SaaS companies—Datadog, Twilio, AWS, Snowflake, and Stripe, to name a few—find success with product led growth paired with usage-based pricing.
The usage-based pricing model allows a customer to start at a low cost, attracting more customers to get started while still preserving the ability to monetize a customer over time because the price is directly tied with the value a customer receives.
Since you aren’t limiting the number of users who can access your software, your customers are able to find new use cases—which leads to more long-term success and higher lifetime value. We’ve seen as much as a 10x ratio in the number of users in an account for usage-based software companies relative to their seat-based peers.
“Usage-based pricing will be the key to successful monetization in the future.”
While we aren’t going 100% usage-based overnight, if you look at some of the mega-trends in software—things like automation, AI, and APIs—the value of a product normally doesn’t scale with more folks logging in.
Usage-based pricing will be the key to successful monetization in the future. But growing with a usage-model is not as straightforward as traditional subscription SaaS. It requires shifts in go-to-market strategy, sales compensation, financial planning, billing, and much more. Transitioning to a fully usage-based model can be as seismic of a shift as going from on-prem to SaaS.
And that’s exactly why we created a playbook to help companies scale to $100+ million ARR with this model. Get the playbook here, or watch the video below for the top takeaways. If you’d rather read them, just scroll down.
1. Land-and-expand is real
Usage-based pricing is in all layers of the tech stack. Though it was pioneered in the infrastructure layer (think: AWS and Azure), it’s becoming increasingly popular for API-based products and application software.
Some folks might have feared that investors would hate usage-based pricing because customers aren’t locked into a subscription. But investors actually see it as a sign that customers are seeing value from a product and there’s no shelf-ware.
“Public usage-based companies are trading at a 50% revenue multiple premium over their peers.”
In fact, investors are increasingly rewarding usage-based companies in the market—and not just because of Snowflake. Public usage-based companies are trading at a 50% revenue multiple premium over their peers.
Investors especially love how the usage-based pricing model pairs with the land-and-expand business model. And of the IPOs over the last three years, seven of the nine that had the best net dollar retention all have a usage-based model. Snowflake in particular is off the charts with a 158% net dollar retention. But JFrog, Fastly, Elastic and Datadog all have north of 130% net dollar retention as well.
2. Pick the right usage metric
There are many usage metrics you could use in your pricing. Make sure the one you choose grows consistently across your customers, helps you communicate your product’s value, and can be predictable.
3. Pay reps beyond the first commitment
The usage-based customer journey often looks different from traditional software. You want to use product led growth to reduce friction in customers getting started. Then, after customers are successful, Sales comes in to generate committed contracts. Customer success also has a really important role in driving usage and stickiness over time.
Make sure sales compensation doesn’t get in the way—and doesn’t create the wrong incentives for your team. Most usage-based companies, for instance, let their reps share in the upside if a customer expands their usage after the initial subscription. This allows the reps to focus on getting that initial subscription quickly and with the usage that is the right amount a customer needs. If that customer winds up being successful, it’s a win-win.
Reps need to be closing deals quickly and then letting usage grow over time. Make sure to include a tail based on actual usage after ramp.
4. You can’t predict your best customers
Consumption-based revenue isn’t as predictable as subscription-based revenue. This means you’ll want to invest significantly in tooling and people to be able to predict your customers’ consumption.
One way to think about it is that you’ll be making a bunch of bets—and some of those bets will pay off spectacularly. The bottom line: Invest in a great experience for all signups regardless of their initial spend.
Ready to scale to $100+ million ARR?
This was just a taste of all that’s in our Usage-Based Pricing Playbook, a resource we created after studying how Datadog, Twilio, AWS, Snowflake, Stripe, and other top SaaS companies have succeeded with this next evolution in software pricing. Dive into the Usage-Based Pricing Playbook now.
Editor’s note: This was originally published on TechCrunch.
2020 was the year of free. And 2021 is the year of reaping the rewards.