Why is Usage-Based Pricing on the Rise? Our Study Reveals a Growing Trend
Usage-based pricing is, frankly, trendy.
45% of SaaS companies now have some form of usage-based pricing (UBP), up from 34% last year, according to new data from OpenView’s State of Usage-Based Pricing Report. (Spoiler alert: I wrote it along with my colleague Sanjiv Kalevar.)
The survey, it should be noted, used an expansive definition of usage-based pricing counting both companies with a largely usage-based or pay-as-you-go model, along with companies that sell usage-based subscriptions.
Newcomers to usage-based pricing include startups like Cypress.io, Pulumi, and Algolia (which called it the ‘most customer-friendly pricing’ in the market); public companies like New Relic; and long-time incumbents like Autodesk. Creative usage models can even be found in unexpected places, like at design giant Canva. They allow folks to buy on a credits basis rather than just a traditional subscription.
Among the UBP holdouts, 20% say they’ll launch or test usage-based pricing in 2022. Another 41% say that they expect to potentially test usage-based pricing in the future.
That begs the question: why is usage-based pricing so popular? Let’s dive in.
1. We’re in the end user era of software buying
Buyers are changing. Increasingly, end users are finding SaaS products and then telling their boss what to buy. End users expect to try-before-they-buy and only pay for what they use.
In many cases, procurement – the longtime blocker of usage-based models – comes in well after a product has been successfully adopted at the end-user level. They don’t have the same power to dictate terms that they once did.
It’s nice to see more sophisticated procurement teams start to get on board, shifting from UBP detractors to even (begrudging) advocates. Procurement folks are often fed up with buying big multi-year subscriptions for products that end up as shelfware. Forward-thinking procurement leaders now prefer usage-based models as a better overall value for their organizations.
Don’t believe me? The slow-moving federal government is now amending its GSA schedule to allow agencies to ‘pay by the drink.’ They’re seeking to “realize the best practices in the private-sector of cost transparency and efficiency, increased cyber security and more robust competition.”
2. The seats are empty
If you look at leading innovations in SaaS—automation, AI, and APIs—the value of software products doesn’t scale with more humans logging in. In fact, it might even inversely correlate in some cases.
SaaS vendors need to align their pricing models with the value they create for customers. Increasingly usage-based metrics better reflect this value compared to seats or user licenses.
In my view, removing the cap on user seats allows more folks within an account to access a product. That makes the software more ubiquitous and seeds new use cases that the vendor may never have known about in the first place. Usage-based pricing allows the customer to discover the full potential of their software investments, then pay later after they’ve been successful.
3. Usage-based companies have better financial performance than their peers
Specifically, usage-based companies tend to have best-in-class net expansion or net dollar retention rates. This net expansion may even grow at scale, so usage-based revenue ends up looking like compounding interest over the long run.
Those who paid attention to Confluent’s recent Q3 earnings call saw this first hand. The company’s most recent net retention from their S-1 filing was a solid 117%. But they’ve more recently reported 130%+ net retention. Why? Usage-based pricing.
Our thesis is that over time, Confluent Cloud with its elasticity and consumption-based model should have a higher NRR than Confluent Platform. The thesis played out nicely this quarter,” said Confluent CFO Steffan Tomlinson
4. Investors are not only getting more comfortable with usage models, they now prefer them
There used to be a healthy dose of fear that investors would hate usage-based pricing models because these weren’t as ‘predictable’ as pure subscription models.
Since then, investors have gotten a lot more comfortable with usage models and usage-based SaaS companies have gotten a lot better at making consumption more predictable. (For more on that, see Toast’s S-1 and definition of ARR.)
It’s fascinating to see companies starting to brag about usage-based pricing in their S-1s as a way to demonstrate a path towards continued growth. HashiCorp, which made their S-1 filing public on November 4, is one such example. Here’s the third bullet point in their Growth Strategy:
Unlock additional value and market share through HashiCorp Cloud Platform. HCP, released in 2020, addresses the needs of our largest enterprise customers and enables us to serve SMBs through a low-touch solution. HCP enables organizations that previously did not have the capacity or ability to self-manage HashiCorp products to benefit from our industry-leading product portfolio. Additionally, HCP not only increases the number and type of organizations that we can serve, but it also enables us to offer consumption-based pricing. Consumption-based pricing allows customers to align spend with usage, and it also provides an organic way to increase monetization with the adoption and usage of our products.
5. Usage-based pricing sends an incredible message to customers that’s hard to replicate.
When vendors introduce a usage-based pricing model, they’re sending an incredible message to customers that they stand behind their products and truly believe customers are going to be successful. In fact, they very literally won’t get paid if a customer isn’t adopting the product.
That immediately begs the question: why aren’t other vendors this confident?
It’s not just a message either. Usage-based companies tend to be the most customer-focused companies out there. Their organizations are centered around the customer experience with every team playing an important role:
- Product: Treat product investments as a revenue-generating expense, carving out dedicated resources to focus on product adoption
- Marketing: Connect marketing efforts with the product and user community
- Sales: Consumption – and not just ‘committed bookings’ are the holy grail
- Pricing: Keep it simple and ‘give away’ valuable features that lead to greater lifetime value
Usage-based pricing is already here, but what does 2022 have in store? Find out in the new State of Usage-Based Pricing report. Can’t wait to hear what you think.