Why SaaS companies should consider a hybrid pricing model
By the end of 2023, 99% of companies will be using at least one SaaS solution. As the Software as a service (SaaS) industry has exploded and matured, so have pricing models. SaaS gained traction because of the lower total cost of ownership (TCO), easier deployment, and the flexibility to add seats. SaaS has continued to adopt more sophisticated pricing models that reduce sales friction and deliver value rapidly.
Traditional subscription-based pricing models have evolved to include usage-based pricing (UBP), where a customer pays as they go, and usage can range from nothing to max every month, instead of a flat subscription fee.
Pure usage-based models, where product or service usage is the only determinant of price, can be a good monetization model for low-friction, low cost of acquisition (CAC) solutions with a known value metric.
However, there are risks in a usage-based model. From a service provider standpoint, there is uncommitted revenue and in a down market you may see less consumption of your service. From a customer standpoint, heavy usage may not allow you to lock in maximum per unit savings that you may receive from an up-front commitment.
Consumption-based pricing, where a customer commits upfront, and then can consume the service in different amounts each period, encourages customer engagement and retention, which ultimately leads to higher customer satisfaction.
The next evolution of flexible pricing and packaging for SaaS is a hybrid consumption pricing model.
What is a hybrid pricing model?
Hybrid pricing models are a type of usage-based pricing model that combines a traditional upfront commitment (often a subscription) with a consumption pricing model.
More adaptive than either pricing element alone, hybrid pricing models offer SaaS companies flexibility and a more predictable revenue stream all while delivering value-based consumption that resonates with the market.
By combining a fixed cost with consumption, hybrid pricing models provide customers with a predictable baseline cost while also allowing them to pay based on how much they use the product or service.
This approach can be particularly appealing to customers who have fluctuating usage needs or who want to try out a solution before committing.
Many SaaS companies launch with prosumer, or Product Led Growth (PLG) sales motions. Hybrid pricing is an innovative way to support PLG strategies, enabling customers to control their spend and add functionality and cost as they mature.
Adoption of hybrid pricing models
Hybrid pricing is growing in popularity as a pricing strategy. According to The State of Usage-based Pricing, Second Addition from OpenView Partners: “While 15% of SaaS companies have rolled out a largely usage-based or pay-as-you-go model, three times as many companies (46%) take a hybrid approach, either by testing UBP alongside traditional subscriptions or offering a usage-based subscription plan.”
The report goes on to say that pure usage-based, or pay-as-you-go pricing has declined 22%-15%, while more complex, hybrid pricing models combining subscriptions and usage-based elements have gained traction.
With the right tools, hybrid pricing models are flexible enough to support PLG, enterprise sales, multiple product companies, usage-based, and traditional subscriptions.
Advantages of hybrid pricing models
There are many advantages to hybrid pricing models.
More flexible and adaptable than traditional pricing models, hybrid consumption pricing models allow SaaS companies to meet their customers where they are. With a lower flat subscription fee and variable usage component, customer risk and sales friction is reduced, which can result in faster deals cycles. Additionally, the risk of churn is decreased because companies are motivated to maximize value, usage revenue, and customer satisfaction.
Hybrid pricing models give companies the agility to experiment and change pricing models as needed.
In terms of revenue, hybrid pricing models provide more predictability and stability than pure usage, especially in a downmarket. Overall, a hybrid pricing model is a powerful tool for SaaS companies looking to maximize revenue while also providing value to their customers.
Challenges of implementing a hybrid pricing model
Hybrid pricing models can be challenging to implement without the right tools and expertise. Data is key and your product must be able to measure consumption in an accurate and timely way.
Billing complexity can also be an issue, as usage-based billing requires invoicing customers for their usage in arrears, which can be complicated by itself. Adding usage to flat fee subscriptions on a single invoice is a challenge that only the leading subscription billing solutions can support.
Hybrid pricing models can incur complex contract modifications and upgrades that are challenging to automate. Strategically, companies must decide whether to charge for overages or use them to upgrade the contract variable rate.
Is a hybrid pricing model right for you?
Whether or not a hybrid pricing model is right for your business depends on various factors. Here are some scenarios when a hybrid pricing model may be worth considering:
- Flat growth
If your growth has slowed considerably, introducing hybrid pricing models could help you attract new customers and increase revenue. By offering different pricing models, you can cater to different segments of the market and differentiate yourself from competitors.
For example, you could give prospects options for 1. pure subscription (for unlimited high use relationships) 2. a pay-per-use model for new, experimental, and occasional users and 3. a combination subscription and hybrid.
- Moving upmarket
For PLG, SMB, or B2Any providers, hybrid pricing can help you attract and retain larger customers with different usage patterns. As PLG customers transition into enterprise accounts, more tailored pricing models are required.
- Reach a new market
Hybrid pricing can help you enter and compete in a new market or to attract a diverse customer base. Different markets have different pricing expectations, and a one-size-fits-all pricing model may not work.
For example, if you are entering a nascent market, you may get the most traction with low-cost pricing models to attract price-sensitive customers. Alternatively, addressing a premium market may require a premium pricing model to capture attention and demonstrate the value of your product or service.
- Customers have wide variability in usage
When customers consume your product or service in significantly different ways, it is difficult to reflect value with a single price that appeals to everyone. Hybrid pricing can help you cater to different consumption patterns and capture the value of each customer.
- Adding new products
As SaaS companies grow, many expand by introducing new products and revenue streams. New revenue streams can result from additional features in existing products or monetizing different parts of the existing product.
Adding additional products allows you to grow your relationship with existing customers by providing more value. Hybrid pricing allows you to bundle and package multiple products in interesting ways that appeal to customers and grow your revenue.
- Reduce churn
When a customer feels that they are paying too much for a solution and can not justify the cost, they may cancel their subscription. Similarly, a customer on a fully usage-based pricing plan who feels that they are using the product or service too much and incurring unsustainable high costs, may also cancel their subscription.
If the company offers a hybrid pricing plan that includes consumption-based billing, the customer may be more likely to stay because they have more predictable costs and an element of value tied to usage. Therefore customer satisfaction and retention should improve.
Components to implement hybrid pricing
It’s important to have the right infrastructure to support hybrid pricing. Here are some key areas to consider.
Metering in your product
You must have the ability to accurately measure and export customer usage data.
Rating and billing solution
While usage metrics can be extracted in multiple ways including manually or using CSVs and APIs, you will need the ability to translate that usage into charges for each contract. To handle this process at scale, you will need a billing platform set up to automate consumption-based billing. This platform should be able to calculate charges based on usage, generate invoices, and process payments.
Flexible invoicing
Because hybrid pricing models often have multiple elements to invoices, it is important that your billing platform seamlessly supports multiple charges on a single invoice.
Contract flexibility
Hybrid pricing models are inherently more complex to quote and amend. Your CPQ and billing platform needs to be agile enough to automate the changes, prorate, and invoice accurately.
Customer communications
Due to the variable nature of usage charges, it is important to provide transparency and proactive communication to customers. You need a communication platform that will be triggered by your usage rules.
For example, if your company strategy is to alert customers before they hit overage, you need the capacity to automate that communications when customers reach a certain threshold.
Conclusion
Hybrid consumption-based pricing models are gaining popularity due to changing economic conditions and increased demand for more flexible and customer-focused pricing models. Hybrid pricing offers a balanced approach between subscription and usage-based pricing, allowing companies to provide more value to their customers while still maintaining predictable revenue streams.
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Making the change from full usage-based to a consumption pricing model requires more than turning on consumption billing. It takes transformation across the organization.
Tune in to Subscribed Live to learn how to make the shift to a consumption model with Zuora’s latest product innovations.
Written by:
Ronak Majmudar – Head of Zuora for Startups