SaaS and subscription-based companies have embraced usage-based pricing models with open arms over the past several years. Instead of making customers pay a set price upfront, these companies have flipped that paradigm so as to allow customers to only pay for what they use.
Use more, pay more. Use less, pay less. Usage-based pricing works because your customers can grow with you. Customers that find initial success with your service and want to use it more can do exactly that with usage-based pricing. In turn, businesses that employ a usage-based model can get more revenue as customers increase their usage.
It’s a sure way to drive subscription growth … right?
While companies with usage-based pricing see faster growth compared to companies without any usage pricing, there is a tipping point where growth eventually stalls.
To sustain growth, subscription companies need to balance the mix between recurring and usage-based pricing—but finding that mix can be tricky.
If we take a step back, there are three strategies that subscription companies mix and match to price their products:
Rather than putting all your eggs in one basket, make sure to find the right balance of usage-based growth and sustainable recurring revenue.
Finding the sweet spot for your company and customers requires a Goldilocks-style experimentation, but, when you hit that sweet spot, you’ll find a new growth channel that reaps big rewards.
If usage-based pricing is so great, why haven’t more companies adopted it? Because it’s a lot more complicated underneath the hood.
Most companies today don’t have the luxury of experimenting with usage-based pricing due to the limitations in their technology systems and architecture. And without the ability to experiment with usage-based pricing, a company’s growth is put at risk.
The challenges fall largely into two buckets: the shortcomings of legacy systems to support usage-based pricing models and the downstream impacts to finance caused by implementing usage-based pricing.
CRM and ERPs were built in the era of selling products, so everything rests on the concept of a SKU (stock keeping unit). But that’s not how a usage-based pricing model works.
Usage-based pricing ranges from pay-as-you-go models to tiered usage models. There are six common types of usage-based pricing models:
And all of these models require a technical solution to:
Since legacy systems do not support usage-based pricing models, IT teams are forced to hard-code existing solutions or build a homegrown hack to support usage.
If your company tries to retrofit usage-based pricing into a SKU-based system, you will inevitably need hard-coded customizations and mountains of custom logic to support metering, rating, and billing customer usage. Retrofitting a usage-based pricing model into legacy systems leads to lengthy, complex, and costly implementations.
Plus, usage-based pricing isn’t a one-and-done process. After the initial launch, most companies iterate and tweak their pricing and packaging to find the right usage model and the right mix of recurring vs. usage. The problem is, every pivot requires the IT team to rewrite hard-coded logic.
If your company is planning to go from one usage-based pricing model to another, you’ll need to hard code the new model and downstream financial rules. If your company wants to change the tier limit on your current tiered usage model, you’ll need to hard code the new tiers across multiple systems. If your company wants to change the usage unit of measure from “Per User” to “Per API,” you’ll need to hard code that too. It’s a never-ending list of customizations.
But there’s more complexity to usage-based pricing than just setting the price. Usage-based pricing impacts downstream finance operations, such as billing, revenue recognition, reporting, and customer communications.
Once you start charging by usage, a set of new operations needs to fall in place:
Because of the dynamic nature of usage-based consumption, subscription businesses need to adopt a three-cloud architecture strategy that will support pricing experimentation and ease the burden of the downstream impact of usage-based pricing.
This three-cloud architecture is comprised of:
A three-cloud architecture enables businesses to monetize products through consumption and quickly evolve pricing strategy over time. How?
According to a recent survey on SaaS pricing and packaging from Teneo, a global CEO advisory firm, of customers surveyed, only 10% offer usage-based pricing today—but there is a rise in the expectation and adoption for usage-based pricing. In fact, according to a recent Forrester report, 72% of companies who are not currently using a usage-based model plan to do so within the next two years.
Meanwhile, 50+% of current Zuora customers have already adopted usage-based pricing. With the support of a third cloud, Zuora customers are able to experiment with pricing and packaging to work towards integrating usage-based pricing into their revenue mix. Rather than having to wait for their IT or engineering team to try to figure out how to build a usage-based pricing solution from scratch or hard code endless customizations, companies with a three-cloud strategy can find that right balance of usage-based pricing to increase revenue and optimize for future growth.
Even Goldilocks herself would have to admit that sounds just right.