Software-as-a-serve (SaaS) is almost synonymous with subscription models. After all, the whole notion of subscribing to something is not that you’re simply buying a product but that you’re committing to a long-term relationship with a service provider. Subscriptions are ideal for SaaS. They allow CFOs to predict their incoming revenue better when customers commit to regular payments. Customers benefit from that regularity by being able to budget and plan.
New SaaS companies can start earning recurring revenue through subscriptions and grow fast. But it’s another, more significant challenge to sustain growth and keep customer churn rates low.
That’s why for every successful SaaS business, there are thousands of failed startups. So, fast-growing SaaS companies, like DocuSign, Zendesk, and Zoom, find ways to garner revenue from usage, not just flat recurring fees. This shift has helped them accelerate growth by identifying the right levers to pull to drive price points and engagement. Plus, they can more seamlessly scale alongside their customers.
Both consumers and companies are starting to prefer to pay for just what they use. According to a survey from Flexera, organizations waste 30% of their IT budgets. So, it makes sense that businesses paying flat fees for unlimited usage wind up wondering how to rationalize the cost.
The pay-as-you-go, or usage-based, model, on the other hand, ensures no money or services get left on the table, and customers can add on or downgrade as they see fit. Additionally, it provides subscription SaaS companies with insight into how customers use their services. It also provides opportunities for upselling.
Subscription businesses with hybrid pricing models consisting of flat recurring fees and usage fees are attractive to anyone interested in the best of both worlds — in this case, both predictable revenue and customer satisfaction.
To monetize usage, companies must identify, first, the right value metric and, second, the charging model for their service. Finally, every subscription company needs to assess the right mix of flat recurrent and usage-based revenue to drive the most growth.
One of the most popular units for monetizing value, and the default for many big SaaS companies like Salesforce, Slack, and Asana, is the number of users. However, companies are exploring many options, and the best value metric should depend on the service. Besides user headcount, other standard metrics include the amount of data used and the total meaningful events, such as invoices processed, SMS minutes, or API calls made.
Within usage-based pricing, there are several variations of the pricing model, each of which has different benefits for different services or customers.
Pay-per-unit pricing (like Amazon Web Services’ pay-per-API offering) can be straightforward and practical when that’s what customers need. It can be less desirable for super-users and unnecessarily clunky for customers who can exactly predict their upcoming usage.
Overage pricing is an option that offers customers a certain quantity of units (for example, gigabytes of storage). If the customer exceeds the limit during the billing period, they are charged per unit on whatever amount is over the limit.
Edge computing provider StackPath operates a similar model and is upfront with customers about the cost if they exceed the bandwidth. If a customer frequently surpasses the amount, they have a chance to upgrade, demonstrating how usage pricing models interact with customer growth. Ideally, the service provider’s billing team flags customer service when there are frequent overages, and the customer success team can set up the client with a more fitting package.
Volume pricing charges an amount based on the volume of committed usage upfront. This gives the vendor a way to predict the revenue, and the subscriber gets a better price in return.
In tiered pricing, the price of units increases as the volume increases. There’s also tiered pricing plus overage to consider, where customers are charged for any usage beyond their tier. For example, 1-1,000 API calls might cost customers $0.06 per call, whereas they’re charged $0.05 per call for 1,000-10,000 calls. Such a structure can incentivize the customer to use more of the service.
These pricing models allow for ultimate customization — like how Zipcar designs pricing structures based on many factors: time of day, type of car, day of the week, and more. Many SaaS companies have custom add-ons that incur an additional fee, like Zoom’s functionality to add on cloud storage, technical support, or mega-group meetings.
In each of these scenarios, pay-as-you-go pricing is far more about growing relationships than transactions. It helps customers equate their dime to value and allows service providers to learn how customers experience that value.
As demonstrated through a range of pricing models, SaaS companies that charge based on usage afford themselves the room to negotiate pricing without overcharging customers. They can also enable new customers to onboard for a reasonable spend, and they can just as deftly cater to super-users — and match them with appropriate packages. At the same time, a tipping point exists for usage-based pricing, where growth eventually stalls.
At Zuora, we analyzed subscriptions across more than 550 companies to understand the relationship between a company’s revenue growth and usage-based pricing. We found that companies that take advantage of usage-based pricing see faster growth than ones without any usage-based pricing. But the companies that saw the highest increase relied on just a moderate amount of usage-based pricing.
Specifically, the companies attributing 1% to 25% of their overall revenue to usage grew by 25% year-on-year — 1.5 times higher than companies with no usage-based pricing and 1.2 times higher than companies with more than 25% of their revenue from usage.
Finding the right balance takes experimentation. Companies must adopt an IT structure that enables them to try different combinations of recurrent and usage-based pricing in the market. Ultimately, this investment will pay off in the service of the customer relationship.
Todd McElhatton is the CFO of Zuora and former finance chief of SAP North America.