More and more businesses are leveraging usage-based pricing (UBP) to drive customer and revenue growth. Is UBP right for your business? 

Is your software-as-a-service (SaaS) business leaving money on the table by being stuck with flat-fee or subscription-based pricing? UBP, also known as consumption-based, metered or pay-as-you-go pricing, has become increasingly popular among SaaS companies. Unlike the per-seat subscription model, the UBP model monetizes primarily through resource usage (e.g., compute, credits/tokens, API calls). 

The UBP value proposition 

UBP offers a variety of benefits: 

  • Lowers the barriers to adopting software  

  • Enables incremental, yet constant, upsell as the UBP contract grows with the organization’s needs 

  • Simplifies the addition of stakeholders for a product, driving a more effective land-and-expand motion 

  • Simplifies the monetization of new features/functionality (more-advanced functionality, such as visualization/querying/generative artificial intelligence, will often drive greater compute) 

  • Better aligns the value received by end users with the price paid, which helps drive key SaaS metrics (e.g., increased customer satisfaction, reduced churn, higher net dollar retention) 

It is no wonder that as of January 2023, 61% of SaaS companies monetize their products using at least some degree of UBP pricing. 

The rise of UBP 

While UBP has existed in some form for decades (think paying for long-distance calls by the minute), its popularity in software began with the rise of cloud computing (infrastructure as a service) circa 2006, where users procure computing resources under a pay-as-you-go model. As more cloud tools emerged and became ingrained in modern tech stacks (e.g., Snowflake, Datadog), this pricing structure extended into the business-to-business SaaS world.  

Today there are several trends driving both businesses and users toward UBP models:  

  • Bargaining power is shifting from SaaS vendors to buyers. Sales differentiators are becoming commonplace (approximately 75% of SaaS businesses offer free trials), buyers complete more than 60% of their evaluations before engaging vendors, and users have more options than ever before as horizontal giants face increasing competition from vertical-specific players. SaaS vendors must now compete on product outcomes and must adjust pricing accordingly. 

  • Software purchasing is becoming more decentralized. SaaS spend by central IT teams decreased by about 35% from 2020 to 2021, bringing roughly 63% of SaaS spend ownership to business units that prefer simpler, more localized decision-making. Barriers such as high upfront fees and long-term contracts have decreased or disappeared entirely from UBP models, simplifying and accelerating the purchase process for such tools. 

Is UBP right for your business?

From infrastructure (e.g., New Relic) to middleware (e.g., Twilio) and, most recently, vertical and horizontal applications (e.g., Autodesk, Mailchimp), a wide variety of SaaS businesses are adopting UBP models. SaaS businesses must now ask themselves which pricing model is right for them. How companies go to market and communicate with their customers should always be evolving, so they may consider adopting a UBP model if they meet specific criteria, such as: 

  • The value customers receive can be accurately measured through consumption of a specific resource (e.g., minutes watched, training modules completed, emails delivered) 

  • The value of its service scales with the outcomes of its service, rather than the number of seats/subscriptions 

  • Customers are accepting of invoices that may fluctuate from month to month

Enterprise customers pose unique challenges 

Enterprise customers face unique tensions that can impact their acceptance of a UBP model.  

Enterprises typically value predictability/expense management so they may have reservations regarding the variable expense of UBP. Furthermore, economic buyers/procurement are more budget conscious and may push for lower overall expenditure, while end users value flexibility of usage and feature access. This tension is particularly pronounced as periods of high usage are often combined with the most critical use cases for end users (think the need to troubleshoot outages for network monitoring tools). Capping usage in these instances creates customer friction and can even drive churn events. No software tool wants to be part of the problem rather than part of the solution. 

So how do SaaS vendors solve for this enterprise UBP problem? The concept of burstable reserve is one such mechanism. This allows enterprise customers to purchase predictable baseline utilization with the flexibility to accommodate spikes and dips in demand. This also creates the opportunity for tiering, with basic tiers only allowing for bursts above the baseline using pre-earned credits (e.g., from earlier periods of lower activity), while advanced tiers allow for more flexible bursting and the purchase of add-on packages for advanced users.

The bottom line 

Overall, UBP is a highly effective monetization mechanism for SaaS businesses. Public SaaS companies that have adopted UBP see a 31% higher year-over-year revenue growth rate and a 9% higher net dollar retention rate compared to the broader SaaS index.1

Despite UBP’s benefits, adopting a UBP model can be difficult and is not the right option for every business. Customers may struggle to understand the usage metrics they would pay for, while company stakeholders may be concerned about variable revenues. Moreover, successfully managing a strategic change of this magnitude presents challenges for any business.  

Navigating what best suits your company requires thorough research with a thought partner that can guide you toward the right solution and sustainable growth. L.E.K. Consulting has a wealth of experience advising SaaS businesses on their pricing strategies. If you’d like to learn more about how L.E.K. can help you optimize your pricing strategy, please contact us at technology@lekinsights.com. 

L.E.K. Consulting is a registered trademark of L.E.K. Consulting LLC. All other products and brands mentioned in this document are properties of their respective owners. © 2024 L.E.K. Consulting LLC 

Endnotes
1Broader SaaS index aggregated by OpenView Venture Partners