Business

Creating a Competitive Advantage: Switching to Usage-Based Pricing

By Habiba Shalaby, Octane

Usage-based pricing is becoming a market standard for SaaS companies worldwide. It is a way to charge users for their actual use of a service, rather than paying a flat subscription fee regardless of their consumption. A simple example of this is Netflix vs a utilities company — with Netflix, you pay a fixed monthly fee, regardless of how many movies or TV shows you watched. With a utilities company, you only pay for the utilities you used, and even then, the amount you are charged is based on a variety of factors such as amount consumed, etc. 

Why are companies switching to usage-based pricing models?

According to OpenView Advisors, over 45% of SaaS companies currently use usage-based pricing, up over 30% from last year.  There are a number of benefits driving this adoption trend. 

From a customer’s perspective:

  1. Transparency
    Customers gain in-depth information around their usage in a digestible format, making the price paid vs. the value attained very clear. 
  1. Flexibility
    Customers can ramp down or scale up their usage based on their business needs. They no longer have to worry about paying for unnecessary technology, giving them increased flexibility around their spending.
  1. Targeted Spend
    Customers can now pay for exactly what they are using, rather than the sometimes arbitrary prices and tiers that current subscription-based models use. 
  1. Limited Downside
    If preferred, clients can start at little to no cost while they become familiar with the product and its features, and then ramp up over time.

From a business’s perspective:

  1. Decreases Onboarding Time
    Given that clients now have limited downside to signing up, it is easier and faster to get customers onboarded onto your platform. 
  1. Decreases Churn
    Rather than cutting out subscriptions entirely, customers can now scale back their usage during down-times, knowing that it will be easy to scale back up once needed.
  1. Aligns Product with Business
    By measuring client usage (and thus, client satisfaction), product teams gain an in-depth understanding of what tools and features are most successful, and which are less important to their customer base. This visibility better incentivizes Product and Sales to work together in order to make sure clients are extracting the most value.
  1. Unlimited Upside
    As your customers grow, you grow. Incentives are aligned, ensuring that the path towards success is shared together without the barriers of renegotiating terms. 

What are the key considerations of usage-based pricing? 

As with any decision, there are some considerations to take into account when adopting a usage-based pricing model:

  1. Predictability
    Expenses are no longer fixed at a certain cost, making forecasting a bit tricky for both the business and the customer. That being said, there are ways to mitigate this by establishing alerts on usage, or by having customers pre-pay for usage credits. Tools such as this can make forecasting easier and usage spikes less problematic. 
  1. Simplicity of Pricing Structure
    Because of its variability, usage-based pricing is inherently more complicated than subscription-based pricing for customers. 
  1. Simplicity of Implementation
    Embedding a usage-based billing system in-house can be expensive, time consuming, and complicated.
  1. Product Fit
    For some products, it may not make sense to charge based on usage. For consumer based products, it might be difficult for consumers to calculate their optimal usage amount vs the amount they are willing to pay. For B2B services, this calculation may be more worthwhile in order to be capital-efficient. 

Despite these considerations, we are seeing an increasing trend towards adoption. Both startups and established companies are pivoting towards this strategy. In fact, our research below indicates that switching to usage-based pricing correlates to superior performance for companies when compared to their peers.

Why it’s becoming a market standard for emerging industry leaders

According to OpenView Advisor’s data from a spread of public SaaS companies, companies that incorporate a usage-based pricing strategy tend to perform better. Companies implementing usage-based pricing have higher projected revenue growth, seeing an average of 30% forecasted revenue growth (compared to the 22% growth forecasted for all SaaS companies). They also have a higher enterprise-value-to-revenue (EV/R) multiple, averaging around 22x (compared to the industry-wide average of 14x).  Finally, companies that leverage usage-based pricing are healthier and more effective, seeing an average of 120% net dollar retention (compared to 110% for broader SaaS companies). 

Companies who incorporate usage-based pricing are also among the fastest growing companies. They make up the majority of companies with greater than 100% ARR growth, and are in the minority of companies with less than 100% ARR growth. 

Business leaders across the SaaS industry have noticed the benefits of usage-based pricing models and have turned to adoption themselves to gain a competitive advantage. Our prediction is that usage-based pricing will be a standard practice for SaaS companies in the near future. 

Octane makes adopting usage-based pricing & billing simple

Octane was founded in 2020 to help SaaS companies embed usage-based pricing and billing into their ecosystem. The many intricacies of building and maintaining a reliable usage-based billing system — especially one that can grow with your business — makes implementation a difficult undertaking. Rather than building a system in-house, most SaaS companies have started to work with leading usage-based billing providers like Octane.

If you’re interested in implementing usage-based pricing or automating usage-based billing, chat with us and start building your competitive advantage today. 

https://www.getoctane.io/contact-us