Fifty bucks a seat. All-access to 100+ features. Monthly recurring subscription.
That is a look at your typical SaaS pricing structure. It’s what many of them used to look like. Many still do. Fixed pricing, per organization or per seat. That’s it.
But at some point, founders & pricing teams started figuring out there were a few problems with this:
- Traditional pricing strategy isn’t directly tied to value. An email-sending service isn’t providing value with per-seat access. The value is in the number of emails sent.
- Customers often overpay (or underpay). A team of five power users may cost you 3X more than a team of five who hardly use the platform. But your billing won’t reflect that.
- Acquisition is harder. Customers aren’t getting what they pay for. It’s far too easy to say “this isn’t worth it,” especially when budgets are tight.
Enter: usage-based pricing. A change from the status quo. Instead of charging flat fees on things that might not be optimized for you and your customers, you charge them based on what they use.
Executed well, usage-based pricing transforms three parts of your business:
- Acquisition: UBP makes it easier for your company to get customers.
- Monetization: UBP makes it easier for your company to monetize whatever it provides.
- Retention: UBP makes it easier to keep people around, if you implement it properly.
We recently talked with Madeleine Stein, Pricing Leader at Algolia, Alex David, former pricing lead at Segment, and Doug Cunningham, former Chief Digital Officer at Monster.com. They are some of the preeminent minds on effective pricing strategy. And they’re all fans of usage-based pricing.
We’re using their insights, and ours, to write this short playbook (it’s a 10-minute read). In it, we’ll teach you how to plan for usage-based pricing, how to implement it well, and how to keep it running successfully in a tough market. If you have your doubts, or haven’t ever experimented with UBP, this playbook is for you, too. You can read this regardless of your knowledge about UBP. Let’s begin.
Part I: The 3 things you need to decide before trying usage-based pricing
A short definition for the unfamiliar: Usage-based pricing is a shift from the traditional pricing model. Instead of charging a flat fee (or subscription fee) for your product, usage-based pricing is rather self-explanatory: You charge your customers based on their consumption of your product.
For example: Imagine you’re running a service that sends emails. Instead of charging users a $99/mo fee to use the service, for example, you could charge users a fee for each email they send out. Or you could batch your pricing into buckets, charging for different levels of usage: $40/mo for a cap of 1,000 emails, $100/mo for a cap of 2,500 emails, and so on.
With usage-based pricing, your customers (literally) get what they pay for.
Now, where to begin? Alex David, says it’s all about the metric you choose to bill on.
1. Choose the right metric to bill on
Choosing the metric you bill on is the most important step to forming a usage-based pricing strategy. It could make-or-break your success. While what you choose is entirely dependent on your business, there are a few rules of thumb:
- Your metric should scale with value. The more a customer uses whatever metric you’ve chosen, the more value they should be getting. For an email-sending service, for example, more emails sent means more value to the customer—so it makes sense to bill on this metric. But it wouldn’t make sense to bill on something arbitrary, like “number of seats”.
- Your metric should be easy to communicate. Consider your audience. What will they understand? If you’re marketing to developers, billing on API calls could make sense—but not if you’re marketing to social media managers. Get creative and come up with something your audience understands.
- Your metric should roughly correlate with the cost to your company. It’s perfectly OK (though rare) if your cost structure stays flat with increased usage. It’s also OK if your cost structure is linear, or something close to it, as usage increases. But if cost increases exponentially with usage, you should probably pick a different metric. You’ll lose money otherwise.
What can you bill on that fits these three categories? What scales with value, is easy to communicate, and aligns with your cost structure? It may be immediately obvious, or it may not.
Sometimes, you may have to create your own metric.
For example: Audible, the audiobook platform owned by Amazon, created their own metric—and succeeded. With Audible, you pay a flat fee each month for a “credit”, with which you can redeem a single book. It’s a smart way to do usage-based pricing while locking users into a traditional subscription structure.
Of course, Audible “credits” aren’t actually real, and they’re not a common metric to bill on. They’re just something that Audible came up with to fulfill the three metric criteria listed above. Audible’s credits scale with value, they’re easy to communicate, and they roughly scale with cost. Think about how you can do something similar for your business.
2. Decide how much of your pricing model you want to change
Making the shift to usage-based pricing is a serious decision. But you don’t have to do it all at once. Madeleine Steine, former Director of Pricing at Hubspot, gave us some sage advice about planning for UBP.
You can ease into UBP, Madeleine says. Before you start implementation, have conversations with three groups of people:
- Your current customers: Ask them what they want & how they feel about pricing.
- Your prospective customers: Ask them for feedback on a UBP model & if it’d help them convert.
- Your sales staff: Ask them their thoughts on sales with a UBP model.
Then, decide how much of your business you want to shift to a UBP model. Remember, you don’t have to do everything all at once: At HubSpot, for example, Madeleine shifted parts of the business to a usage-based model while retaining the traditional model for core features.
Continuing with our example of an email-sending service, here’s what a hybrid pricing model could look like:
- Usage-based billing for emails sent: You charge customers based on how many emails they’re sending with your service each month.
- Traditional subscription pricing for core platform features: You charge customers a flat fee for access to the platform and your other core features (like email templates and design).
Depending on how complex your business is, and how many features you offer, you may be able to implement something like this. It’ll let you test out UBP without going all-in, all at once.
3. Evaluate how UBP will affect the other parts of your business
Shifting to UBP isn’t as easy as flipping a switch. Besides the technical implementation you’ll have to deal with (which is what Octane helps with), you’ll have to consider how it affects the other pieces of your business. Doug Cunningham, gave us some examples.
Doug’s got experience working at online job boards (and services). In a traditional model, you pay for a job and see what you get. It’s up to you to get good value for the money that you spent. Naturally, this can be difficult for customers that aren’t sure about the value up-front, and who may become frustrated if they pay for something and don’t get results.
No longer requiring payment at the top of the funnel increased acquisition dramatically. It also meant smaller contracts, at times, but less churn and quicker acquisition.
But, the shift in pricing model meant that the pressure to provide value was shifted from the customer to the company: In other words, if you’re paying for a certain amount of value, it’s up to the company to deliver that value.
As you plan to implement UBP, think about how it shifts the burden to provide value. This is another reminder of why it’s important to pick a metric that’s valuable to your customers—and that, the more they use, the more value they get.
Part II: How to successfully implement usage-based pricing
Got a plan? Great. Now it’s time to implement what you’ve been working on.
Here’s a list of considerations (which we’ll elaborate on further in just a minute)
- Technical issues: Your new billing model can be difficult to get used to. And, without something like Octane, it’s difficult to set up systems to run it effectively.
- Revenue collection: You’ll have to consider whether your UBP model means you’re shifting how you view and collect revenue.
- Changes in billing and sales roles: The functions of your billing and sales teams will change with UBP. It’s important to understand how to navigate this.
- Changes in acquisition and marketing: Because UBP is a totally new model for your business, you’ll also have to change how you think about acquisition and marketing.
Let’s break down each of these pieces.
1. Dealing with technical challenges
So you’ve figured out the metric you want to bill on. Great. But do you have a way to actually track and bill on that metric? Odds are, you’ll need to do some problem-solving to figure out how you’re going to be able to accurately capture your customers’ usage statistics, then bill on them.
To start, many companies (especially at the earlier stages) will experiment by manually tracking everything in an Expel spreadsheet. And while this can work to get started, it’s not typically a sustainable way to bill on usage long-term.
To bill on any metric—without all the technical challenges—try Octane. We help you get set up for usage-based pricing without putting huge burdens on your engineering team. We’re easy to integrate and built for scale.
2. Reworking how you collect and report revenue
Revenue collection changes when you implement usage-based pricing & billing.
Why? Well, in a traditional pricing model, it’s easy to bill quarterly or annually with flat-rate pricing. But when you’re billing on usage, it’s impossible to know exactly how much your customers will use—and while you can get pretty good at guessing, you don’t want to mislead your customers with false expectations.
Here are a few things to consider as you make the change:
- Is your company shifting how it collects revenue? Are you going to bill monthly or quarterly, instead of annually?
- How will you report and forecast revenue with your new model? If you’re billing monthly instead of annually, your long-term revenue isn’t as immediately clear (even if it ends up being higher as a result of shifting to UBP).
- How will you deal with overages? If your estimation of a customer’s usage is way off, how will you manage that?
These are all solvable questions, but the answers will vary by team—and will require some thinking.
3. Understanding changes in billing and sales roles
Your billing and sales teams will need to undergo some changes to make the shift to UBP a success. Your salespeople will need to relearn how they sell your company—since your pricing model is completely different and comes with different sets of objections. And, UBP typically requires a strong set of analysts in-house to make sure you’re billing accurately.
Your team’s responsibilities aren’t going to change, but your team members will have to build different expertise over time. Adjusting to UBP is an iteration on the skillset that your team members already have.
Now, another shameless plug for Octane: we help you bypass much of the heavy lifting and in-house work. Our no-code portal lets you iterate your pricing, without involving your entire engineering team.
4. Adjusting your acquisition strategy
It’s only natural that the way you market your product will change as you adjust the way you charge for it. When you switch to UBP, there will be angles and value props now-available that you didn’t have access to previously. You can get creative with messaging in ways you couldn’t have before.
With UBP, you can now tell customers that they “only pay for what they need”, and that they’re paying directly for the value they’re getting. These are angles that are unavailable to you if you’re using a traditional pricing model. Additional possibilities are near-endless—and depend entirely on your business and who you’re marketing to.
Part III: How to navigate UBP in a downturn
Debate the term “recession” all you want, but one thing’s for sure: As of this writing, in 2023, lots of companies are slashing marketing budgets and headcount. Businesses are more reluctant to spend on anything. This makes them harder to market to, but also gives a significant advantage to businesses with UBP models.
Because UBP is closely-tied to value delivered, it’s often more attractive to businesses when budgets are tight. It’s something you can leverage in your marketing—something that gives you an edge over businesses with traditional pricing models.
What about your own business? Will UBP help you make more money?
In many cases, yes. Using a UBP model can shine a light on your margins. And you’ll usually know exactly how much usage is costing you vs. how much you’re charging for it. This is why it’s important to bill on a metric that has a relationship with your cost. If you choose something that’s totally decoupled with cost, you could see problems at scale.
Recap: What every business needs to know about usage-based pricing
Usage-based pricing can have serious positive effects on your acquisition, monetization, and retention. In this mini-playbook, you learned:
- Consider 3 things before implementing UBP. You should decide which metric to bill on, figure out how much of your business you want to shift to UBP, and think about how it’ll affect the other parts of your business.
- Be thoughtful about how you implement UBP. Consider how you’ll implement it on the technical side, how UBP affects revenue collection and report, how UBP affects the roles of your sales & billing teams, and how you’ll adjust your marketing to reflect your new offer.
- Use UBP to your advantage in a downturn. With businesses more cost-conscious than ever, position UBP as an efficient pricing model that lets businesses get exactly what they pay for.
There it is: Your crash-course on usage-based pricing. If any of that sounded interesting to you, think about trying Octane…
Octane lets you bill on any metric. Without the hassle of building expensive, in-house teams.
Get Octane and start billing on any metric for your SaaS business. It’s the smarter way to do UBP, and saves you hours (and lots of money). The first step to getting set up is to book a short demo, where we’ll walk you through our model and talk through how you could implement UBP.