Pricing is evolving at a rapid pace. SaaS trends like automation, AI, and developer applications (i.e. APIs) have led to a break in the value chain leading to permutations beyond traditional subscription pricing models. With increased automation, many businesses and their customers are finding per-seat pricing redundant since AI applications are less likely to be tied to human users, and in some cases, it isn’t even humans, rather one set of APIs using another – that creates value.
Pricing is always transforming to fit the market, and in 2023, customers want to ensure they are receiving tightly coupled value for their money. Because of this, the SaaS market is increasingly shifting toward pricing based on consumption and value metrics.
But it isn’t one or the other. Rather than existing in opposition, subscriptions and usage-based pricing should actually coexist to create a hybrid model – one that gives SaaS businesses the best of both worlds.
Usage-based pricing: A refresher
Usage-based pricing (UBP) is a flexible pricing model based on a customer’s consumption of products and services within a billing cycle. It differs from other pricing models – like subscriptions – in that it creates a direct link between a customer’s usage of the product (and value gained) and the price they pay in arrears of that usage, rather than paying for expected need up front (i.e. capacity). Benefits of UBP include:
- Easier adoption – Customers can get up and running quickly without fearing they will incorrectly estimate their capacity needs.
- Customer satisfaction – Customers can easily scale their usage up or down as needed. If the right value metric is chosen, they will only see higher costs when their own business is succeeding as well.
- Costless upsell – Revenues can grow without any effort or intervention from Sales, making go-to-market functions more efficient and profitable.
- Margin control – For SaaS companies whose costs are significantly driven by customer usage, like third-party APIs or cloud infrastructure, choosing the right value metric links revenues and costs more tightly with usage and delivers more consistent unit economics.
UBP – in all its forms – is becoming more widespread among software companies, with 61% of SaaS companies offering some form of UBP in 2022 versus 45% in 2021. An internal Chargebee survey also found that 74% of SaaS companies will likely offer more products using UBP in 2023.
Subscription + UBP = Hybrid Pricing
First, some pricing history. At the height of the dot-com bubble, Salesforce – a relative newcomer at the time – declared the “end of software”, and with it promised a cheaper and easier alternative: the ability to access cloud-based software for a monthly subscription fee, or Software-as-a-Service (SaaS).
The subsequent rise of SaaS during the 2008 recession moved the business world from largely buying and owning on-premise software to multi-tenancy rentals. Subscription was the main form of pricing for SaaS and is still thought of as the default to this day.
But now, we’re seeing a new age of pricing. SaaS pricing strategies are changing because both businesses and customers want to see a tighter link between value and spend, but also want predictability around what’s going to happen in each billing cycle.
Why can’t you get this from pure subscription models? The strength and weakness of fixed subscriptions are that they are arbitrage models, relying on the light and medium users to make up for the heavy users (who receive more value than what they are paying for). This typically works great in B2C, but has severe limitations in B2B.
Now, back to UBP. This year, the conversation has turned to talking about the spectrum of consumption-based models, going from no UBP to pure UBP. According to OpenView, the middle of the spectrum is the most popular, as SaaS companies turn to more complex, hybrid models.
From OpenView’s second edition of The State of Usage-Based Pricing
Combining subscription and UBP into a hybrid pricing model gives SaaS companies the best of both worlds:
|1. Predictable – Customers know what they are getting and can plan accordingly, reducing the fear of uncontrolled and unexpectedly high bills. Sellers also get more predictable recurring revenue.
2. Recognizable – A commonly used pricing model that isn’t overly complex or confusing.
3. Repeatable – Customers know what their subscription gets them month-to-month.
|1. Tie value to price – Bain & Company found that 80% of customers reported consumption pricing gave them better alignment with the value they receive.
2. Growth and innovation – UBP enables exponential growth for heavy users and encourages more rapid innovation with better usage data.
3. Creative pricing & packaging – Extending subscriptions with UBP gives space to better fine-tune your offering to customers
The thought of paying for usage may scare some customers, as they are looking for the benefits of subscriptions listed above. But pricing and billing controls can protect both customer and merchant and keep bills within bounds while preventing or smoothing over any spikes. These can include commitments, prepayments, minimums, and even the rollover of allowances. Adding notifications or alerts for when these are being approached, or when usage surges or drops, keeps customers protected and provides a reason for your sales team to reach out.
Hybrid pricing example: Matomo
Joining the new age of (hybrid) pricing in 2023
Before any SaaS founder reading this starts panicking about redoing their pricing from scratch, a little reassurance: hybrid pricing is about improving and growing subscription models. You don’t have to throw everything up in the air and start over; rather, you can build on existing, successful forms of pricing and add usage elements to capture more value and right-size your offering to each of your market segments.
Why is 2023 the right time to experiment with hybrid pricing? First, because blunt subscription models are leaving money on the table from heavy users whilst scaring off lighter users at a time when most SaaS companies can’t afford to waste cash. Heavy users are taking advantage of your offering by not paying a price that matches the value they get from your product. Light users are making hard choices about canceling tools they are not getting full value from. Hybrid pricing enables you to extract a bit more revenue from successful existing customers, like heavy or pro users, whilst also creating something that light or occasional users are happy with.
Retention is another reason the time is right. As an indicator of both the growth and stability of the revenue stream, Net Revenue Retention (NRR) is the most important metric for SaaS companies. It’s also a major concern in the current economic climate, as more than half of SaaS businesses had lower retention in 2022 compared to 2021. In a year of slow customer acquisition, a hybrid model that links value to usage better can positively impact retention.
Even though new customer acquisition is slower this year across the board, adding usage elements can help companies win more new customers than subscriptions alone. With hybrid, customers grow with a product over time without committing to heavy minimums or fees, making it less daunting to adopt your product for the first time.
Best practices for deploying and managing hybrid pricing elements
For SaaS businesses ready to move toward hybrid pricing, the general flow will look something like this:
- Refine your existing model and overlay UBP on top of subscriptions.
- Seamlessly move customers through subscription tiers with usage tracking and overages (value metric).
- Capture and enforce the cost of usage outside allowances.
Choosing the right value metric to layer on top of subscription tiers is a key exercise and can have varying levels of complexity. Our partners at Chargebee developed the following chart:
Adding usage-based elements to your pricing is a big deal on its own, but it’s a whole other challenge to ensure you actually have a way to capture and bill for those elements, monitor usage patterns, and avoid revenue leakage. Deploying and managing a hybrid pricing strategy is made easier when pairing Chargebee’s revenue growth management platform with m3ter’s pricing operations platform.
The m3ter integration for Chargebee enables users with a new or existing Chargebee service to quickly set up and implement highly configurable UBP models, with all the benefits of usage-based elements. The integration is seamless: all you have to do is ingest usage data into m3ter, then bill through your Chargebee service. That data can also be utilized within m3ter for our analytics tools and to support other use cases, including Finance & Ops, Product, Engineering, and Sales & Customer Success.
While Chargebee enables your customers to natively upgrade/downgrade their subscriptions plans, and helps you gain more control over plan-level data (including renewals, expiries, and more), the integration with m3ter ensures that you avoid sticker shocks with your customers with accurate invoices every time.
If a hybrid pricing strategy is the next step for your SaaS business, you’ll have to solve the underlying data problem and connect it out to your stack. By connecting m3ter with Chargebee for you, we made it available out of the box – just bring your CRM.
Wondering if a hybrid pricing strategy is right for you? Join Chargebee and m3ter in a live webcast where we break down:
- The challenges and benefits of hybrid pricing models
- Strategies to mitigate the risks associated with pricing changes
- Best practices for implementing usage-based pricing
- Examples of companies who have successfully implemented hybrid pricing