A SaaS revenue model describes the framework for how a software provider will generate income. Pricing and billing for your products within this model is a simple concept: It’s what customers are willing to pay for a product or service.
However, determining the right pricing structure for your SaaS solution may not feel quite as straightforward. Pricing represents one of the most crucial business and profitability decisions you will make within your revenue model. A well-priced solution attracts customers and gains market share, while a poorly priced solution leaves money on the table (priced too low) or drives business to competitors (too high). That’s a lot of pressure to put on selecting a pricing structure.
From a customer perspective, pricing boils down to two things: value and alternatives. Customers must believe that your pricing aligns with the perceived value you aim to deliver, and that value must be stronger than what your competitors are offering—and more attractive than maintaining the status quo.
Packaging structures and price points are two pricing mechanisms you can use to communicate value, position your solution in the market, and build a competitive advantage to acquire and retain customers. Packaging structures determine how your customers consume and pay for the solution, and price points establish how much they pay for different options.
Of course, costs and expenditures also play a role in pricing. As a SaaS provider, your pricing model must take into account an intrinsic part of your offering: the cloud and data architecture that powers your SaaS solution. If you don’t align the way customers pay to consume your application with the underlying costs associated with delivering your application, chances are high that you will launch an unsustainable endeavor.
Whether you’re a startup SaaS company or a well-funded enterprise adding SaaS offerings to the mix, one thing is certain: Pricing will impact your revenue and business models and play an outsized role in your chance for success. That’s why SaaS providers must make pricing and packaging decisions with their cloud and data architecture in mind.
Provider Beware: Subscription Pricing May Bleed You Dry
Over the last decade, SaaS providers have relied on various forms of subscription pricing. For example, a set of features may be offered at a fixed, flat-rate price for a specific period (month, year, multiyear), or a tiered subscription model may be used with different levels of features at various price points.
Today, the most commonly used subscription model offers a product or service on a per-seat, or per-license, basis for a set period. When the purchase is made, the customer estimates upfront how many seats or licenses will be needed, often without knowing how (or if) the solution will be adopted and used by its employees.
Standard subscription models are popular because they represent a fairly uncomplicated transaction. Customers are able to budget for the purchase in advance, and providers can forecast sales with relative precision. Nonetheless, standard subscription models are often not the best choice for SaaS providers for one simple reason: They lack alignment.
- Customers want stronger alignment between usage and cost. Today’s customers don’t want to waste money on seats that may go unused, nor do they want to spend money in advance without any guarantee they’ll get the full value out of the solution.
- SaaS providers require better alignment between costs and revenue. Many SaaS providers are discovering a significant financial gap between the fixed recurring price they charge customers and the variable costs they pay to cloud and data platform vendors to support customers.
This second assertion points to the fact that modern SaaS solutions are powered by cloud and data architectures, and those vendors charge customers using a usage-based, consumption model. That means SaaS providers pay for exactly the amount of cloud and data services their customers and employees consume, which is a variable infrastructure cost.
Warning bells may be going off in your head right now, and for good reason. It’s not hard to imagine a situation where a SaaS provider receives payment for a year-long subscription and then discovers that the customer has chewed through a heavy amount of cloud and data services after six months. The faster the customer adoption, the quicker the SaaS provider’s margin compresses. That customer is now costing the company money every month because the subscription price was lower than the customer’s actual usage of the cloud and data resources driving the solution.
And it’s too late to ask the customer for more money. That’s not how subscriptions work.
Remarkably, this scenario demonstrates how the type of customer SaaS providers dream about—engaged, active users—can become an Achilles heel with the ability to cripple a company financially, especially startups with limited cash and short runways.
Four Reasons Consumption Pricing Is the Better Choice for SaaS Solutions
The best way to align usage and value is to put the same pricing model in place from bottom to top. If SaaS providers pay for consumption with cloud and data platform providers, they should offer some form of usage-based consumption pricing to customers. Whether customers are heavy or light users of the SaaS solution, they will always be charged appropriately with usage-based pricing. It’s the only way to ensure usage and cost parity—and protect your margin.
Building and delivering a SaaS solution requires you to put your best foot forward. Pricing cannot be an afterthought. Instead, it should drive conversations about customers, go-to-market (GTM) strategies, and costs. There are four major reasons why the consumption model is the best approach for pricing SaaS solutions.
1. Aligns intrinsically to the value you provide customers
Customers have many options when it comes to SaaS offerings, which is why they are looking to adopt solutions that provide real value for the money. With consumption pricing, it’s easy to communicate that value to customers with three simple statements:
- You don’t pay for what you don’t use.
- You pay more only when you derive value and use more.
- There is no waste.
The consumption model demonstrates a commitment to your customer by aligning their usage with your company’s financial success. You suddenly become a partner, not a vendor. You succeed only if they consume the solution. Gone are the days of debating shelfware or the need to pay for features that aren’t needed. If customers don’t want to use it, they don’t pay for it. It’s that simple.
Pro tip: Align sales compensation with customer consumption. When salespeople are compensated for landing the deal and for how much the customer uses the solution, it’s in their best interests to engage more deeply with customers and help them accelerate adoption by discovering new use cases, even after the sale is finalized. Remember: You derive no revenue until your customer uses the product.
2. Accelerates your GTM strategy
The beautiful thing about consumption pricing is that it’s easy to gain market share by attracting customers—without requiring a commitment. The “land and expand” concept is baked into the consumption pricing model. Prospective customers simply try out your SaaS solution and see the value for themselves, without sizing a contract or taking any upfront risk.
There are two ways you can onboard new users. “Pay for what you use” means customers can experiment and try the solution for a very low cost, or you can offer free trials by granting complimentary usage credits. This capability to offer usage credits also saves you from creating complicated pricing and packaging models for “trial” or “freemium” subscription tiers.
In a similar manner, consumption pricing simplifies operations for your team by eliminating complicated subscription and user pricing models, based on user types or roles. Usage-based pricing is more elegant and easy to understand because consumption is consumption, no matter who uses it. With these pricing hurdles removed, it’s easier to go to market with speed.
Pro tip: Spend the requisite time upfront to determine a simple and measurable usage-based metric that captures value. This will become the essence of your business model and will help you scale faster.
3. Matches up better to your costs as a SaaS provider
When your GTM strategy aligns with your underlying cloud and data platforms, your infrastructure vendors are no longer thought of as the cost of goods sold (COGS) but rather as an enabler of new or enhanced revenue and margins.
All major cloud service providers use consumption pricing, as do modern data platforms. By adopting usage-based pricing for your customers, underlying costs are passed along in sync with customer usage. There’s no chance of misalignment between cloud and data vendor costs and what your customers pay for the solution.
Usage pricing also makes it easier to deliver value to customers while growing revenue and expanding margins. In fact, companies that adopt usage-based pricing have been shown to have a 38% faster revenue growth rate than those that don’t use a consumption model.
Pro tip: Your usage-based value metric does not need to be a 1:1 pass-through of your cloud provider’s usage charges. Rather, be thoughtful in developing the correlation between your usage-metric and your provider’s and price your solution accordingly.
4. Compels you to understand customers better, now and in the future
One downside to usage-based pricing is that it’s harder for customers to predict expenditures and for SaaS providers to predict revenue. However, data comes to the rescue.
By metering usage with individual customers and measuring consumption trends across different company sizes, use cases, industries, and types of customers, SaaS providers can run data analyses to understand customer behavior in real time. While these insights might be considered “nice to have” for SaaS companies that operate traditional user-based subscription models, they are a must-have for companies with consumption pricing.
Regular analysis enables you to forecast usage and share trends with customers to help them budget properly. Data-driven customer insights also enable you to share usage trends with new customers who are of a similar size or in the same industry as other customers. Over time, with more and more data, analysis can address some of the uncertainty in consumption pricing models by delivering regular usage insights to customers.
Data-driven customer insights also help determine what future enhancements to build into your solution. Your roadmap can be driven by actual customer usage, which optimizes profitability and drives higher customer satisfaction.
The Future Is Consumption Pricing
One of the positive consequences of a global pandemic has been the accelerated adoption of consumption-based, data-driven, cloud solutions to solve complex problems. For the foreseeable future, cloud and data platforms will provide the infrastructure on which SaaS solutions are built. Not only does consumption-based pricing enable SaaS companies to maximize and leverage these investments in cloud and data, but it also ensures their business model scales with simplicity and agility.
At the same time, adopting a consumption-based pricing model accelerates and simplifies delivery of your solution, which results in a powerful GTM strategy with higher revenue retention rates. And data takes on new meaning when you provide customer and usage insights, which helps you future-proof your SaaS application.
Best of all, consumption-based pricing is what customers want. They are ready to align what they pay with what they use. Isn’t it time to deliver that value?
This blog is the first in a series of three blogs on pricing models. The next blog will discuss best practices and strategies for pricing your SaaS solution.