How to Implement Usage-Based Pricing for Your SaaS Business

Apr 27, 2021

Usage-based pricing can be very profitable for a SaaS organization when executed well. If implemented incorrectly, usage-based pricing can turn into an expensive administrative nightmare.

The business leaders we speak to have been asking about why usage-based pricing is so popular amongst SaaS organizations and whether it will work for them. We have assembled this guide to help them and you avoid the risk of a poorly executed changeover to UBP backfiring and damaging profits and brand image.

Why adopt a usage-based pricing model?

According to KeyBanc Capital Markets Inc., UBP is the second-most prevalent pricing model used by enterprise technology companies. It's rapidly become the default go-to-market SaaS pricing model, as usage-based pricing pairs particularly well with a product-led growth model.

29% of companies lack the software support needed for usage-based pricing.

Source: Forrester (2018)‍

Despite the widespread adoption of UBP, don’t underestimate the risks involved in making the change. Implementing usage-based pricing is not a matter of simply changing the price. It is a significant organizational shift that requires operations, compensation, and account management to be modified or re-designed.

Clean and Organize Your Data

UBP requires you to collect usage data. That can be complex because enterprises might not have their “data ducks in a row.” Only 48% of organizational decisions are based on quantitative information and analysis.

According to a Forrester survey, 29% of companies lack the software support needed for UBP. The common struggle is that sales and consumption data come from different sources that aren't aligned internally.

Developing an effective strategy to collect accurate, up-to-date, and real-time usage data from your clients is critical for implementing usage-based pricing.

Gogo Aviation (in-flight internet) has to collect data from multiple devices, planes, towers, and countries to calculate usage and bills. Amazon and Snowflake use proprietary artificial intelligence to automate sales compensation administration and accrual forecasting.

Accurate usage data is also crucial for calculating sales compensation. An error rate of 1% in sales compensation calculations could affect the salary of 10% of sales representatives.

Establish Your Value Metric

To implement usage-based pricing, you need to define which usage metric of your SaaS you will use to bill your client. An ideal usage metric will be:

1. Value-based

Use a metric that is based on the value clients derive from your product. For example, Stripe allows businesses (including Amazon, Shopify, Zoom, Slack, and Salesforce) to make and receive payments for a 2.9% transaction fee.

2. Flexibility

Clients should be able to pay for their exact scope of usage. Allow them to start with a small commitment that can be upgraded later. For example, customers can use different products offered by Amazon Web Services without paying the full price of every product consumed. They simply pay a fee based on the products they use.

3. Scalability

The correct usage metric will show a steady increase in usage over time. If use is shown to be stagnating, but the customer is still deriving value, consider using a different value metric.

4. Predictability

Your clients should be able to forecast their usage and budget within reason. Some customers will opt to purchase 'blocks' of usage credit in advance for the added predictability and assurance.

5. Feasibility

You should be able to monitor, track, and even credit usage across your customer's organization. If overages occur — intentional or not — alerts and overrides will help preserve the customer relationship.

Types of UBP

There are four types of UBP your business can implement.

1. Per-Unit Pricing Model

A fixed approach where every unit consumed costs the same. Consider a pay-as-you-go phone plan where every GB costs $25, no matter the volume.

2. Overage Pricing Model

You charge extra if clients exceed the usage allowance of their plan. For example, a cloud-storage customer may agree to capped usage of 500GB / month and pay $5 for every GB over.

3. Volume-Based Pricing Model

The amount you charge per unit may vary based on the number of units consumed. For example, you are charged $.1 per call if you make 1,000 API calls, and you are charged $.05 per call if you make more than 1,000 API calls.

4. Tiered Pricing Model

Similar to volume-based, but only additional usage will vary in price. For example, you are charged $.023 per GB for the first 50 TBs of storage. Once you consume 50TBs, you are charged $.022 per GB for the next 50 TBs.

Outline and Determine Value of Customer Journeys

UBP reduces the initial purchase commitment and helps to attract new clients. Ideally, you want usage and client’s business to increase together with time. However, not every client will become highly profitable.

Portfolio Theory suggests that we manage clients in a portfolio, to mitigate the variability. Most clients will only be small or medium-sized users, but a few clients might become highly profitable. According to the 70/10 rule, your top 10% of clients will account for 70% of usage.

Twilio, a cloud-based communication platform used by businesses (including Airbnb, Lyft, and Netflix), has more than 200,000 active clients. Seven of their clients spend more than $10M per year, and 142 clients pay more than $1M per year. The long tail can be profitable, but your sales performance incentives should help the team to identify and nurture customers that could into large accounts.

Reorganize and Retrain Your Sales Team

Through a free version, your client may interact with your product before they interact with your sales team. To increase adoption and conversion, create a good user experience and provide excellent customer service, even for free users.

Defining a Product Quality Lead (PQL) for your business will help your sales team identify opportunities. For Slack, a client that has sent 2,000 slack messages is a PQL. Identify PQLs and share them with the sales team.

The initial purchase might be small for a usage-based product, and usage might increase gradually over time. Compensating your sales team based on the initial commitment might give the wrong incentive. Such an incentive might encourage your sales team to over-sell or secure a big initial commitment.

A client who has been overcharged or oversold can be dissatisfied. Address these challenges by providing sales representatives a tail period of 4-12 months to earn commissions after the initial commitment ends.

Lastly, reward clients for accepting your UBP.

Twilio offers a discount(s) when clients commit to UBP for long periods. Amazon Web Services allows clients to commit in advance without paying in advance. Snowflake, a data analytics solution, allows clients to carry their unused usage credits if they commit to equal or greater usage in the next year.

Upgrade Your Sales Administration and Processes

Billing in a usage-based model can be complex. Once you have collected usage data, you need to set a rate and calculate the bill in an integrated process.

For example, billing Verizon’s Shared Data Plan consists of a monthly recurring fee, usage-based fees, and overage fee. Verizon’s billing system needs to measure usage data and calculate the correct price for millions of customers.

On top of added complexities, the switch to UBP may increase your client’s bill. You can help them reduce uncertainty and prepare for overages:

Alert clients when they are about to reach their usage limit.
Allow clients to monitor usage in real-time.
Give a grace period and encourage consumers to upgrade to a better plan to avoid overages.

Ironically, your most significant obstacle won't be how you charge for your service but rather how you compensate your teams.

Sales compensation constitutes 10%–50% of an organization’s expenditure, and overcompensation costs businesses 3%–5% of their annual compensation expenditure. More than 60% of companies rank themselves as average or below-average at sales compensation administration. And 60% of organizations do not track payment accuracy.

"Without usage-based pricing, you limit customers and your growth"
Tien Tzuo, CEO of Zuora

Flawed implementation of UBP can amplify these risks and nullify any benefits UBP has to offer. Make sure your sales compensation solution is up to the task.

Implementing Usage-Based Pricing for SaaS is a Major Change

Implementing usage-based pricing is a challenging and risky endeavor. Flawed execution can negatively affect profitability, customer relationships, sales performance, and employee satisfaction.

Poor sales operations planning or delivery can cost SaaS organizations opportunities that equivalent to 10% of their revenue. However, a usage-based pricing strategy can be highly beneficial if implemented successfully.

According to a Forrester survey, 68% of the companies which implemented UBP are satisfied with the implementation. 60% of the companies which implemented UBP generate higher recurring revenue.

Before incorporating usage-based pricing for your SaaS, research whether it's suitable for your customer profile and business operations. If you can prepare your sales operations data and automate sales compensation admin, you can unlock long-term cumulative growth.