Why Changing to Usage-Based Pricing Could Destroy Your SaaS

It may seem like usage-based pricing is a ticket to greater profitability, but that's not guaranteed at all. Without the proper attention to reorganizing roles, processes, and compensation, usage-based pricing could turn into a costly disaster.

What's the danger of usage-based pricing?

HubSpot, Snowflake, and Slack have all examples of SaaS companies that have embraced usage-based pricing (UBP). In a recent survey, 72% of SaaS businesses that are not using UBP today plan to do so in the next two years. It's tempting to follow in their footsteps.

Implementing usage-based pricing is not a simple price change. It's a significant company-wide change that requires re-organization of sales, billing, demand-planning, and account management processes. 

Making the switch to UBP too quickly, or doing so without considering the broader implications could spell disaster for your company. 

Can Your SaaS Align Usage to Value? 

Usage-based pricing could be right for your SaaS if you can align more usage to more value for your customer. To determine usage-to-value fit, first determine the right usage metric to measure and monetize. 

Stripe charges a 2.9% fee on every transaction. In this case, their usage metric is the volume and value of transactions. UBP is a great fit for Stripe because every transaction corresponds to more revenue generated for their customers. 

36% of businesses consider “unpredictable revenue” a challenge of implementing usage-based pricing. 

Source: Forrester (2018)

When InfluxDB Cloud was looking for a usage metric, they considered query duration. The problem with query duration was that it was difficult for end-users to estimate, which would indirectly discourage product usage. Despite being more aligned to value creation, InfluxDB moved away from query duration in favor of query count — an easier metric to forecast.

InfluxDB's VP of Cloud, Brian Mullen, explained, “[Developers] would be hard-pressed to guess query duration on infrastructure they can't even see. So we decided to charge by query count, which is knowable by the customer."

Usage-Based Pricing Isn’t Always More Profitable 

Hired, an online marketplace that helps businesses find technology and sales employees, learned the hard way. When they introduced a UBP model, they found that clients shared fewer positions on their platform and began to turn to alternatives.

By incorporating UBP, Hired had unintentionally taken away what customers found valuable about their service — unlimited usage. Since then, Hired has stepped away from pure UBP in favor of a hybrid pricing model. (link to internal blog) 

The new model incorporates elements of usage-based pricing on the low-end (to allow low-volume customers to use their product), and fixed subscription pricing with unlimited usage on the high-end. See for yourself on their pricing page to learn how they synthesized both pricing models. 

Another consideration—a fixed subscription might be more suitable to clients that are less technology-savvy and prefer a simple purchasing experience. 

Usage-Based Pricing Creates Uncertainty on Both Sides 

If you implement UBP, your customer's legal and procurement department might struggle to forecast their needs and consumption. The variability of UBP will create massive discrepancies in financial models established at the beginning of the year—since most enterprise planning functions are performed on an annual basis.  

“From a customer’s perspective, they want to have consistency for budgeting purposes,” said an industry professional.

“It’s a big concern for these larger companies when you go through legal and procurement and they have a really tough time wrapping their head around how much is the purchase… I have seen deals stall because they got stuck with procurement. They couldn’t procure a purchase for something when they didn’t know what the cost was.” 

Your clients won't be the only stakeholders confused by UBP.  

Your sales employees might struggle to understand their compensation. There are ten different types of sales compensation plans you could offer, and each plan might have a different formula to calculate sales compensation. This complexity combined with the unpredictability of usage-based revenue could affect the morale and retention of sales employees. 

Billing Challenges Are Inevitable 

Due to inefficient and time-consuming sales operations, many SaaS companies don’t have the time or flexibility to experiment with different pricing models and incentives. In fact, 29% of businesses lack the software-support needed for billing usage-based products. 

Most organizations would agree that it is important to have fast and flexible billing and sales compensation software to help customers understand how their bills are structured. 

“I still haven’t seen a great company on the finance ops side of things, to be honest,” said one industry professional. 

“Consumption-based billing is really tough. I’ve now been at three companies where billing is usually one of the biggest negatives in the model around the customer experience because it’s really hard to explain the bill to a customer." 

Billing disputes are inevitable — even if the data is clean and accurate. That’s why organizations should optimize for both dispute resolution time and billing accuracy. Both functions will build trust with your customers and smooth out internal processes. 

Compensation Uncertainty Will Be Amplified 

Your sales teams may resist usage-based pricing — especially because their commissions will be less predictable. 

To mitigate uncertainty, you may consider compensating your sales team based on initial commitment. Unfortunately, this tends to encourage the type of behavior UBP is meant to avoid. The sales team will over-sell or secure a big initial commitment, and your new customer will feel they’ve been over-charged. 

Instead, to inspire confidence in your sales team, you need to rethink your sales compensation plan and incorporate a tail period of 4-12 months that allows reps to earn commissions even after the initial commitment has ended. 

Avoid the pitfalls of usage-based pricing 

If UBP is suitable for your business, follow the techniques prescribed in this post, and reap the rewards. 

• Identify a usage metric that aligns usage and value, and is predictable by the end-user.
• Some customers value the simplicity of “unlimited” usage.  
• Legal and procurement teams may find UBP confusing or difficult to assess. Invest in a robust forecasting tool to assist in planning. 
• Billing inaccuracies can cause conflict and confusion. Try your best to keep usage data clean and accurate, and optimize for dispute resolution time. 
• Your sales team may resist UBP. Design a compensation plan that incorporates a tail period that allows them to reap increased usage over time. 

Implementing UBP is a risky and challenging endeavor, but for many SaaS companies, making the switch is worth the long-term benefits.