What is Usage-Based Pricing (UBP)? How is it different from a traditional subscription model? Are we still talking about SaaS (software-as-as-service)? Before we dive into the nitty-gritty, let’s make sure we’re all aligned on some of the key terms.
Traditional subscription in SaaS is a form of fixed, recurring payment structure. This type of model is usually tied to the number of users and is not directly correlated with the actual usage of each of those users. It can include a single tier or multiple tiers, which are based on features set, scale, commitment duration or other factors.
UBP in SaaS, as its name suggests, is a type of pricing structure that is tied to actual usage. It’s a variable payment structure tied to the level of consumption and is usually agnostic to the number of users. UBP can be in pure form as a linear function of usage, or as a tiered step function where the different tiers are tied to different usage levels.
Think about the difference between your gym membership where you pay irrespective of how much you actually go (traditional subscription), and your electricity bill where you pay based exactly on how much electricity you consumed (UBP). For the tiered version of UBP, think arcade tokens: If you bought enough for 5 games, you’d pay a certain amount per token, but if you bought enough for 20 games, you’d probably pay a lower price per token.
Before we move on, it’s important to note that both subscription and UBP are different pricing structures that can be implemented in a SaaS business model. The business model should be decoupled from the pricing mechanism that is used to price it. SaaS is a form of delivering or distributing the application or software layer as a service rather than in a one-time installation. As we’ll show in this series, different pricing schemes can be used with a SaaS business model.
Why should you care about UBP?
The Oracle from Omaha, Warren Buffet, is famously credited for saying “Price is what you pay; Value is what you get”. It’s time for this narrative to be shattered – at least in cloud-based services and applications.
Over the past few years, companies deploying UBP schemes – aligning the value customers get with the price they pay – have increasingly outperformed the general SaaS public indices. The world is changing, and investors, founders and users alike are all embracing new UBP models that have come to replace the dominant go-to-pricing strategy – traditional subscription.
As we can see in the graph, usage-based companies outperform general SaaS public indices in EV/Revenue multiples.
Several overarching trends drive UBP’s outperformance. This is not a trivial statement and it requires some explanation. We believe there are three major trends pushing this pricing model forward: (1) Advances in cloud technologies are making hyper scaling more feasible and achievable. (2) In tandem, cheaper equity, which is flooding the market, is shifting investors’ focus from efficiency metrics, such as CAC ratio, to growth metrics, like LTV or YoY revenue growth. (3) Fueling these trends is the proliferation of enterprise applications of the past decade. Combined with a very low cost to the software vendor, this proliferation is democratizing adoption processes and allowing for grassroots decision-making. This shift has lowered the decision-making individual level from C-suite level for on-prem solutions (as seen in the 1980s-90s),to business unit managers for subscription SaaS (2000s-2010s), to individual contributors for usage-based solutions (mostly seen in the past 5 years). These three trends together have made growth the new king.
UBP in cloud services is unique not because it’s new, but because of its potential. It has the potential to unlock exponential growth for digital services, far beyond what traditional subscription-based schemes can support.
A great example of unlocking the potential of UBP is by comparing two of the most successful enterprise companies in years – SnowFlake and MongoDB:
SnowFlake is deploying usage-based pricing for DBaaS (database-as-a-service) offerings and is seeing exponential growth. MongoDB, on the other hand, is seeing much slower growth as the majority of its business is driven by traditional subscription. Even for MongoDB, the majority of its growth in recent quarters is tied to the Atlas service, which unlike MongoDB’s traditional offering, has UBP.
Now that we’ve discussed what exactly UBP is and hopefully triggered your interest, part 2 of this series will dive deeper into some key terminology and the history of UBP.
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