As can be seen through the comparison between SnowFlake and MongoDB that we shared in our first post of this series – both very successful cloud native databases – subscription and UBP lead to very different growth trajectories. With set recurring payments or subscription fees, growth is somewhat linear with relatively low variance. The key differentiators for companies deploying this model on unit economic, cohort and enterprise level, are CAC ratio or the “magic number”, gross churn and ARR growth, respectively.
For usage-based companies on the other hand, growth is exponential with high variance. Key differentiators for success on unit economic, cohort and enterprise level are lifetime value, net dollar retention, and YoY revenue growth (to account for seasonality), respectively.
Exponential growth for UBP models is the product of several benefits across the different parties involved.
For customers, UBP offers several benefits:
(1) Aligns value and price – the more the customer uses the product, the more value they extract, the more they feel comfortable paying higher prices. And vice versa.
(2) Provides accessibility and affordability – because customers can start at a low usage level, their initial price is low, making this pricing structure, at least in lower usage levels, more accessible and more affordable.
(3) Allows a larger distribution – as the scheme is agnostic to the number of users, more users can use the service without affecting costs.
(4) Supports agility and flexibility – because customers have the option of changing their usage and costs based on their periodic needs, this structure allows for higher levels of flexibility.
From the Independent Software Vendor’s side, benefits mirror that of customers:
(1) Provides uncapped upside potential – because value and price are aligned on the customer side, there is uncapped upside potential on the vendor’s side – as long as value to customers continues to rise.
(2) Expands TAM – accessibility and affordability on the customer side lead to a larger addressable market. Smaller or more price-sensitive customers can now afford to use the product or service, even to a low extent.
(3) Makes adoption easier – having a larger distribution and being agnostic to the number of users, allow for easier and quicker adoption. Friction of adding additional users in the organization is very low and this, in turn, increases usage.
(4) Reduces gross churn and provides ability to reaccelerate growth – agility and flexibility on the customer side lead to lower gross churn on the vendor’s side and provide an ability to reaccelerate growth, an obstacle many subscription-based companies find very challenging to surpass.
As we’ll touch on later in this series, the benefits of UBP to software vendors, the first of which is uncapped upside, have fundamental implications on companies’ sales strategy. It shifts the focus from not only acquiring new customers to also expansion and growth within an existing customer base.
The benefits, however, are accompanied with some key challenges both for customers and vendors alike:
(1) Low predictability – as there is sometimes no commitment to a level of use or when the commitment is non-binding, Independent Software Vendors can find it hard to predict customers’ usage. This is especially true for new customers. On the other side, customers themselves face low predictability. As the customer’s usage of services or products is tied to their end user or business operations, it’s not always easy for them to predict usage and accompanying costs.
(2) High complexity – the challenges in predictability, or the nature of charging based on usage metrics, lead to complexities on both sides. For customers, it’s sometimes hard to understand and track invoices. For Independent Software Vendors, managing billing operations is far from easy.
When to deploy UBP, and when not to deploy
Like all good things with strong benefits and substantial challenges, UBP is not suited for every cloud-based product or service.
Based on our experience, UBP should be deployed in the following circumstances: First, when a traditional subscription scheme creates a disconnect between the value customers derive and the price they pay, leading to the Vendor leaving money on the table and the customer either overpaying or underpaying. Another type of supporting environment is when product adoption is slow. If customers can start small without a commitment and build up to higher usage by realizing the benefits of the product – UBP makes sense. UBP is also beneficial when customers enjoy flexibility – for example, if they value adjusting their usage (and thus costs) to changing elements such as seasonality.
Conversely, there are clear situations when to avoid UBP. When it’s a challenge to attribute the product’s usage to the value derived, using UBP will only lead to price haggling from the customers’ side. When predictability is important to both customers and enterprise, and when usage is highly variable, both sides will find it challenging to adopt. In addition, when customers value simplicity in billing or might try to minimize usage when possible (the “taxi-meter” effect), UBP will not work well enough.
Our experience shows that UBP is highly successful in specific circumstances. The common denominator is clear value attribution. Meaning that the service or product provided is clearly attributed to the value generated to the customers.
Three main categories emerge: transaction-based products such as Stripe, results- or output-driven products such as Attentive, and resources- or capacity-driven products such as SnowFlake. All these examples have 3 common elements that support attribution: there is a direct causal link between service or product to value, said service or product delivers significant impact on value generated to the customer, and there is limited existence of other contributing factors to the value generated to customers.
As we’ve shown in our previous post, when done right, UBP outperforms general SaaS indices of public companies in EV/Revenue multiples and in YoY revenue growth. Viola’s proprietary data shows similar characteristics in our portfolio companies.
Early on in companies’ life cycle, when growing from $1M to $30M of annual revenue, usage-based companies have an average of 150% YoY revenue growth compared to 85% YoY revenue growth for traditional SaaS subscription. In other words, UBP contributes to ~2x higher growth rate.
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