Many businesses I talk to, who are designing their pricing model for the very first time, are overwhelmed with all the aspects and choices of designing a pricing model. And almost always, one of the first questions asked is “should we do user based pricing, or usage based pricing?”
Similarly, when talking to established SaaS business who are re-evaluating their pricing model, the question is “do we stick with user based pricing, or should we move to usage based pricing?”
First, let’s define the difference between user and usage based pricing.
User based pricing, or per-user pricing, is just as it sounds. You pay $x/user/month. The more users you have using the product, the more you pay.
Usage based pricing, or consumption based pricing, is based upon actual usage of the product. For example, you pay $x/transaction or $x/SMS. The more you use, the more you pay.
So, back to the question, “should we do user based pricing, or usage based pricing?”
There are 2 things making this question top of mind at the moment.
1. User based pricing is most common, and the model people understand the most. It’s a legacy of license based software sales models pre-SaaS. It’s been around for a long time, and is most commonly combined with feature based tiering. It has its place, but its role is becoming more and more a secondary metric. Profitwell go so far to claim that Per user pricing kills your growth and sets you up for long term failure.
2. Usage based pricing is the latest pricing trend for growth in SaaS. New technology is enabling us to track more complex metrics than just Users, and for many SaaS products, Users are completely irrelevant to the product value (e.g. Stripe and Sendgrid), and so new pricing methods have surfaced and are becoming more common and more acceptable. Openview claim Companies With Usage-Based Pricing Grow 38% Faster.
So, back to the question, “should we do user based pricing, or usage based pricing?”
Actually, this is the wrong question.
Not all products are the same, and therefore not all pricing models should be the same. So the answer is not one or the other.
The right question to ask is "What pricing model delivers sustainable, accelerated growth for my product?"
To achieve this, there are 3 critical things to get right.
Your pricing model must:
Be easy to understand
Align to customer value
Correlate customer value to revenue growth (and create expansion revenue)
Read more about this and see examples here: 3 Critical Factors to ensure your Pricing Model delivers sustainable, accelerated growth
If you can hit all 3 critical factors with your pricing model, it doesn’t matter if it’s users or usage or some combination of both. It’ll be the right model for you.
Let's have a look at some examples, good and bad.
**Disclaimer: I am not affiliated with any of these companies and so I am making some assumptions about how their customers gain value from their products.
Example: Pure usage based pricing model
Octopus Deploy charge based upon number of deployments. It's simple, easy to understand, aligns to customer value and likely grows with customer value too. Typically as you get to the higher end of the scale, people with more deployments are likely to need additional management or administrative tools than mainstream users. Octopus Deploy may be missing an opportunity for expansion revenue by providing additional tools and capabilities at the high end of their customers. They are a relatively young company so it will be interesting to see if this changes over time.
Another great example of Usage based pricing is Stripe, who charge % fee per transaction. It;'s easy to understand, aligns to customer value, and irrevocably correlates customer value to revenue growth. You could be a start up of one person, or a $100M business and use Stripe, and only pay for what you use, which is 100% aligned to your own success. The more payments or revenue a Stripe customer makes, the more Stripe are able to charge, and the model scales without tiers or cut-offs that make customers begrudge having to pay too much, or have too little value.
Example: Pure user based pricing model
Tradify provide job management software for tradies. They provide a single price per user, independent of business size, business type or features desired. This means it is very easy to understand for their customers, but I suspect it fails dismally when aligning to value received, and ability to correlate value with revenue. In this model there is no expansion revenue beyond adding more users. I suspect Tradify are leaving a lot of money on the table, whilst also not providing the best value for all user types.
In order to work, user based pricing almost always needs to be combined with either Usage or Feature Tiering.
Example: User and feature tiering combo pricing model
This is the most common pricing model in SaaS today.
Monday is a good example, where they charge per seat (user), but have tiers with different features to support different user needs. This means as customers grow out of one tier (or require additional functionality in a higher tier), they upgrade to the next tier. Revenue can grow from either additional users, or from companies upgrading to higher tiers.
In summary
Usage based pricing, if you can find a metric that closely aligns to value for your customers, provides the greatest opportunity for happy customers who only pay for what they use, and unlimited expansion revenue.
User based pricing, as a metric in conjunction with usage or tiering, can be an effective model if it's easy to understand, aligns to customer value, and correlates customer value to revenue growth.
When designing your pricing model:
Make sure it hits 3 out of 3 Critical Factors
Ensure you always validate your assumptions with customer research or testing. Your assumptions will almost always be wrong!
Don't set and forget. You should always be learning and tweaking your model. Customer expectations change, market and competitors evolve, and you need to be on top of your pricing at all times to maximise revenue growth.
We hope this article has been helpful. Any feedback or questions are always welcome!
If you'd like help with your pricing, please get in touch!
Contact jeni@gobigadvisory.com or +61 404 421448
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