Replacing your subscription model with pricing based on consumption could help you boost revenue without having to grow customers or products, Matt Kropp, a Boston Consulting Group partner, said in a SaaStr webcast.
AWS is the poster child for consumption pricing. Companies using the cloud giant start off paying little but by the time they ramp up consumption, the bill can be huge. That was especially the case when Covid hit and companies turned to remote work.
“We’ve certainly heard stories in the news about companies being hit with unexpected AWS bills last year,” Kropp said.
For companies that make the change, there are ways of mitigating that kind of sticker shock if they correctly structure their pricing, he suggested.
The main benefit to companies is greater revenue growth as long as customers perceive the pricing to be fair and in line with market dynamics, the sales team has a channel for selling consumption, and the prices align with company costs.
“We can see typical 20-25% increases in annual recurring revenue (ARR) just out of driving a different pricing model,” Kropp said. “That’s quite a powerful lever that companies pursue.”
The model is especially attractive to startups in the Series B or C stage.
“Very often these companies are still operating on the pricing model that they found at the beginning,” he said. “They’re on that growth path to $1 billion, but the pricing model becomes a drag.”
In the typical subscription model, which dominates software-as-a-service (SaaS) pricing, companies bill customers a fixed amount upfront, usually monthly or annually. In a consumption model, billing is backward-looking. For that reason, companies can expect to go through a revenue trough as they give up that prepaid, fixed amount for the use-based amount.
“What’s critical is to communicate to your investors how you’re going to make that change and so model out what’s going to happen to your revenue line,” he said.
Kropp recommends staying away from an actual usage-based model; it can lead to dramatically escalating prices for big users, which might push them to a different provider, while small users pay next to nothing.
“You can’t just scale your price linearly,” he said.
What’s better is to devise a discount curve in which big users pay less per use as their volume increases.
“Typically we want to implement a logarithmic discount curve, which usually provides a discount in the range of 15% to 20% for every 10x increase in usage,” he said. “That typically gets you to something that matches what customers expect.”
Tiered-pricing is another way to protect big users. By creating tiers, you make the cost more predictable and also give the sales team engagement opportunities.
“You sell them a certain amount and, if they overrun their tier, you ask them to re-up or you use it as an opportunity for your sales team to go out and upsell them to the next tier of consumption,” he said.
Maybe the biggest reason of all for switching is the impact APIs are having on subscriptions. Application programming interfaces are lines of code that enable companies’ software to interact with other companies’ software automatically, a convenience for both companies and users.
There’s a downside, though. With an API sitting on top of a company’s SaaS product or service, it’s possible multiple users can gain access through a single entry point, potentially robbing companies of licensing revenue.
In these cases, Kropp said, “the user access actually bypasses the user interface (UI). So, more products are exposing significant functionality via their API. And if your customer can replicate what your UI does, building on top of your API, charging per user is definitely not going to be capturing the value they’re receiving. So, think carefully as you roll out APIs how the customer gets value through that API and how they may cannibalize your per-user pricing.”
Consumption pricing can act as a good antidote to that, because it enables companies to generate revenue from usage rather than the user.
“You can really leverage that growth in usage of APIs to generate more revenue for yourself,” he said.