In part 1 of this series, we discovered how SaaS vendors commonly overlook pricing models as a strong lever for growth and we explored some common pitfalls. Let’s continue where we left off.
SaaS pricing is fundamentally value-based pricing, pegged solely to the value a particular customer ascribes to the particular solution: hard financial value, strategic value, or personal value. As such the single most important feature of a pricing model is scalability. Pricing must easily scale to customers A, B, or C. And pricing must scale over time for any given customer as their value from using the software grows.
Most B2B SaaS subscription pricing is built on two dimensions: functionality (more or fewer features, module 1, 2 and 3, etc.) and a “scaling unit.” The majority of cloud apps use seats (users) for a scaling unit. It’s probably the oldest application software model in the book and harkens back to the “licenses” model of the early packaged apps of the ’90s. Its greatest strengths are its commonality and simplicity. And it has stood the test of time: small company vs. large, growing user base over time – it works.
Oji Udezue, VP of Product at Calendly and a former Head of Product for Atlassian’s communications products, sees user-based pricing as the undisputed gold standard: “Customers should be able to connect with the unit of value,” he says. “User pricing is tried and true. Be careful with units customers can’t understand and predict. I think we’re in the third gen of technology, the convenience era, where many apps are about making life easier. And user pricing just makes sense there.”
But it does have some drawbacks, and there are cases when the number of users is at best a poor proxy for value received and can be completely misaligned, creating a perverse disincentive to grow usage and ultimately ensure renewal and stave off churn. Check out Patrick Campbell’s blog post for an insightful view on why and when user-based pricing might not be the way to go.
Unit-based pricing beyond seats
Wherever you fall on that opinion spectrum, everyone agrees that there are cases where user-based pricing just doesn’t work, such as applications that drive tremendous economic value but have very few users. Think of email marketing solutions, simulation/planning software, or B2B payments apps. These solutions generate top line growth or release millions tied up in inventory and working capital, and yet have only a few users.
This is when you need different pricing units as the basis for your pricing model, units such as orders, payments, emails, locations, minutes, data volume — units that are much better aligned with true customer value. Just to be clear, we are still talking about subscriptions here, not usage-based transactional pricing. So just like user pricing, these unit-based models are the best of both worlds. They conveniently scale price to a given customer’s size and value proposition and organically grow with each customer over time. Yet they present in the form of a flat (within volume limits) subscription that is easy to understand and is charged and collected upfront, a crucial requirement for vendors’ tight cash flow.
Unlike seats, these unit-based models much more closely align with the value delivered — for instance, by number of orders submitted for an ecommerce storefront solution or by payments submitted for a purchase-to-pay platform. This also removes the seat-price barrier to growing users and ultimately usage, and therefore positively impacts growth rate and counteracts churn through higher stickiness.
Pick your unit wisely
As you can already tell, picking the right “unit” is crucial and must be done with a deep understanding of the customer (outside-in view vs. inside-out) to achieve strong value alignment. And with an eye toward the following common pitfalls:
Relatability: User-based pricing is clear and common, and buyers can compare across SaaS vendors and have a good feel for the range. Conversely, the price per order or asset or minute is much harder to relate to and compare. This was confirmed by Craig Shull, GM of CX Solutions at SurveyMonkey and previous SVP Pricing & Product Strategy at Salesforce: “You have to pick units customers can relate to and estimate future use,” he says. “That can be tricky. We [at Salesforce] developed what we internally referred to as pizza box pricing. Nobody knows how many slices they will eat. But you do know if you are in the mood for a small, medium, or large. In the same way, we packaged subscription tiers with different numbers of units included — small, medium, or large. Not ideal, but much easier to explain and manage.”
Predictability: Nobody likes surprises. So customers will want to be able to tell beforehand what volume of units they will need. For some units (e.g. orders) that’s easier and the customer will know. For others (e.g. data volume) it can be hard or even impossible to anticipate. It will make your life much easier if you use a unit that represents something real, something that has meaning to the customer independent of your solution. Shull has seen this firsthand: “We learned that prospects never know how many units they will need. And they don’t want surprises. So they tend to dramatically overestimate their usage and negotiate a huge implicit discount. When actual use lags far behind a year later at renewal, that discount is forgotten and customers try to renegotiate the price down further, arguing ‘we are not using 80% of the subscription.’ So make sure you document the fact base for future renewal negotiations.”
Consistency: Seats are great as their growth within a customer is generally always up and gradual. But other units can be highly variable and seasonal. This drives additional complexity around using average or high watermark to size the subscription and can create the impression of “constantly overpaying.” Similarly, some units are notoriously inconsistent across customers given customer- or industry-specific practices. As an example, in a transportation management solution priced “per shipment,” shipments for one customer could be ocean containers full of high-tech devices, but for another customer they could be parcels with a few low-value spare parts. Clearly, the value per shipment to these customers will diverge greatly.
Administration: Seats are simple. They live in your system and customers can’t exceed their limit unless you let them. But other units often live outside your system and you can’t stop the presses when customers go beyond their subscription ceiling. Typically, SaaS vendors must add an entire infrastructure to monitor customers’ adherence to their unit ceilings and to detect “overages.” And overages are a whole topic and headache onto themselves, which we will get a better taste of in the third part of this series.
If that list of challenges turns you back to user-based pricing, hold on. Think carefully about the tradeoff you are making. If seats are a good value proxy and fit your business, great. If not, find the right unit and see if you can manage these operational challenges. In my experience, the benefits of higher average selling price, higher growth, and less churn are well worth it. In fact, in part 3 of this series, we will drill down a bit more on this topic and explore true usage-based “transaction pricing” and dive further into the pros and cons and how B2B SaaS companies can benefit from the right pricing strategy.
Andy Stinnes is Venture Partner at Cloud Apps Capital Partners.
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