Buying software has evolved. The days of executives choosing software for their employees based on IT compatibility or KPIs are over. Employees now tell their boss what to buy. This is why we see more and more SaaS companies - Datadog, Twilio, AWS, Snowflake and Stripe, just to name a few - succeed with a usage-based pricing model.
The usage-based model allows a customer to start at a low cost, while maintaining the ability to monetize a customer over time.
The usage-based model allows a customer to start at a low cost, minimizing the friction to start while maintaining the ability to monetize a customer over time because the price is directly tied to the value a customer receives. By not limiting the number of users who can access the software, customers are able to find new use cases, which leads to longer-term success and higher life value.
While we're not going 100% based on overnight usage, looking at some of the megatrends in software - automation, AI, and API - the value of a product doesn't normally scale with multiple hits. Usage-based pricing will be the key to successful monetization in the future. Here are four top tips to help businesses scale up to over $ 100 million ARR with this model.
1. Land-and-expand is real
Usage-based pricing is across all tiers of the technology stack. While it was a pioneer at the infrastructure level (think: AWS and Azure), it is becoming increasingly popular for API-based products and application software, across infrastructure, middleware, and applications.
Some worry that investors will hate usage-based pricing because customers aren't tied to a subscription. But investors actually see it as a sign that customers are seeing value from a product and there are no shelves.
Indeed, investors increasingly reward utilization-based companies in the market. Usage-based companies are trading at a multiple premium of 50% of revenue than their peers.
Investors particularly appreciate how the usage-based pricing model matches the land-and-expand business model. And of the IPOs over the past three years, seven of the nine that had the best net dollar retention all have a usage-based model. Snowflake, in particular, is off the charts with a net dollar retention of 158%.
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