The purchase of software has evolved. Gone are the days when executives chose software for their employees based on IT compatibility or key performance indicators. Employees now tell their boss what to buy. That’s why we’re seeing more and more SaaS companies – Datadog, Twilio, AWS, Snowflake, and Stripe to name a few – succeeding with a usage-based pricing model.
The usage-based model allows a customer to start at low cost, while still retaining the ability to monetize a customer over time.
The usage-based model allows a customer to start at low cost, minimizing the friction to get started while preserving the ability to monetize a customer over time, as price is directly related to the value the customer receives. Without limiting the number of users who can access the software, customers can find new use cases, leading to greater long-term success and greater lifetime value.
While we don’t rely 100% on nighttime usage, looking at some of the software megatrends (automation, AI, and API) a product’s value doesn’t usually increase with more connections. Usage-based pricing will be the key to successful monetization going forward. Here are four top tips to help businesses grow to over $ 100 million ARR with this model.
1. Landing and growing is real
Usage-based pricing applies to all layers of the technology stack. Although it pioneered the infrastructure layer (think AWS and Azure), it is becoming increasingly popular for API-based products and application software, in infrastructure, middleware and applications.
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Image credits: Kyle Poyar / OpenView
There are concerns that investors hate usage-based pricing because customers are not subject to a subscription. But investors actually see it as a sign that customers see the value of a product and that there are no items on the shelf.
In fact, investors are increasingly rewarding use-based companies in the market. Use-based businesses trade with a 50% multiple revenue premium over their competitors.
Investors particularly like how the usage-based pricing model is combined with the “land and expand” business model. And among the IPOs of the past three years, seven of the nine that have had the best net retention of the dollar all have a usage-based model. Snowflake in particular is off the charts with a net hold of 158% of the dollar.