Pricing in SaaS: Usage vs Per-Seat Pricing
In Part 1, we examined the ARPU-CAC spectrum, and looked at how SaaS companies need to think about their pricing. Today, we’ll examine two common pricing strategies in SaaS - per-seat and usage pricing.
Good SaaS pricing strategy scales with the value it delivers to customers. When Zoom is pricing their product for 30K undergrads at the University of Washington, and also a 1000 student high school, they need to charge for the amount of value they’re providing in this wildly different scenario.
Per-Seat pricing is the traditional option for most SaaS companies trying to tackle this problem - when you’re selling an HR software to small businesses, or selling a CRM service, it makes sense to scale the price with how many people are using your product. As such, per-seat pricing is the most common pricing strategy for SaaS companies, and it has been for the last few decades. Any good pricing strategy attempts to scale with the amount of value provided to the customer - a “unit of value”. Number of users is something that customers can easily understand and can be a good proxy for value - Oji Udezue, VP of Product at Calendly and a former Head of Product for Atlassian’s communications products says “Customers should be able to connect with the unit of value. User pricing is tried and true. Be careful with units customers can’t understand and predict.”
However, there are notable exceptions to this B2B SaaS pricing approach. When the number of users fails as a proxy for value, other strategies should be considered. A good example is AWS, where the amount of value a company receives from the service is usually tied to the amount of data they’re storing, the amount of compute time they’re taking up, or the number of API requests their end-point is processing. Moreso, from Amazon’s perspective, their costs have very little to do with the number of users, and far more with usage. As such, AWS - and other services that can scale value without scaling users - benefit from a usage pricing model. Another great example is Twilio’s SMS service, which scales with individual messages.
Between the two approaches, there are some important considerations. Per-user pricing is far more consistent - when SaaS companies want to forecast expected revenue from a usage-based pricing model, they need to anticipate the future usage of every customer, which could vary greatly depending on seasonality, macroeconomic factors, management, etc. There are a variety of ways to mitigate unpredictability - including combining tiered-pricing and usage-based pricing, having users pre-pay for usage caps instead of individual units, and more. However, that inherent unpredictability of usage pricing is inevitable. And as we’ve already mentioned, user-based pricing is easy to understand for the user - one Zoom user for $14 is easier to wrap your head around than one API call for $0.003.
That being said, usage pricing has some big advantages as well. It avoids the challenge of convincing customers to “jump the gap” to a larger or more expensive plan. Moreso, the low cost associated with low usage customers can create a land-and-expand mechanism, as small adoption can easily scale into larger scale use as the product integrates more deeply into the workflows of the company. Moreso, it avoids a large initial investment that scares off cash-strapped businesses. Lastly, a true usage model can be included in Cost of Goods Sold, as opposed to OpEx. Andy Stinnes of Cloud Apps Capital Partners says, “I have personally witnessed cases where large enterprise customers balked at a six-figure annual subscription but happily allowed a very healthy seven-figure usage fee to be embedded in the payments flow. As OpEx it was a show-stopper. In COGS it was a rounding error.”
At SaaS Operational Tactics, we always encourage our readers to reexamine and reframe what they do. Pricing is something that all SaaS companies should frequently scrutinize, and always make sure that they are scaling value with price. Successfully doing so encourages growth, better customer relationships, and long-term success.
This article is a collaboration between Archit Bhise and Alex Li.