Usage-Based Pricing for SaaS: Benefit or Risk?

As if managing SaaS spend wasn’t hard enough already, software companies continue to keep us on our toes. Over the last few years, they’ve increasingly adopted usage-based pricing models – also known as consumption pricing. And there’s no sign of them taking their foot off the gas.

Many experts tout usage-based pricing as a win-win for both buyers and sellers. That’s because it lowers costs and improves value for buyers, while providing sellers with an effective product-led growth strategy.

To put that into your everyday context as a consumer, think about this: Have you ever experienced a sudden realization that you’re wasting precious dollars on paying for an underutilized service?

Maybe it’s the gym you visit once per month, or the subscription to the seldomly used third-party streaming platform. Regardless, you come to a reckoning where wasted spending clearly outweighs the ROI for these services.

Now, think about a service where you pay for consumption, say, the electric bill. You turn the lights off when you leave a room because it reduces waste and keeps monthly payments manageable. As a consumer, it seems fair because you only pay for what you use. But it also benefits the utility company, as mindful homeowners don’t overburden the power grid, and companies can charge a fair rate based on actual usage.

In the context of your business, this applies similarly. But first, let’s understand how usage-based pricing works.

What Is Usage-Based SaaS Pricing?

Usage-based SaaS pricing works exactly like it sounds. Instead of paying a set cost – regardless of whether an employee ever uses the tool – software companies charge by consumption. It replaces the traditional, tiered-pricing model that dominated the industry for decades.

The shift dovetails seamlessly with the industry’s move away from IT-managed, on-premises software to the cloud. And rightly so. 

Today, our SaaS Management Index shows that companies manage an average of 269 SaaS applications, yet 51% of all SaaS licenses go unused in a typical month. For large enterprises, portfolio size and license waste rise to 650 and 58%, respectively. 

It’s a staggering number when you consider how much spend goes to waste on underutilized software. It also makes the negative aspects of the subscription-based model abundantly clear.

Now that SaaS makes up a majority of software (now 60% of software spending, according to IDC), there’s no doubt software companies will continue to switch up their pricing models to accommodate the market. 

What Are the Key Benefits of Usage-Based SaaS Pricing?

Before diving into the consumer benefits of user-based pricing, it’s important to note the model offers several benefits for software providers. Major companies like Slack and HubSpot already offer usage-based pricing, and they’ve seen amazing results.

According to TechCrunch, “Public SaaS companies that have adopted usage-based pricing grow faster because they’re better at landing new customers, growing with them and keeping them as customers.”

Usage-based SaaS pricing also enhances customer retention and recurring revenue, as software consumers are more likely to become life-long users when they understand the ROI of their investment.

OpenView attributes usage-based pricing’s rise in adoption to companies experiencing “superior CAC payback and net dollar retention rates.” As you can see from the chart below, net dollar retention is at 110% for the top quartile of companies offering usage-based subscription tiers. Meanwhile, CAC payback is 7 months shorter for the top quartile.

On the consumer side, usage-based SaaS pricing provides several key benefits, most notably by:

Reducing Spend

Traditionally, software companies sold tiered packages based on the number of licenses or seats, and organizations based their purchasing decisions on an estimated number of users for the year. Considering that about 51% of SaaS licenses go unused in a typical month, it means the average organization wastes a sizable portion of budget on unused software.

Instead of paying a fixed price up front for licenses that may never see the light of day, user-based pricing lets organizations only pay for what they consume. As they see more value in the tool, they can increase their spending at their own pace, which also boosts customer satisfaction.

Streamlining Operational Efficiencies

Popular product-led growth strategies from companies like Spotify and Canva that allow users to sign up for a free version of the software (with the hope they love the software and become paying users). Similarly, usage-based pricing reduces the risk of trying out new SaaS tools by letting users join for a minimal cost. If the organization sees value in the tool, they can level up their investment, or cancel altogether if it proves invaluable.

Validating Your Investment

Data drives all important business decisions, especially costly software acquisitions. With a usage-based pricing model, managers and department heads can come to the table with insightful metrics to show a return on their investment, and clearly articulate the value of the SaaS tool or software.

Instead of telling your supervisor, “My team needs the tool to do their jobs,” you can give specifics like, “We had five licenses last year and our designers used the software for an average of 30 hours per week. Based on these findings, we’ll need to add three more licenses to hit our 2025 goals.” It’s a far easier sell to upper management when you present quantifiable data to support software utilization.

What Are the Risks of Usage-Based Pricing?

Do you remember the days of buying minutes on your cell phone? It was often easier to pick a plan with more minutes than you thought you’d need. That way, you could pay a lower rate and avoid running out of minutes. The downside is that you probably wasted a ton of those minutes – and ultimately money.

This is the perfect depiction of the downside of consumption pricing.

While many praise usage-based pricing, it makes accurately planning for consumption more complex. To start, if you don’t understand the drivers for usage, it’s hard to estimate what you’ll need. Then, the fear of running out of units or paying more per unit makes it easy to over purchase. 

We saw this in the early days where pricing plans allowed you to save by purchasing reserved capacity or pre-paying. But often that leaves you with unused units that you paid for but wasted – similar to the problem with unused licenses. On the other hand, if you underestimate your usage and use more units than expected, this overconsumption leads to an unpredictable increase in costs.

Software vendors add to the complexity by offering hybrid pricing models – including both traditional user-based pricing and usage-based. Just last year, OpenView reported that 46% of companies take a hybrid approach. Now, consider keeping up with all of these pricing models across hundreds of apps. Is your head spinning yet?

The long and short of the matter: Usage-based pricing is complex, nuanced, and hard to do well without expertise. You need to understand the model each of your vendors is using and what factors drive costs so you can make more informed decisions about your company’s needs.

Usage-Based Pricing Expected to Grow

When we originally wrote this blog in 2021, we predicted that usage-based pricing would grow. According to OpenView’s State of Usage Based Pricing, it has. In 2018, just 27% of SaaS vendors had adopted this pricing model. Jump to 2023, and OpenView predicted adoption to reach 61% with an additional 21% testing usage-based pricing.

Now, with the explosion of AI, usage-based pricing is everywhere. Some of the most disruptive AI pricing models are coming from the likes of Salesforce, Intercom, and OpenAI – according to a recent update from Kyle Poyar, operating partner at OpenView. Here are just a few insights he shared:

• Salesforce: $2 per conversation (Agentforce)
• Intercom: $0.99 per AI resolution (FinAI agent) and 10 free tickets per agent, per month (FinAI copilot)
• Zendesk: Per successful autonomous resolution (Zendesk AI)
• OpenAI: Per input/output token (GPT-40)

Interestingly, Poyar called out two trends from this analysis:

1. Vendors are selling “units of work” completed, a paradigm shift from charging for access or seats. Instead of paying for the capability to use a tool, customers pay for the results the tools generate.  They’re billed for outcomes, rather than access. This makes expenses more transparent and aligned with actual output.
2. True outcomes-based pricing is still quite rare. Why? It requires complex tracking of specific business results that are directly tied to software usage, which is difficult to standardize. Usage metrics are easier to quantify.

It’s clear that usage-based pricing is here to stay. At the end of the day, it offers tangible benefits to consumers by increasing value and reducing waste, while SaaS vendors can acquire long-time clients to grow their revenue. Yet, there are complexities and nuances you need to understand to avoid unpredictable increases in SaaS costs.