How software pricing strategy is evolving [Q&A]
Buying software used to be relatively simple. You either paid a one-off fee, or an ongoing license, or sometimes a combination of both.
With the advent of cloud and SaaS, however, things have become rather more complicated. Usage based pricing is more common, plus in a difficult economic climate there's a spotlight on software costs.
We talked to Griff Parry, CEO and co-founder of SaaS metering and pricing engine m3ter, to find out more about how software pricing is changing and what’s driving that change.
BN: What is going to be different about software pricing in 2023?
GP: 2023 is the year we'll see an increased strategic focus on software pricing from SaaS leaders as they experiment with different and new pricing models. Until recently, many software vendors took pricing for granted as they enjoyed a period of relative prosperity punctuated by favorable economic conditions, easier access to capital from investors, and rapid customer growth. As a result, the average SaaS company typically only spends six hours working on their pricing strategies, according to ProfitWell.
But with 150,000 tech layoffs in 2022, the looming global recession has catalyzed a new set of challenges SaaS companies will have to contend with in order to survive. In such a macroeconomic environment, pricing is a powerful growth lever to increase revenue and margins that should not be overlooked.
CFOs are exercising greater diligence over company budgets, and IT teams are under pressure to reduce spend. To get there, 40 percent are consolidating their SaaS applications, meaning the risk of customer churn for software businesses is greater than ever -- unless they can hold on through flexible offerings.
In order to ride out the challenges of 2023 and continue growing, SaaS companies will have to review their pricing strategies and find room for innovation.
BN: Is raising prices the only option for SaaS companies given the current economic climate?
GP: No, raising prices is not the only option for SaaS companies -- and it's a decision that leaders should think about very carefully. As each customer becomes that much harder to win, increasing prices also increases the risk of logo churn.
I'd urge vendors to explore usage-based and hybrid pricing models. It gives customers the flexibility they need to help them through a difficult economic environment, by scaling usage -- and therefore their spend -- up and down. It's a powerful value proposition on both sides because it also ensures they pay for the software they use so as not to leave money on the table.
That said, raising prices in 2023 is not impossible. Last year, SaaS companies were able to increase their prices four times faster than global inflation, and vendors with solid long-term customer relationships may find this strategy works best for them. What's important is that SaaS leaders assess key factors such as customer loyalty and build out a strategy that creatively puts the business' unique characteristics to work.
BN: What is usage-based pricing and what are some of the biggest misconceptions about it?
GP: Usage-based pricing (UBP) is an alternative to the traditional cost-per-seat subscription model that has long dominated the software industry. Metering has been around in other contexts such as telecommunications, utilities, and logistics, but is a relatively new concept in B2B software. With UBP, customers are billed according to consumption, i.e. how much they actually use a service. This model allows companies to quickly respond to changing customer needs, improve retention rates, and reduce revenue leakage. Importantly, it links costs to value and allows fees to scale as customers grow.
A common misconception about UBP is that it only benefits the company, or makes the customer experience more expensive, but neither of those statements are true. It’s actually a win-win because customers have lower upfront costs while onboarding, increased operational flexibility because they have better visibility of and can easily limit their spend, and most importantly, it helps both sides realize more value from the relationship.
While UBP isn't right for every business, when it works, the benefits are significant.
BN: What advice would you give to a software company considering usage-based pricing?
GP: Implementing usage-based pricing is done best when a diverse range of functions -- beyond the finance department -- input their perspectives and data into the development and execution of the new pricing strategy.
Get your product teams involved to help build a representation of how customers engage with your product, and which features are most heavily linked to success. For usage-based models, this is crucial for making sure you are monetizing the correct features so value can be directly attributed to usage and spend.
Customer success and sales teams are also highly valuable to the process. With a clear view of the entire customer journey as new pricing models are rolled out, these departments will be documenting crucial feedback and ensuring successful transitions to the new system.
This year we're likely to see a greater range of C-suite executives become interested in IT spend and reviewing software usage. Reflecting their different points of view and ways of thinking in the development of your pricing strategy sets you up for success when rolling out UBP.
BN: Is there anything else to keep in mind when planning new pricing strategies?
GP: There is no one size fits all solution when it comes to pricing, and some experimentation is not only natural but a desirable part of the process for identifying the pricing model that best serves your business and customers.
Usage-based and subscription-based billing do not have to exist in vacuums, new strategies can be tested in a soft and controlled way. Hybrid models, such as flat-fee subscriptions with usage-based overage costs, present valuable opportunities to explore ways to realize more value from existing customers without sacrificing positive user experiences or spooking them with a brand-new strategy out of nowhere.
Now is the time for companies to seriously reconsider their pricing strategies to make sure they are optimizing their bottom line.