Shiv Pabari, Pricing Strategy Specialist in Hg’s Portfolio Growth Team, explains why now is the right time to be rethinking your price metric.
To achieve value-based pricing, choosing the right price metric is key. However all too often it’s not given enough thought, with SaaS companies often defaulting to “per user” pricing. Now especially is a great time to be rethinking whether your price metric really is aligned to the value you give to your customers.
What is a price metric? And why is it so important to get right?
A price metric is what your price is based on, effectively its “unit of measure”. In B2B SaaS the most commonly used metric is ‘users’ (usually ‘users per month’) but many more exist such as gigabytes (‘GBs’) of storage, downloads, proportion of cost saved, hours used etc.
Let’s say a company has two packages, a cheaper “Essential” package and a more expensive “Premium” package which has the full suite of features. Without a price metric (i.e. where you get unlimited users & usage for the same price) a small start-up with 20 people that wants the “Premium” set of features would pay the same as a large, 1,000+ employee Enterprise. That either means a prohibitively high price for the start-up, meaning you miss out on potential customers, or a bargain for the large Enterprise, meaning you’re leaving money on the table. Having the right price metric in there is the missing piece of the puzzle that allows the price to scale with differences in customers’ willingness and ability to pay.
Choosing a price metric that grows with your customer gets you the dream situation of increasing ARPU (Average Revenue Per User) over time, without needing to rely on your Product team coming up with a never-ending roadmap of must-have products/features and your Sales team continually upselling. However, choosing the wrong metric can mean you need to continually innovate just for your ARPU to remain flat.
Why now is the right time to rethink your metric
As businesses recover from the impact of COVID, there is understandable hesitation about making big new investment commitments, not to mention a heightened focus on cashflow.
Switching to a value-based price metric, i.e. one where customers only pay for what they use or the direct benefit they get, takes the risk away of the investment for customers. Not only can this be used as an acquisition tool for prospects, as it reduces the pricing barrier to entry, but offering a usage‑based metric can also be a retention tool for any customers threatening to leave if they feel they aren’t getting enough value due to reduced usage of your product.
Choosing a value-based price metric can serve as an acquisition and retention tool today, however will be a monetization lever in the months and years to come as businesses return to ‘normal’ volumes.
There are also longer-term trends that support you revisiting your price metric. In the past companies often had to use proxies for customer value such as number of employees or customer revenue as it technically just wasn’t possible to measure usage or impact. Now, particularly with the move to cloud-based solutions, not only can every click be recorded in real-time but often so can the knock-on effects of what impact that click has on the rest of the business.
What’s wrong with user-based pricing?
Given that the most common price metric used for software companies is user-based pricing, surely it doesn’t make sense to re-invent the wheel? Wrong.
“Defaulting” to pricing per user can limit your potential for ARPU growth in a number of ways. Firstly, in many industries, “users” is a declining metric. Law and Accounting are two prime examples of industries where there will continue to be a trend of automation and consolidation and hence a decline in headcount. Charging based on the number of users also can limit widespread adoption of your product as cost-conscious companies restrict it to those that “need it” rather than making it available to anyone that can value from the software.
A more fundamental problem with user-based pricing is simply that it often isn’t a great proxy for value. The key question you need to ask to determine this is “Does each incremental user get the same (or more) value as the first?”. If you’re offering a productivity tool then the answer probably will be “yes” but if you’ve got a data processing tool then it will almost certainly be “no”.
If we look at the price metrics used by the big B2B tech company IPOs this year, it shows that user-based pricing isn’t going to be as commonplace in the future. Out of Snowflake, Sumo Logic, Jfrog, Kingsoft Cloud, ZoomInfo, Agora and Asana (i.e. the notable B2B tech companies that have gone public this year and publish their pricing online), only Asana has user-based pricing.
That’s not by coincidence.
So what metric should you use?
You ideally want to choose a price metric (or metrics) most aligned to the value your customers get from your product. In theory, this would be a performance-based metric, for example based on the incremental amount of revenue earned or cost saved due to your customers using your product, similar to the way online advertising costs are often ‘per click’ or even a direct percentage of the sale value resulting from that click.
However, in reality performance-based metrics are tricky to implement. They are often very difficult, if not impossible to directly measure and if you try to define the performance impact with the customer you’re sure to struggle to agree – who’s to say it was your data analytics software that led to a change in strategy, and not the brilliance of the person interpreting the data analysis?
Usage metrics (e.g. per image, per download, per report generated, per GB) are often the best proxies for value that are now, with the move to SaaS, much more likely to be measurable. It’s important that you consider whether each “use” is equal, for example, if we were using the “reports generated” metric, is the value of each report the same or does it vary depending on the length, complexity and/or customization? In these sort of cases you can differentiate between the types (e.g. simple vs. complex reports) or add an additional metric (e.g. GBs), but of course there’s a trade-off between getting a better proxy for value and ensuring your pricing isn’t too complex – with the right answer usually depending on where you are on the maturity curve.
As your product offering develops it becomes increasingly hard to find a single metric that aligns perfectly with customer value and hence it will make more sense to offer multiple metrics. These can be implemented in many different ways, e.g. different metrics for different products/customer segments, introducing a secondary metric for “overages” or a credit system where you “use up” credits based on multiple different metrics. However it’s important that there’s discipline in not letting it get too confusing. What you don’t want is 10 products/modules, each with their own metric, as it is not only confusing for the customer but will be a nightmare to try and package together.
Deciding what price metric(s) to go with requires both internal and external inputs: discussions with Product to see what’s technically feasible; speaking with customers to see what’s understandable/fair; benchmarking with competitors (a different metric can be a competitive advantage); modelling to see winners & losers of moving your current customer base to the new metric(s).
How you apply your metric can be as important as the metric itself
How the price metric is applied, i.e. how the price scales with volume of your chosen metric, can be as important as the metric itself. Options here range from “per unit” (i.e. pay-as-you-go), which gives your customer the most amount of flexibility, to negotiating at the start of the contract a fixed fee based on expected usage, which gives your customers the most amount of predictability.
The right answer usually depends on who you are selling to and what your goals are. If you’re selling to accountants, hospitals or banks the chances are they will value predictability more. However it also depends on the size and maturity of your customer – smaller, newer and more tech savvy firms tend to prefer something more flexible and are more used to having usage-based pricing, while more mature, traditional firms will pay a premium for certainty in their pricing. If you sell to both type of customers then there’s no need to choose one structure, as long as you can train your sales team on when to use each option. Using pay-as-you-go pricing can work as a great way to enable customer acquisition, due to the low price barrier to entry, but as the customer experiences your product there will likely be mutual benefit in moving to a more fixed structure.
– It’s more important to get how you price right, than the specific price point you charge
– Select a price metric that aligns best with the value your customers get from using your product, while being simple enough to understand and implement
– Choosing the right value-based price metric can help you acquire new customers as well as “automatically” increase their account size over time as they use your product more
– Don’t default to pricing “per user” because that’s what you seen other software companies do, it’s often not a great proxy for customer value
– If you serve different customer segments who use and value your product in different ways, then the right answer may be to have a different pricing approach for each segment
A word on Growth Teams
“COVID-19 has brought a unique challenge to many businesses over the last few months and those focusing on revenue growth and customer retention are certainly no exception.
By definition, the mission of these functions is to attract and persuade prospective and existing customers to invest in their company’s products and services. Not an easy task against the uncertainty the next few years may bring.
Here at Hg, we have a Growth Team covering the often disparate and disconnected practices of Strategy, Attracting & Retaining Customers, and Delivering Value.
We use the combination of this expertise to support our portfolio companies in their growth aims as we believe that aligning these areas is the key to growth success.
Now, more than ever, we urge you to avoid allowing these different departments to tackle their problems separately. With resources and budgets under pressure for buyers and sellers alike, the time for mismatched objectives, inconsistent messaging, an unplanned customer journey and departments butting heads is over.”