Subscription-based pricing is dead: Smart SaaS companies are shifting to usage-based models

Software buying has evolved. The days of executives choosing software for their employees based on IT compatibility or KPIs are gone. Employees now tell their boss what to buy. This is why we’re seeing more and more SaaS companies — Datadog, Twilio, AWS, Snowflake and Stripe, to name a few — find success with a usage-based pricing model.

The usage-based model allows a customer to start at a low cost, minimizing friction to getting started while still preserving the ability to monetize a customer over time because the price is directly tied with the value a customer receives. Not limiting the number of users who can access the software, customers are able to find new use cases — which leads to more long-term success and higher lifetime value.

While we aren’t going 100% usage-based overnight, looking at some of the megatrends in software —  automation, AI and APIs — the value of a product normally doesn’t scale with more logins. Usage-based pricing will be the key to successful monetization in the future. Here are four top tips to help companies scale to $100+ million ARR with this model.

1. Land-and-expand is real

Usage-based pricing is in all layers of the tech stack. Though it was pioneered in the infrastructure layer (think: AWS and Azure), it’s becoming increasingly popular for API-based products and application software — across infrastructure, middleware and applications.

Image Credits: Kyle Poyar / OpenView

Some fear that investors will hate usage-based pricing because customers aren’t locked into a subscription. But, investors actually see it as a sign that customers are seeing value from a product and there’s no shelf-ware.

In fact, investors are increasingly rewarding usage-based companies in the market. Usage-based companies are trading at a 50% revenue multiple premium over their peers.

Investors especially love how the usage-based pricing model pairs with the land-and-expand business model. And of the IPOs over the last three years, seven of the nine that had the best net dollar retention all have a usage-based model. Snowflake in particular is off the charts with a 158% net dollar retention.