SaaS (Software-as-a-Service) was not only a technology innovation to offer software. It was also a business model innovation: users only paid based on usage. It has led to a situation where you can start to use a SaaS offering for free, with limited time and limited functionality, or a nominal price per month. But customers soon learn that this is not the whole story. It is more relevant to offer customers better value and user experience; a pricing trap doesn’t work anymore.
The SaaS model enabled many startups to enter and disrupt the enterprise software market. Many businesses were tired of paying for expensive software licenses with annual support fees, and they liked the model where one has to pay only for usage. It is an excellent method, especially when your usage is negligible. However, when you use more, you also pay more and can spend more than a fixed-price license.
Old tricks to lock in customers
As a friend from a London finance company once told me: “first, our quite small company used Salesforce CRM for a few hundred dollars a month, but it forced us to use many other Salesforce components, so now we are paying a million dollars a year, and Salesforce keeps our people happy with fine-dining events.” The same vendor lock-in can happen with the SaaS model, although SaaS companies often argue that software license companies lead to a one-vendor lock-in. It is also good to remember that usage-based pricing is not the same as value-based pricing, sometimes, it can be, but this is not guaranteed.
Many startups also came to the market by offering attractive pricing. Yet, it is important to remember that it is often the offering from a loss-making VC-funded business. If you get a low price or free SaaS services from startups that have raised considerable funding, you must remember that sooner or later, you will pay a high price for those services and solutions, or the company could disappear.
I have heard SaaS salespeople joking about getting a customer into a trap. Yes, you can immediately start using the service, but you have your data there and use it for essential processes; if you want to use more features and have more users, the prices start to go up. First, everything looks nice, and you don’t need your own IT for the project; someone with a company credit card can make the $99 a month subscription with a usage limit.
Customers have learnt the trick
But customers are getting smarter. They have learnt the trick. Maybe in a problematic way, but they learned anyway. They don’t go for these $99 a month offers anymore. They want to know the costs of using the service on a larger scale before they start. Many enterprises go beyond this and want to make a deal where they cap the total price they are willing to pay.
Such developments in pricing have created a new dynamic for the market. There are those SaaS companies that want to win more market share, and many of them are also VC-funded. They are ready for those capped price deals because they need more customers, a more significant market share, and higher monthly recurring revenue (MRR). VCs love MRR; it is the only metric some venture capitalists understand.
Now we are in a situation where the old SaaS salespersons’ trick no longer works. They drive their own company into a trap. They have promised services to their customers, but when their usage grows, they hit the price cap and cannot cover their costs. And the MRR also stops growing.
This happens to vendors that are startups and growth companies operating with the ‘pricing innovation’ approach and want to challenge incubators and competitors with lower usage-based prices (also called consumption-based pricing). They need to win more market share. It is another situation if a vendor can offer something unique where buyers can no longer get this kind of deal.
Real innovations and value to customers
Usage-based pricing makes sense for many needs, and there are many versions of it, based on used resources or processes, usage time, the number of users and fixed components. But it is naïve to claim or believe it always offers lower prices. Let’s take a simple example from our personal lives. Does it make sense to buy a car, rent one when needed, or use a taxi service? If you need a car a couple of times a month, it is probably better to use a taxi or rent a car. But if you drive a long way every day, it is probably cheaper to buy a car. Renting or using taxis have usage-based pricing models.
This is a simplified example, but it is very much the situation with consumption or usage-based models for software and processing capacity. It makes sense in some cases, and in some other situations, other pricing models are better. Vendors should also understand which customer segment a usage or license pricing model makes sense and still be successful in the longer run. For example, you can get small customers with it, but bigger corporations won’t want it.
Business model innovation has been a popular term in many startup management board meetings and VC pitches for years. However, if your only new idea is usage-based pricing for a SaaS service, don’t call it an innovation. It is no longer innovative; your business should not rely only on that. Business model innovations are still essential and are needed for technology innovations.
In the end, users want to get real value from the software they use. If the software enables them to do some new things and be more effective, users will be ready to pay a higher price. It also matters how easy it is to start using a service. But most companies now avoid getting trapped in a service merely because it offers a free trial or a low usage starting price. They want to see the actual cost and true value in real use. And software vendors must also think about how they offer valuable tools and platforms to their users; the usage-based pricing trick is an old story from tired salespeople.