Usage-based pricing, as a model for SaaS, has been around for some time. But, a slew of wildly successful IPOs from companies like Twilio, Snowflake, and others has brought the idea of winning with a usage-based pricing model to the fore.
One voice that has risen above the rest in the discussions about usage-based pricing is Kyle Poyar, VP of Growth at OpenView, the expansion stage VC.
Kyle has been a vocal proponent of the benefits of Usage-Based pricing and leverages his deep understanding of pricing to help portfolio companies optimize their pricing for success.
We had the pleasure of chatting with Kyle about Usage Based pricing, why he’s passionate about it, and how companies can leverage it to their benefit.
Below are excerpts from that conversation that have been lightly edited for clarity.
Thanks for joining us today Kyle.
Could you tell us a bit about your background and your journey to becoming VP of Growth at OpenView?
Thanks for having me.
I originally went to college for Environmental Studies and Economics, not a traditional SaaS pricing path if one exists.
After graduating, I wanted to work in consulting and was fascinated by Simon-Kucher because their model for revenue growth was not cost-cutting or M&A integration.
I learned a ton in the six years I spent there and it gave me the opportunity to understand pricing and packaging as a way for companies to grow revenue. Despite seeing how important it was, most companies were dramatically underinvested in pricing.
They didn’t really have anyone focused on it.
I saw a disconnect between the value and the importance of pricing versus the resources that were being put towards it. That made me passionate about writing about pricing and helping companies improve their processes.
I joined OpenView 5 years ago, starting out on the growth team with portfolio companies and now lead that team as VP of Growth.
We find that pricing and packaging is such a hot topic with our portfolio companies right now so that’s a major area of focus for me.
Usage-Based Pricing in SaaS seems to be something you put a lot of thought into. Why do you think Usage-Based has such great promise for SaaS companies?
To me, it feels like the next step in the evolution of SaaS.
When you think about moving from on-prem software to cloud-based, the per-seat pricing was the default for companies like Salesforce.
In some ways it made sense, especially if you are used to software being provisioned at the individual device or computer level, the “seat” is the closest equivalent.
There are different expectations today.
People might want to try before they buy or open up the product to be used by a wider group in the company beyond the few individuals who want to pay that expensive license fee for it.
Beyond user expectations, the technology needed to charge based on usage has gotten better. Companies are now able to capture a lot more data around how people are using their products and what events are happening.
The adoption of Usage-Based pricing has been further driven by the COVID-19 pandemic. When I talk to companies, they tell me they don’t want to get locked into an expensive subscription, they want flexible pricing based on their actual usage and the success of their own business.
If a business is doing well, they are happy to pay more. But if a business is shrinking, they want to save as much as they can.
To me, Usage-Based pricing helps capitalize on these trends. It’s more customer-friendly, so it opens up a product so that more people can try it out.
It also has natural expansion built-in, as your customers are happy with your product and see value from it, they are going to pay you more money without you needing to go upsell them. They are just going to naturally be spending more.
You see that with Snowflake, which has a 160% Net Dollar Retention, and Datadog with 130%. Elastic, the same thing.
You grow as customers grow; there are shared incentives.
Do you see this Usage-Based pricing trend continuing due to COVID-19? What are the challenges that companies are facing in terms of pricing as we transition into whatever happens next with COVID-19?
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I see this trend continuing.
Part of it is just a trend towards greater flexibility more generally. Even for “traditional” companies, we’re seeing things like opt-out provisions in contracts, or the ability to pay monthly or quarterly even if there is a longer commitment.
Folks just don’t have the certainty needed to make a three-year commitment paid upfront. It’s hard to imagine doing that these days when you don’t know what your business will be like in the future.
To me, this model of more flexibility and being more customer-friendly is going to help allow software companies to differentiate from others and take control of the buying cycle.
Usage-Based pricing is tightly intertwined with that concept.
You often talk about the importance of Usage-Based pricing in the product-led model. What’s your opinion about the challenges of moving from a purely product-led model to then include an enterprise sales motion, how does the Usage Model fit when it requires more hand-holding and can be more complex in its pricing.
In the ideal world, and this doesn’t always happen, the customer is using the product and seeing success with it and really doesn’t want it taken away. They’re totally fine with a pay-as-you-go model and just charging it on a credit card. But, especially with enterprises, procurement wants to get involved and add more predictability to their bill, and to have more control over it.
So, while you can think about some antagonism between the Usage-Based model and what procurement wants, at the end of the day if your developers are really happy with the product, procurement only has so much power to stop them from using it.
Enterprises are really looking to have more control over their spend. They don’t want to have some shock expense they weren’t able to budget for. They might want some volume discounting given the spend that they have as well.
They normally want to make some sort of annual commitment, they will say “we know our usage levels from the past, we’re going to make X commitment for annual usage.”
If they underuse it, they are contracted in and have a predictable spend. If they are over-using it they can pay more on top or upgrade their plan later on.
I think that’s a win-win for the enterprise and vendor. The enterprise gets more predictability and a discount – they get the feeling of greater control over their spend.
Procurement also feels like they have savings over what spending had taken place before.
For the vendor, you are getting a commitment of a larger roll-out. Normally this kind of customer will commit to a higher level of usage than they were at previously and vendors end up getting more predictability themselves into their financial situation and their cash flow.
Usually, folks are looking at a mix of models, but the annual commitment model is most frequent.
There are some nuances. For example, you could have a model where you are allowing the customer an annual usage allotment vs. monthly. So instead of getting 100,000 text messages a month, you get a million over the course of the year. This controls for some of the seasonality that they might face and allows the customer to use the product longer before seeing overages.
You might also see models where the customer could not see any overages during their contract period and they’ll just re-up for a higher amount in the next year.
There are many ways to use pricing structures and contracting to overcome customer objections.
One thing that is interesting to think about is that before Instagram was purchased by Facebook for $1 Billion, they had around 10 engineers – imagine charging them on a per-seat basis for any sort of developer tool.
It just doesn’t make sense.
Usage models just align a lot more closely with what the customer is doing and the value they are receiving from using a product.
Taking a step back, what are some of the mistakes and pitfalls you’ve seen in terms of companies getting pricing wrong?
One pitfall I have seen is when early-stage companies price too low early on.
That happens a lot.
I think a lot of B2B buyers aren’t as price-sensitive as you might expect. So while you do want to have attractive price points for them to get started and try out the product, once they’ve seen value you also want to capture a fair amount of that value that you are able to deliver.
So companies might wait too long before raising prices or experimenting with higher price-points due to fear about slowing down customer acquisition. I’ve seen first-hand some of the companies I work with raise prices 80%-90% with conversion rates staying the same.
You don’t want to wait until you are a Series C or D company to get to that point, it becomes hard to control burn or invest further in customer acquisition if you aren’t able to capture the right price for what you’ve built.
Another thing that happens a lot is that companies don’t have a great way of landing new customers or expanding customers with pricing, you really want to think about different pricing and packages for the customer journey.
You have to think about where they are when they start, what are their known needs for the product – how do you create an offering that makes it seem frictionless for them to try it out.
If they are a really sophisticated enterprise that treats this as mission-critical, you have to think about how you can stair-step them up in the value chain over time. For a lot of companies, they don’t have a good way of changing their monetization model for the customer over time.
Another one is that some companies don’t have full-time hires that work on pricing. It ends up being a responsibility that falls to the CEO or the management team, so they aren’t collecting data on it or asking customers about or testing it live or piloting it with the sales team.
To me, having someone that can manage pricing, even if it’s just part of their responsibility, is key. Without someone like that, who is going to figure out if your competitor is changing pricing or if you are winning or losing too many deals because of price. You need to collect that information to be able to make decisions off of it, it shouldn’t just be the CEO that’s looking at that.
You mentioned that a lot of companies let someone who is really not paying attention to pricing, who do you think should be in charge of it in a company?
Who is the person, ideally, that should experimenting and doing the research?
In my mind, there are pros and cons with different functions owning pricing. The title of the person doing it is less important than what they do and their skillset.
That said, I think the places where it’s the best fit are Product Marketing because they own voice-of-customer and are great at competitor research, positioning, and launching new products.
New pricing is kind of like a product launch in a lot of ways. So I think it’s a natural fit with that function.
Other groups would be BizOps or RevOps, they own the funnel and are working closely with the sales team, they often have the best point of view around pricing information and insights.
They have the best ability to execute a change or a new test, especially if it’s a strategic Revenue Operations organization.
Other places where it could end up are Marketing or Product.
What kinds of pricing experimentation can companies do in order to find optimal pricing?
So we’re normally not talking about on-site A-B testing, your classic test. It’s not that kind of test, especially because you don’t want to create ill-will and adverse reactions if you are being overly aggressive with testing out pricing for different customer segments
I would say that any kind of online research environment or survey is a great starting point.
You can use techniques like conjoint measurement to figure out what package customers would choose if given different options at different price points. That lets you untangle what the price-sensitivity and value of different product features are.
That will help you not only optimize the price-point but also what packages are right for your customers. And it feels like an online purchasing environment as the customer is going through it.
There’s also a technique called the Van Westendorp, which is another survey technique that’s pretty common in pricing.
I’m a big fan of doing pilots with your sales team. This would be for pricing that’s not published on the website, not transparent. Sales can actually be a major roadblock to the successful launch of pricing because if reps are doing something that’s working, they don’t necessarily want to get in the way of it. They don’t want more barriers to be able to sell a deal.
But you probably have a few early-adopter reps that are forward-thinking, that can sell based on value, and who are already achieving a higher price-point or an above list point for deals. These are the reps you should have pilot new pricing and then measure what the outputs are. It won’t be a true scientific experiment, but I think that gives the team a lot more confidence that they’ll be able to make more money selling with this new pricing.
You might even start seeing pull from the field for wanting to sell that way because they see it’s in their best interest.
So I think pilots, even for as little as one or two months, are an under-appreciated tool in the price testing belt.
What do you think are some low-hanging fruit in terms of pricing that a company can use today to help get them back on track with their pricing?
I would start with a win-loss analysis and having, ideally, an independent person that’s not a sales rep revisit conversations with existing customers and lost prospects to better understand what motivated them in their purchase decision. It helps to understand how the price compared to the alternatives and how they perceived you versus the competition.
I think that really helps crystallize what the sentiment is like with your pricing and how much of a hurdle that is to be able to sell new deals. I think, in some cases if you see price coming up too often as a reason why you are winning deals, that’s probably a negative sign. It means you are attracting the wrong kind of customer that is overly price-sensitive, people that aren’t fully appreciating the differentiated value that you are able to provide.
So I tend to start with win-loss when I do a pricing exercise.
Kyle, thank you so much for taking the time to chat today. It was really great getting your insights into this fascinating topic.
It was my pleasure!