Per Seat or Per Use Pricing: A Framework for Evaluating the Right Strategy for Your Startup
Should you price your SaaS per seat or per use? That was one of the salient questions Madhavan Ramanujam answered in last week’s Office Hours at Redpoint. Madhavan provided an excellent framework for answering this question, in addition to a multitude of other insights.
The first thing to state is that massive companies have been built using both pricing structures: Salesforce and Adobe bill per seat while Snowflake and Twilio charge per use. Deciding which to use involves considering factors such as customer preference and competition.
Many people think of pricing as monetization, but just as important to think through it as an acquisition strategy. Here’s a simplified 2x2 matrix to distill some of the ideas we discussed.
When to use per seat pricing
If your customers demand predictable bills, then per seat pricing is the way to go. The question is do they prefer it or do they demand it? Most customers will prefer predictability, but won’t necessarily demand it. Would they switch if the pricing weren’t predictable? That’s a question worth examining in your pricing research.
If you would like to create switching costs, per seat pricing with annual contracts establishes some lock-in. Usage pricing provides more flexibility to customers to try alternatives.
When to use usage based pricing
If your costs are material and scale with usage like Twilio, then usage based pricing aligns your costs with your customers’ spend. This prevents very large customers from being your worst customers, by generating lots of revenue, but costing you money because the account is gross-margin negative.
If you are pursuing a two step go-to-market strategy with which the first user has a low willingness to pay, but the ultimate buyer has a larger budget, consider usage pricing. This is a land-and-expand motion. But, don’t give the farm away with the first product. One of the most memorable parts of the session is when Madhavan shared with us that the most common pricing mistake in a land and expand motion is to cede too much value in the free/lesser product, scuttling any expansion opportunity.
If customers use the product intermittently and the value is intermittent, usage based pricing works well.
A hybrid approach
There are many companies who employ a two-part tariff: a base platform fee and an ongoing usage fee to capture positive aspects of both types of pricing strategies. Segment is a good example of this. The platform fee establishes a stable relationship and the usage pricing enables the customer to scale up or down as a function of their traffic which might vary throughout the year.
Sometimes, entering the market with a different pricing model disrupts incumbents. Michelin developed a much more durable tires. Taking it to market with the existing pricing model would have meant cannibalizing sales. So the company evolve to selling tire miles to truckers who preferred this model because they could pass the cost on to their customers.
Those are some of the chestnuts from the session, and they provide a rough framework.
The most common question in the session was: how to determine the right pricing strategy for my start-up? In chapter 4 of Monetizing Innovation, Madhavan prescribes the questions to ask, the kinds of customers to solicit, and the analyses to be done to drive to the right conclusion.
I’m grateful to Madhavan for joining us and sharing his insights, and for the audience’s participation in this very popular session the most vexing topic for startups.