Enhanced UBP monitoring and proactive management tools

Three Things To Know About Usage-based SaaS Revenue. (Not good things.) When usage-based pricing emerged as a popular alternative to seat-based pricing around 2019, overall growth in the SaaS industry exceeded 30%. In that environment, UBP was delivering significant expansion dollars and lofty net revenue retention. Expansion revenue is valuation gold because it is highly profitable, and usage-based pricing (UBP) companies were trading at a premium. However, over time, it’s become clear that two characteristics of usage-based revenue cut in the opposite direction. #1. The most straightforward fact is that when overall economic growth slows, UBP revenue slows more quickly than subscription revenue. Subscription contracts lock in revenue for SaaS companies, even as the need for their products declines. The most recent macro SaaS slowdown was in 2022, and consumption-based SaaS companies took it on the chin first. The data in the graph is from the Maxio Institute and is highly reliable, as it covers over 2,000 companies and is directly extracted from their accounting systems, eliminating self-reporting errors. Growth collapsed from 38% to 8% in four quarters, while subscription revenue declined much more slowly. This data may be ancient history to some, but it’s what happens in a slowdown -- consumption pricing makes SaaS revenue more sensitive to economic trends. #2. Consumption pricing often leads to high customer concentrations and drives a value-destructive phenomenon I call “churning out the top.” I don’t have empirical data for this, but I have observed it several times, and it’s something all consumption-based pricing SaaS businesses should be aware of. Many new customers begin using only a small amount of a product, resulting in a low monthly bill that often goes unnoticed. However, a successful land-and-expand or product-led growth strategy can lead to an exponential increase in usage. The resulting bill can prompt a company’s most successful customers to seek alternatives (either make or buy), resulting in unexpected and significant customer churn. A value proposition that made sense at $10,000 a month may be upside down at $100,000 a month, and this can all happen quickly and quietly. #3. The other challenges of variable SaaS revenue are forecasting and metric calculation. Forecasting is challenging for obvious reasons, and each company faces distinct fact patterns that make learning across companies challenging. Linked here is a blog post that outlines several methods for addressing the problem. Problems also arise when calculating metrics because ARR is less well-defined when revenue is variable. ARR is only known looking backward, and that’s less helpful in calculating current metrics. I also address a few ways to handle this in the linked blog post. Consumption pricing is powerful and a good fit for many products. However, it does come with its challenges, especially for CFOs.