The world of SaaS is strange. On one hand, SaaS companies are constantly on the cutting edge of product development due to their proximity to the end user. On the other, it seems small details will slip through the cracks and go untouched for years.
I read The Road a few weeks ago and it got me thinking about how easily and naturally humans adapt to change. It’s a haunting story about a man and his son navigating and attempting to survive a post-apocalyptic world, but that’s not really the point. It’s a book about adaptation. And at risk of condensing a literary theme that probably went far over my head, it is this quality that I’d like to explore below.
We’ve seen tremendous change in the SaaS ecosystem over the past few years (I wrote this sentence before SVB imploded). I believe we’ll continue to see more in the coming months and would wager that many industry-wide corrections will be centered around pricing strategy - specifically, hybrid pricing.
Before I make the case, let’s take a quick (and grossly oversimplified) trip down memory lane…
Close your eyes. Take a deep breath. Now, try to remember the first time you purchased Microsoft Office. If you’re over 35, you’re probably remembering walking around a Staples, holding a circular device formerly referred to as a CD-ROM. When you bought this device, you went up to the cashier, paid, they handed you the CD, and you both went your merry way.
Now, jump forward a few years - you’re jamming out to Green Day on your iPod Nano, flipping through the technology pages of the Wall Street Journal. You read Microsoft is getting ready to launch a new and improved product called Office 365, Google has launched a suite of apps including Gmail and Docs which are taking the consumer market by storm, Amazon is not just selling books, they’re offering up an innovative web service, and we’re seeing hundreds of new “SaaS” startups follow in the footsteps of a young behemoth called Salesforce.com. And they aren’t hosting their products on CD-ROMs.
They’re hosting them in the “cloud”.
These SaaS startups don’t totally know how to monetize their fresh new ideas, so they think “hey, I remember buying Microsoft Office, why not apply a model similar to that?”. And many of them, by the hundreds (and soon thousands), will model their monetization strategies off of an outdated, fixed and/or “per-user” pricing structure for years to come.
What many of them will discover over the next few years is that one of the luxuries of the cloud is the ability to ingratiate themselves with the value of their customers thus monetizing their usage rather than users. They’ll learn that, in most cases, charging solely per user or a standard fixed pricing rate is grossly devaluing their products and if they instead charge on a different value metric, they’ll see ARPU and NRR skyrocket.
By the time we get to 2022, this pendulum will have swung so far that nearly half of all SaaS companies will have experimented with usage-pricing in some capacity. They’ll see higher retention rates and higher expansionary revenue leading to greater valuations than we’ve ever seen in the subscription ecosystem.
Then, to the chagrin of these SaaS leaders, funding will dry up, customer spending will decline, many will lay off 8-20% of their staff, and fears of a highly variable, usage-based pricing model will wake up even the bravest CFO in a cold sweat.
Out of the dust, a model used by a subset of SaaS companies will emerge to the masses. It’s called the hybrid model.
The hybrid model is, as it sounds, a blend of fixed subscription pricing and usage-based pricing. It protects SaaS companies from highly variable revenue forecasting while also capturing incremental revenue from customers using the product more than others. In a world where the goal posts have largely moved from growth at all costs to de-risking, the hybrid model provides a welcome antidote.
Take New Relic, for example. If you haven’t heard of them, they're a company that allows developers and IT teams see how their apps are performing in real time and spot any issues that might be causing problems for users. And they have a pretty phenomenal pricing model. I’ve dropped three key screenshots below from their pricing page:
First, notice how they offer at least some product functionality upfront for free. Up to 100GBs /month, always free. Great acquisition funnel.
Second, as you scroll through the pricing page you’ll notice there’s a fixed fee associated with each tier, priced per user in two categories: Core and Full Platform users. Again, depending on the type of target buyer or user, folks will ascribe value differently. This is another great way of establishing a fixed subscription fee based on value.
Third, this is where New Relic captures value best. Rather than being satisfied with a fixed subscription model, they charge $0.30 per GB beyond the 100GB threshold given to everyone. It’s a terrific blend of a fixed pricing model married with variable usage. This way as folks use the product more (thus ascribing incrementally more value), they pay more.
Another company doing this well in a different way is GitLab. GitLab offers a platform for dev teams to manage their code, automate their software delivery pipeline, and collaborate with each other. If you check out the screenshot below, you’ll see they have five primary value metrics: individual users, storage, GB transfers, CI/CD minutes, and users per namespace.
They give all of these metrics at a capped rate in each tier but for customers that need more usage, they charge an additional, incremental fee:
This is another effective model for a few reasons.
It allows their buyer to self-select which tier they believe they’ll fall into based off of historical usage.
In the event that same buyer reaches 100% capacity for CI/CD minutes, this model allows the buyer to opt into purchasing more, thus increasing the value ascribed by the end user and retained by GitLab.
It gives GitLab a forecasting blanket. Imagine a scenario where GitLab instead chose to offer only their free plan, but rather than capping CI/CD minutes, they charged a $.002 fee for every minute. This might work exceedingly well at times (like during the bull run of 2021). Other times though, they may struggle to map an accurate revenue forecast for their board on a quarterly basis.
Like point #3, it gives GitLab’s buyers a forecasting blanket as well. Even though it may be cost advantageous at times, most buyers right now don’t want high variance in accounts payable forecasting.
New Relic and GitLab aren’t the only companies doing this effectively. According to OpenView, 46% of SaaS companies are already starting to entertain hybrid pricing; folks like AutoDesk, Algolia, HotJar, ZoomInfo, and Klaviyo (not to mention the emergence of AI in SaaS - Jasper, Canva, OpenAI, Craft, etc). We’re going to see many more SaaS companies adopt models like this in the next 12 months.
Part of my job is helping SaaS leaders with their pricing strategy and one of the clearest threads I can draw in 2023 is the need for operational efficiency and proper forecasting while also doing right by buyers.
Few models capture this ethos better than the hybrid model.
As is often the case, things will change, and we’ll adapt as we should. Right now though, it appears the years of pricing adaptation in SaaS have led us to some form of the hybrid model. We’ll see what comes next.
See you in 2 weeks!
-Evan
Great information that was enjoyable and easy to stay engaged in.