Pricing ambiguity is inherent to the subscription model. This can be either empowering or paralyzing. There’s a lot of pressure not to mess it up. You can give your service away for free, and spend years chasing down brutally small conversion rates. You can make things too complicated with too many pricing charts and feature laundry lists. You can err on the side of simplicity with a flat monthly fee, but then you might be leaving money on the table. The list goes on.
But what happens when you get it right? Well, then you’re no longer a victim of circumstance, relying on guesswork and the pricing pages of your next closest competitors. You can create an intuitive growth path from good to better to best that features relevant incentives and tipping points. You can run A/B tests on discrete cohorts within your subscriber base, with the strategic goal of increasing their overall lifetime value. You can optimize.
Here at Zuora, we periodically release benchmark studies (based on anonymized, aggregated data from our customer base) in order to share the winning pricing strategies behind some of the most successful companies in the Subscription Economy. Our Subscribed Institute teamed up with McKinsey & Company to dig deeper into three specific B2B pricing growth levers, and the results are really compelling.
That being said, let’s dig into three pricing strategies that we know to be effective because we’ve seen it in our data. Special thanks to Zuora’s Amy Konary, Carl Gold and Aarthi Rayapura for this study — please feel free to download the complete version.
1. When it Comes to Product Offerings, Less is More.
Piling on more products doesn’t necessarily mean you’re going to grow faster. As a matter of fact, the winners in our data set offer fewer products and product versions than the laggards, when you adjust for overall revenue. Counting products and product versions (ie. bronze, silver, gold) together, the fastest-growing companies have less than one product per million dollars of revenue, growing at an average rate of 31%. Companies that have more than five offerings per million dollars of revenue, however, grow at an average rate of only 12%.
This might sound intuitive — keep it simple, stupid — but it’s still fascinating to see it confirmed in the data. What do SaaS all-stars like Docusign, Okta and Zoom all have in common? Clarity in their value proposition. They focus on doing one thing (identity, security, communication) exceptionally well, and that’s reflected in their product strategy. They may offer a limited number of versions depending upon customer size, but to paraphrase Led Zeppelin, the product remains the same.
2. Choose “Per Unit” Pricing over Flat Fees
The highest-growth companies in our study use a value-based “per unit” pricing model as opposed to a “flat fee” access model. In fact, companies that primarily use per-unit pricing average 26% ARR growth, compared to an average of 19% growth for companies that primarily use flat fees.
So what can a unit in a “per unit” model refer to? It can be anything: seats, minutes, boxes, events, gigabytes, locations, texts, family members, monthly subscription boxes, you name it. It just has to make sense for the service, and communicate a clear sense of value to the user.
3. Usage-Based Revenue: 0 to 25% Is the Sweet Spot
Finally, the research also shows that having some kind of usage component in your pricing model is imperative to driving revenue growth. We’ve found that usage-based pricing boosts year-over-year upsells substantially (1.5X) and also helps to mitigate churn. In general, we recommend that 1–25% of your subscription revenue should be coming from a usage component.
For this part of the study, we compared companies where usage-based pricing comprises different proportions of the total revenue mix: no usage pricing, usage pricing contributing less than 25% of revenue, and usage pricing contributing more than 25% of the revenue.
More than half of the B2B companies in our study employ usage pricing, and roughly a third of those are in the 1–25% range. At Zuora, we use a balance of tier-based pricing based on functionality and complexity, and usage-based pricing based on invoice volume. It’s important to note, however, that many companies don’t launch with usage pricing right out of the gate, and that’s fine. Most of the time you need to watch how people are using your service for a while until you land on a reliable usage metric.
As always, I hope you’re staying as safe and sane as possible, and I hope that this has been a worthwhile use of your time. Thanks again to the team at McKinsey & Company, and please feel free to download the complete report or contact the Subscribed Institute.
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Disclosure: These opinions expressed are mine, not those of the company. The companies mentioned in this newsletter are not necessarily Zuora customers.