Usage-Based Pricing: A Market Niche For Startup Tech Companies?

Griffin Parry detects a sea change in the way software-as-service companies charge their customers. As he sees it, increasing numbers of vendors regard pricing as a strategic lever as they compete for business in a crowded marketplace. In particular, instead of charging fixed subscriptions based on an agreed number of users, they are adopting more flexible usage-based pricing models. “The problem,” he says, “Is that usage-based pricing is difficult to do.”

Parry – along with partner John Griffin – is co-founder of M3ter, a London-based startup specializing in usage-based pricing. Launched in 2022, the company has just raised $14 million in Series A funding to expand its operations in the U.S. and introduce new analytics-based decisioning features.

And you could see this is a bold move. The concept of usage-based pricing has gained traction over the past couple of years M3ter is not the only platform provider in the pricing game. But Parry sees a rising tide of demand and an appetite for workable solutions and that creates opportunities for specialist startups.

Market Tailwinds

In a report published in September 2022, consultancy Bain & Company noted that charging based on usage rather than subscription was “fueling some of the fastest-growing and highest-value SaaS companies,” Snowflake, Datadog and Twilio were among those cited in the report.

It’s a simple enough concept. Traditionally, software-as-service has been sold on a subscription model, with the price staying fixed, unless the plan is changed. The usage-based approach model allows users more flexibility. This might mean cutting down on costs if usage drops or, conversely, the ability to scale up their use of the software – and pay a bit more – when required.

Now that sounds pretty straightforward. After all, it’s a model we may well be accustomed to as consumers when we pay for metered water, electricity or phone calls. So why is this a growth market, providing opportunities for startups such as M3ter?

Parry says there are some helpful tailwinds in the market.

Product Led Growth

“The rise of product-led growth is helping,” he says. Over the past few years, it’s become easier – although by no means that easy – for vendors of all sizes to sell to enterprise customers by finding corners of the organization that are willing to try out a product, often on a free-trial or freemium basis. The idea is that once some people start using it, others within organizations will follow. A usage-based approach to pricing can be helpful, not least because it allows end users to scale up usage relatively easily.

Then there is the macro-economic situation. We are living through difficult economic times. Buyers of software products are looking more closely at pricing. In particular, they are looking for pricing models to suit their needs.

But here’s the question. Given that usage-based pricing is not in itself a new concept and that aforementioned utilities are among those who have been doing it for years, why don’t SaaS companies simply build their own billing systems?

Pain Points

Parry acknowledges that there is more than one way to create a usage-based offer. “You can build your own platform or do it using a spreadsheet,” he says. “And in the past companies have had to do it for themselves.”

But, he argues, it’s not easy to get right. When running a previous company – Gamespark – Parry says he and co-owner John Griffin dabbled with usage-based pricing but it was difficult to do. When the company was sold to Amazon, he worked at AWS (Amazon Web Services). Again, he says he saw difficulties implementing a usage-focused approach.

One of the major challenges, he says, is to ensure that everyone has the usage data. That includes, not only billing departments but also customer facing staff. “Anyone who speaks to customers needs to have the data at their fingertips,” he says. It also needs to be transparent for customers. Unless they know why they are being charged a certain amount, they may not be happy. So any system needs to combine usage and price data and distribute it to whoever wants and needs it. “If you make errors, you get revenue leakage and a poor customer experience.”

Strategic Pricing

There are of course non-technical challenges around pricing. It may well be the case, a vendor can charge on a usage basis, but is that actually what the bulk of customers want? A subscription-based approach may be a bit of a blunt instrument, but it is predictable. Finance department personnel can sleep easy knowing that costs aren’t going to jump because of a spike in users.

Bain’s report found 80 percent of users saying usage pricing delivers services that are better aligned in price terms to the value they receive. But it is important to get the model right. That could be simple as pay-as-you-go or a model that moves the end user through tiers of payment depending on activity.

For his part, Parry acknowledges that he is not an expert in strategic pricing. The role of M3ter and its competitors is to provide their customers with the means to align pricing with the demands and requirements of users. Customers include Stedi, Sift and Clickhouse.

The Data opportunity

Parry also sees a data opportunity. Part of the Series A money will be spent on adding analytics features. As he sees it, the customer usage data can be deployed to underpin a huge amount of automated decision making around pricing.

Usage-based pricing is on the up. Parry says that in 2020, 34 percent of software companies used the model. Today it’s 61 percent. Uptake has been in part driven by the economic environment which has forced both users and vendors to focus on the cost equation. However, when the world economy improves, he believes the trend will continue.

For startup companies working in the software arena, the concept may help them with their product-led growth strategies. It also creates a growing market for flexible pricing enablers.