Tips on building a hybrid pricing model for SaaS

I write about the financial implications of various SaaS business practices and metrics, so it’s easy for me to elaborate on the financial benefits of hybrid pricing -- it provides a steady base of predictable subscription revenue while easily allowing for expansion revenue to boost NRR, growth, and profitability. It’s pretty amazing if you can pull it off.

And while that’s all great, if hybrid pricing is not a good fit with the value your product delivers, it will do none of the above mentioned things. Deploying hybrid pricing, because of its seductive financial rewards, without fundamentally aligning perceived customer value to price will fail.

Definition of Hybrid Pricing

For my purposes, hybrid pricing includes at least two pricing metrics, one being usage-based (UBP).  There are other ways to define hybrid pricing, but incorporating some form of UBP is what makes hybrid pricing challenging and powerful.

Starting from square ___.

Most SaaS companies don’t start with hybrid pricing from day one because their initial product is simple, and so is their capacity to price and bill. So, everyone’s starting point for developing hybrid pricing is unique. I would also suggest that the process is inherently specific to each company and product. I will outline best practices and tips from experts in the remainder of this article, but this is not a recipe; it’s more of a cooking class.

Selecting the value metrics

Most successful hybrid pricing models have two to four value metrics packaged in various ways. The most crucial part of building a hybrid pricing model is selecting the proper value metrics. It’s likely you know, or think you know, one or two of these metrics already, but it makes sense to occasionally step back and re-confirm your understanding of what users really care about.

Each pricing metric should fit the criteria below. However, the financial rewards of hybrid pricing are amplified if one metric is relatively static, like seats or users, and the other is usage-based. This combination provides revenue that is sticky on the downside but has frictionless expansion potential on the upside.

The criteria below are generally agreed to be important when selecting a usage-based pricing metric. Credit to James Wood of m3ter and Chis Mele of Software Pricing Partners, as well as guidance from the Snowflake team, for helping pull together this list which I have condensed and streamlined.

1. Is the metric tied to perceived value?

2. Is the metric easy to understand?

3. Is the metric linked to growth?

And there is one disqualifying criterion:

4. Will pricing tied to the metric constrain usage by the customer?

How you develop a list of metrics from the criteria above is up to you. Many experts suggest engaging in external market research, which can make sense episodically or with the release of new functionality. For most companies, however, internal resources from sales, product, marketing, and customer success should be close enough to the customer to build and refine a list of pricing drivers. 

And as with all things in software, borrow liberally from your competition. Review the websites from as many SaaS vendors as possible to draw inspiration on the various metrics that can be measured and tied to pricing.

Usage-based metrics currently used by major software vendors currently include:

What about “seats”?

Seats or users remain the single most popular pricing approach; for some products, it makes perfect sense. If the product's value is delivered through individual contributors, then seat-based pricing does an excellent job linking value to pricing. Salesforce Automation is the classic example, as is Customer Success Management. The challenge in these segments is finding the usage-based metric to complement seats. 

Do no harm

Criteria number four above is essential to keep in mind. Expansion revenue will be limited if a customer constrains their usage because of a pricing metric. The best way to address this is to find sufficiently small and granular metrics. Metrics measured in hundreds or thousands have small incremental costs, which customers don’t consider. This concept is also relevant to pricing tiers. The wider the tier, the more likely customers will pay attention to it and work to stay below that level. Atlassian improved its pricing substantially by eliminating tiers completely.

Tracking and analyzing the value metrics

Once a list is built, you need to track the potential qualifying metrics for some time before you can understand their utility for pricing. This is where the finance team plays a role in modeling what various pricing scenarios would look like based on past usage behavior.

If your business has seasonality, you may need to track usage for an entire year, but in most cases, a few months will suffice.

As you study usage, different patterns may develop for different use cases, and this needs to inform your metric selection and packaging. SaaS companies typically optimize pricing for the most common use cases, although, in some circumstances, it makes sense to build separate pricing for different customer sets.

Closely analyzing various usage-based metrics across your customer base is a healthy exercise, even if you don’t use most metrics for pricing. Some valuable insights are likely available here for product management,  customer success, and even sales. This is excellent data to have when negotiating a renewal, for example.

Packaging

Properly assembling the pricing metrics into coherent packages to encourage adoption and expansion is paramount and difficult. Again, look at successful packaging in the market today and borrow from the best. Below is a list of suggestions on packaging that I put together with James Wood. James now works at the pricing and billing platform m3ter and previously worked at Insight Partners and Segment, where he designed and implemented pricing programs.

1. Simplify, simplify, simplify: Pricing plans with multiple metrics can quickly become complex, and it takes intentionality to keep them simple and intuitive.

2. Focus on how rather than how much: Your pricing metrics are already doing the hard work of increasing the price customers pay as they scale usage. Orient packages mostly around new features and use cases rather than additional metrics.

3. Be customer-led: Design your packages around customer segments and the journeys customers take as they grow into using your product. A good rule of thumb is that each new customer should be able to select themselves into the right package fairly quickly because that package matches their expected usage profile. This minimizes the risk of choice paralysis hurting your conversion.

4. Iterate: As your product and market develop, customer journeys will change, and your packages also need to. Over time, expect to cascade premium features down through packages (as you add more into the higher tiers) and continually check that your packages are working as expected so you can make proactive changes.

Don’t stop

Pricing is one of the most potent economic levers in a business. Revisiting it only occasionally sub-optimizes your company's growth and profit potential. This is particularly true with hybrid pricing that contains rich usage data. Your customers constantly provide you feedback on their monthly bills – use it.

Monitoring customer usage is both tactical and strategic. Tactically, it’s important to identify outlier usage and get in front of unexpectedly large customer bills. A mid-month conversation with a customer about how they could save money is much better than an end-of-month surprise bill.

Strategically, monitoring usage across a customer base helps identify new use cases, tweak packaging, and refine ideal customer profiles. Collecting and trending usage data over time also allows you to simulate the potential impact of future pricing changes.

Hybrid pricing is hard

As outlined here, selecting the right pricing metrics and packaging them into intuitive offerings your customers will adopt and use takes careful consideration. It’s also clear hybrid pricing takes more ongoing support and monitoring than traditional subscription pricing.

Executed well, however, the financial benefits of hybrid pricing are substantial and are worth the up-front and ongoing investment. Small increases in NRR compound and significantly impact a SaaS company’s value.

Hybrid pricing also forces organizations to take a much closer look at how customers get value from their products. This might be the best long-term ramification of the hybrid pricing model. Nothing focuses attention on the customer more than linking their usage directly to your company's top line.