Organizations are spending 50% more on cloud technologies than they did just two years ago. The American software market, meanwhile, has only gotten more competitive and saturated, hosting more than 8 times as many SaaS companies as any other country.
As a result of increased competition and differing customer preferences, multiple SaaS subscription models have emerged to try and avoid their software being on the chopping block come budget season.
SaaS companies have the advantage of being able to create, deploy, and adjust pricing models that go beyond a single payment due to the continuous nature of product delivery. How they go about this usually gets grouped into two models: license- & usage-based.
In this post, we’ll dive into the respective advantages and disadvantages of each as well as how your organization can choose which model is the right fit.
What Subscription Models Can SaaS Businesses Offer to Customers?
While there are endless numbers of variables that determine the most profitable pricing model for your organization, they can be bucketed into two groups: whether your customer pays per license or whether they pay based on usage.
Up until the rapid adoption of cloud computing, license-based pricing was the norm for nearly every software organization. Many customers are also familiar with this mode of pricing too as software or servers they were purchasing in the early 2000s would be used or stored on-premise and paid for per license.
Once a license is paid for and procured, this model allowsa business to use the product based on the terms of the deal. For most SaaS companies, this means that their customers have access to the service only as long as the customer remains a paying subscriber.
Advantages of this model:
This pricing model can give SaaS businesses the ability to project potential revenue and control customer usage. They can understand exactly how many subscriptions or licenses must be sold (and at what rate) in order to meet their revenue goals. Customers, on the other hand, can manage their expenses and add performance capabilities as needed.
Disadvantages of this model:
For SaaS businesses, license-based pricing might be leaving money on the table. This model discourages the adoption of the software by charging per user as the customer may choose to buy a smaller number of licenses to control costs. For customers, if they need to scale up or down, they may need to purchase additional licenses or return unused ones, which can be a hassle and incur extra costs.
While license-based pricing models can be highly profitable for the vendor, users can sometimes find themselves holding the short end of the stick.
Prices are determined based on the number of licenses given out and paid for even if the service is not used. The highly competitive nature of the market and a more customer-centric approach has led to the increasing adoption of this pricing model.
Usage-based pricing (UBP) among SaaS companies has been on the rise for the past few years and is expected to become the most common pricing model for software businesses in the future.
Advantages of this model:
Obviously, customers prefer this model over a license-based one as they only pay for what they have consumed. At the same time, usage-based pricing allows users to remain assured of a service that can scale with them as they grow—but they don’t pay high prices for capabilities not used within the payment period.
Disadvantages of this model:
For customers, UBP comes with a lack of predictability in monthly/annual bills and confusion about how much the software costs. On the other hand, for service providers, the disadvantages include difficulty forecasting revenue and potential revenue leakage if undercharging or overcharging customers.
3 Ways SaaS Businesses Can Choose Between Usage-Based and License-Based Subscription Models
There are three main ways to help guide the decision behind which pricing model is best for your SaaS product.
1. Choose a Preferred Profit Maximization Strategy
Your chosen pricing model is heavily tied to maximizing profits. Companies that choose to offer their products using a license-based pricing model must continually develop and sell new products to new and existing customers in order to ensure a continuously-growing revenue stream in the long term.
Each new product must have a compelling value proposition for current and new customers to increase their investments. While this can be highly profitable when done well, it requires significant marketing and upselling efforts from the software company. Software companies that choose a usage-based subscription model are usually free of this pressure.
Offering upgrades and additional features can help keep their customers happy as paying subscribers and growing their usage levels. This can be much easier than attempting to convince a customer to pay for an entirely new software license.
2. Understand the Needs and Wants of Your Target Clientele
Choosing the right subscription model is crucial for maintaining customer satisfaction, managing finances, and ensuring profitability.
The right pricing model can help give customers access to your product at a price point they can justify internally. License-based subscriptions allow businesses to project key financial and operational metrics easily with fixed payment commitments and usage limits.
Usage-based subscriptions provide new customers with an easy and commitment-free way of trying a new product or service for a longer period of time than a trial period would allow. They can use the product in a way that scales with their business.
The best way to understand which model is best? Talk to your customers.
3. Collect and Analyze Industry Information to Keep Up With Offerings Provided by Your Competitors
No business is able to operate within a bubble and remain competitive and profitable in the long term. Every organization must be fully aware of the options available to their customers—in terms of both product offerings and payment models.
Companies that offer products with mass market appeal often have even more competition and might choose to give their customers multiple payment models to choose from. This can make billing and revenue management complicated unless a specialized solution is deployed to simplify these processes. SaaS businesses with a niche product offering might have more freedom to choose a pricing model that works best for their needs.
Each of these pricing models offers software companies a unique set of benefits and presents a different set of challenges.
SaaS companies must find the best way to monitor their income, measure financial health, and manage key financial processes effectively, and their chosen subscription model is a critical component.
If you would like to find out how Place can help SaaS businesses manage financial processes for usage-based and license-based subscription customers, schedule a demo with us today.