Impact Pricing Podcast

Ep145: Usage-Based Pricing: What Most SaaS Businesses Need to Know with Kyle Poyar

 

Kyle Poyar is the Vice President for Market Strategy at OpenView since 2016.  He is responsible for helping OpenView’s portfolio companies accelerate top-line growth through deep insights.  He leads segmentation, positioning, channel/partner strategy, new market entry, and packaging/pricing initiatives, partnering closely with portfolio leadership teams. He also covers OpenView’s SaaS metrics and benchmarking research.  

Previously, he worked for Simon-Kucher & Partners as a Pricing Consultant for six years.  Kyle earned his AB Economics & Environmental Studies at Brown University.  He graduated Magna cum Laude with departmental honors in Environmental Studies.

In this episode, Kyle shares how you have to charge based on a pricing metric that has a lifetime value to your business.

Why you have to check out today’s podcast:

  • Find out the many nuances of usage-based pricing and see where customers are seeing value and provide more of that
  • Understand the nuances between consumers and businesses in terms of how they make purchase decisions so you create a long-term value and availability to expand customers over time
  • Find out what forms part of your ARR (Annual Recurring Revenue) and track them to see the health of your business

              

Really do the work to figure out what are the one or two usage-based metrics that correspond with the value your customers see. You might find that, hey, these are things where the customers you keep or that spend more tend to consume more of that, as opposed to the ones who churn tend to, you know, consume less of it. And think about how you could maybe incorporate that as like a limit or a fence from one package to the next. 

Kyle Poyar

           

Topics Covered:

01:39 – Defining usage-based pricing

02:34 – Usage-based pricing being a customer-friendly model

04:40 – Is buying a hamburger at McDonald’s a usage-based pricing?

05:17 – Pricing metrics as also usage-based pricing

06:47 – The nuances to think about in usage-based companies

08:04 – That rollover minutes that is giving folks that peace of mind

09:10 – Understanding usage-based subscription tiers

10:23 – Kyle’s interpretation of Zuora’s report where it says 25% usage and 75% subscription

11:48 – Why minutes are probably not the best value driver or value metric for phone companies

13:50 – What is part of your annual recurring revenue (ARR)

17:11 – Lifetime value of customer

20:10 – How credits can get in the way of simplifying customers’ buying experience

23:34 – Are credits related to the value the customer gets or to the usage companies are using

25:50 – Credits as used and shown in arcade games

26:48 – Piece of pricing advice that can greatly impact one’s business

         

Key Takeaways: 

“You don’t necessarily want to price out usage. If your usage metric is declining rather than increasing, you’d rather make a creative move and say, hey, we’re going to give you unlimited usage, but we’re going to charge you per gigabyte of data.” – Kyle Poyar

“While you don’t want to have unprofitable customers, you really need to simplify the buying experience for them. And trying to align how you charge with how someone sees value, and how your cost structure is set up is really on you. It’s not the customer’s responsibility.” – Kyle Poyar

“A good way of thinking about credits is building a retainer for a customer and having an agreed upon rate schedule at which they will draw down that retainer.” – Kyle Poyar

                   

People / Resources Mentioned:

                   

Connect with Kyle Poyar:

                    

Connect with Mark Stiving:   

                          

Full Interview Transcript

(Note: This transcript was created with an AI transcription service. Please forgive any transcription or grammatical errors. We probably sounded better in real life.)

Kyle Poyar 

Really do the work to figure out what are the one or two usage-based metrics that correspond with the value your customers see. You might find that, hey, these are things where the customers you keep or that spend more tend to consume more of that, as opposed to the ones who churn tend to, you know, consume less of it. And think about how you could maybe incorporate that as like a limit or a fence from one package to the next.

[Intro]

Mark Stiving 

Welcome to Impact Pricing, the podcast where we discuss pricing, value, and the manual relationship between them. I’m Mark Stiving, today our guest is Kyle Poyar. And here are three things you want to know about Kyle before we start. He worked for Simon-Kucher & Partners for six years, which means he actually understands pricing. He joined OpenView, a venture capital firm over five years ago. And he was our guest on Episode 20, which was over two years ago. Welcome, Kyle.

Kyle Poyar 

Thanks for having me, Mark.

Mark Stiving 

It’s going to be fun. And we’re going to talk about usage-based pricing. If somebody wants to know how you got into pricing, that’s on Episode 20. They can go back and listen to that one. But this concept of usage-based pricing, I think I get it from a high-level perspective. But there’s so many nuances that make me really curious. I am excited to talk to you about this. So, first one, have you defined usage-based pricing?

Kyle Poyar 

Well, at the highest level, usage-based pricing is where a customer pays for a good or service based on how much they consume of that service. It’s not, you know, all that surprising in our consumer lives. We were used to paying for utilities that way, many of us might pay portions of our cell phone bill that way. I think we can all remember, well, depending on how old folks are. Remember paying for cell phone bills based on minutes of talk, and now based on gigabytes of data. So, it defines that mentality towards B2B software buying.

Mark Stiving 

Okay, so the concept, I love the examples you gave, because I was going to throw some of those back at you for a second. And what I love about it is it’s not necessarily a new concept. It’s really kind of evolving this concept of subscriptions and adding something to it, is that a reasonable thought?

Kyle Poyar 

Absolutely. And one thing I would clarify for folks is that it’s not necessarily an either or, folks could go all the way down the path of purely leader billing, that is pay as you go based on customer’s exact consumption. But for many folks, they find a middle ground where there’s usage-based subscription tiers, where you commit to a certain amount of usage, and you get a predictable subscription fee for that, and then you can move up or down upon renewal. So, I would say that this is not sort of a black or white decision. And then the other thing I would add is that usage-based pricing is a way to actually be extremely customer-friendly. And so, there’s a lot of folks that might have concerns on how customers are going to react to it. And some of those could be very valid. I mean, some folks might be hesitant to pay when there’s not a set predictable cost. But I would argue that from a buyer’s perspective, you only want to pay if you’re actually using a product and seeing value. Otherwise, you might have a high shelf ware where you’re paying a subscription and not actually seeing the results from that subscription that you wanted to see. And so, in my mind, it’s an extremely customer friendly model. And more and more folks are starting to wake up to that. I think, if you follow the GSA schedule, which is one of those things for us, pricing nerds, because the GSA kind of negotiates all of these agreements with different vendors, software included, and controls a huge amount of spend in the economy. They’ve even sort of gotten on board lately, they released an updated draft policy where they’re finally incorporating consumption-based models into the GSA schedule for the first time and it’s because they see it as a way to avoid shelf ware, drive a better return on technology spent.

Mark Stiving 

Okay, all of that makes sense. I want to go back to the basics for just a second though. If I buy a hamburger at McDonald’s, is that not usage-based pricing?

Kyle Poyar 

You can see it that way as well. If you’re paying per unit, there’s no subscription, at least currently, although I believe Panera and some others have started playing the subscription model. Yes, I would think of it that way.

Mark Stiving 

Okay. And I just asked the question because then is it fair to say a usage-based pricing model, what we’re really saying is what is the pricing metric? And I think you and I talked about pricing metrics a couple years ago when we did this. And the pricing metric is what is it that we’re going to charge for? Is that truthful?

Kyle Poyar 

Exactly. That’s what it is, so I think different from the McDonald’s example, for software companies, folks tend to use the product in a recurrent way, how I guess McDonald’s, you could get a fan, they are recurring users as well. And so, you’re looking at different ways that folks consume the product or see value from it. And you’re looking for a specific metric that you can monitor and track yourself, meter-based literally, and that becomes the basis for what a customer pays for that. That’s sort of the pricing metric. And these are really complicated to figure out, what’s the right model, because you know, when you look at usage metrics, it’s not as simple as charging per user or fee, you’re looking at maybe data consumption, and maybe number of contacts, percentage of spend, compute, maybe there’s a whole host of metrics that a lot of companies even come up with their own metrics, or can’t decide on just one, call it a credit pitch is an amalgamation of other metrics. If that is a key area to focus on, if you’re thinking about usage-based pricing,

Mark Stiving 

I want to come back and talk about credits in a second, because I think it’s a really important concept for us. But first, some examples of usage-based companies that I think are purely usage based, are Uber, Lyft and AWS. I think those are ones that everybody knows of. Would you agree that those are just purely usage-based?

Kyle Poyar  

Yeah, those are great examples. Although, going back to the gray area, for a second, with AWS, you can buy on demand pretty much all of their services, so pay, and I completely use the usage basis. You can also commit to a certain volume, but then draw down that volume flexibly and sort of pay flexibly, but you get a discount for making that commitment. And it’s normal to use it or lose it. Like if you don’t use the commitment by the end of the year, you don’t get your money back. And then there are models, where it’s almost like a gift card in exchange for a discount in the McDonald’s analogy. And then they offer models where you can make a commitment purchase annually as a kind of prepay, which looks like a subscription. But it’s a usage-based subscription. Because if you exceed your usage, you’re going to be paying more and overage fees. So even in these usage companies, there are nuances to think about.

Mark Stiving 

Yeah, what’s funny is, as you describe every one of those nuances, almost every one of them. It reminds me of cell phone bills, and all of the iterations of cell phone bills we’ve seen over the course of the years, right? It’s the use it or lose it minutes and it’s pretty fascinating. We’re trying to guess how many minutes we’re actually going to use and

Kyle Poyar 

Then the rollover minutes, too. I mean, you think that that went away. But if you read into, Netflix is one, they’re probably one of the hottest companies to go public in recent years and have a usage law, they actually have a slide in their investor relations stack. We are not a subscription model; we are a usage model. And they just call it out for kind of full clarity. And they do have a notion of rollover, where you commit to a certain amount. But if you don’t consume all of that, within your commitment period, they do have some possibilities to roll over your usage, which gives folks that peace of mind. So, it’s fascinating to see things like that come back.

Mark Stiving 

Yeah. So, one more question on defining usage. Another thing that I often think about then is what about companies who create tiers of usage? So, think back to cell phones again, right? I used to be able to buy 100 minutes or 200 minutes. And so, I’m really paying usage, but I’m really paying a subscription. How do you think about that?

Kyle Poyar  

Yeah, in my thinking that would be a usage-based subscription tier. And so ultimately, folks are buying based on how much they consume the product. But it’s packaged up in a way that feels more predictable, gives folks a decent headroom, where it’s kind of in between. It’s not a kind of classic SaaS subscription, but it’s not a classic usage-based-pay-as-you-go model either. And that is a very popular place for a lot of folks. So, I am about to release a new benchmark report around the state of usage-based pricing where we’ve surveyed nearly 600 software companies, and we found that among the folks who have usage-based pricing, they’re actually divided pretty equally between whether they say they’re mostly kind of largely usage-based model, this kind Pay-As-You-Go contact versus mostly usage-based subscription tiers.

Mark Stiving 

Hmm, okay. Did you look into Zoura’s report where they came out and said that the optimal was 25% usage and the rest subscription? And was that true usage by the use or by the tier? I don’t want to put you on the spot on that. But I was curious if you saw that?

Kyle Poyar 

You know, I saw some of their findings there. I don’t know all of the details around how they qualified everything. In my view, there is a, I think they have a vested interest in subscriptions. I mean, they’re called, they’ve coined the term subscription economy. And from my vantage point, a subscription can still be usage-based. And so, you can have a usage-based subscription. And so, this model of this idea of 75%, subscription, 25% usage is sort of an odd concept. That sounds to me, like the best companies that are growing the fastest, have a usage-based model, but sell customers or give customers the option of a usage-based subscription, or give me the option of having some flexibility of paying as you go or topping up that subscription with purely usage, or one-off non-recurring revenue. And so, I guess my interpretation of the report would be probably different from the way they interpret it.

Mark Stiving 

Okay, that’s fair. So now we started this conversation out, and you said, you think a lot of customers would rather pay usage than a subscription? And so, I want to push back on that, just to get your opinion. Why did we see tiers of minutes go away? And everybody gets all-you-can-eat cellphone minutes now?

Kyle Poyar 

First off, I would clarify, there are nuances between consumers and businesses in terms of how they make purchase decisions. And when you know, you’re buying for yourself and your family, you’re looking at kind of a very different set of decisions, or decision drivers versus if you’re buying on behalf of a business, where you’re looking at ROI, and kind of total cost of ownership and all of that stuff. But on the minute side, specifically, one thing that I would point out is that minutes are probably not the best value driver or value metric for phone companies. And so, as folks started spending less time actually calling people by texting or emailing, minutes, no longer was a really great way to monetize folks. And then actually minutes, and I don’t have all the data on this, but I would suspect, overall minutes of talk have gone down over time. And so, you don’t necessarily want to price out usage, if your usage metric is declining, rather than increasing. You’d rather make a creative move and say, hey, we’re going to give you unlimited usage. Well, but we’re going to charge you per gigabyte of data that you know has a much better kind of long-term value and availability to expand customers over time, in a way charging based on a declining metric just doesn’t do the same thing.

Mark Stiving 

I think that is a brilliant answer. And I would be shocked if I make one phone call a day. I’d be shocked.

Kyle Poyar 

We’re all on Zoom these days.

Mark Stiving 

Absolutely, absolutely. Okay, another really fascinating topic, I read your article in your newsletter this morning or yesterday, on Toast. And what I saw is fascinating is ARR. And so, most of us think of ARR as annual recurring revenue, but they’re going to calculate it slightly differently. I’ll let you explain it because you’ll do a much better job than I will. And then I’m going to ask you why that makes sense.

Kyle Poyar 

Yeah, exactly. So, there’s this sort of classic question that many companies have faced off, what is ARR? Is that the subscription software revenue component? Or can you start to think about other revenue streams that might operate as if they’re recurring as part of your ARR, and so the way Toast defines it is that they’re looking at both kinds of subscription software component of spend which is generally subscription agreements with their customers. And then they also take FinTech or payments that they smooth things out by looking at it really fits trailing for months. And you know, from their vantage point, if you kind of think about a restaurant, a restaurant probably has fairly consistent payment volumes that happen over the course of a month or over the course of a year. And so, when you think about, if you’re in Toast position, if that customer is going to keep using your product next year and paying you subscription fees, they’re also paying you those payments and those FinTech fees, and you can be pretty confident, you know, assuming they don’t go out of business and cancel entirely. You can be pretty confident about what that revenue is going to look like from both streams. And so why wouldn’t you think about both revenue streams as part of your total recurring revenue? And so, I think that there’s a lot more openness to broadening the classic definition of ARR. And folks are maybe calling it a different thing, because it’s no longer classically annual recurring revenue, and maybe annual revenue run rate, or annual recurring revenue, is another term that I’ve heard recently. And it better reflects these different revenue streams that have similar characteristics of a subscription just aren’t classically subscriptions.

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Mark Stiving

So, in a lot of ways that makes sense. So, let’s jump to let’s go to Uber just because it’s an easy one to understand. Somebody who lives in New York City, they take Uber twice a day to get to work and home or whatever they’re going to do. Uber could take a look at that individual and say, look, they spent, you know, $400 with us for the last three months each month. So, I’m going to expect they’re going to spend $400 going forward as well. And so even if that’s usage-based, it kind of makes sense to think of it as I’ve got a customer, I want a customer, I’m serving a customer.

Kyle Poyar 

Well, I think that’s where folks do see, you know, you look at the lifetime value of a customer. And I think they could probably show characteristics that people continue to buy and might spend more over time. And when you think about metrics, like ARR, you track them, because you want to understand the health of the business and also help other folks who invest or be constituents to understand the health of the business. And you’re looking to kind of put that in perspective. And so, for Uber, if they’re spending a bunch on sales and marketing to acquire a customer, that’s not just to acquire a customer who’s only going to spend money in year one, they’re going to keep spending money in year two, year three, year four, year five, where I think that folks can get into trouble though, and I would capping out this that generally for me, I get hesitant about any revenue stream where the net retention rate is below 100%. And so, if folks are spending the same amount next year, the year after the year after, and you have kind of cohort data to prove that or if they’re spending more next year in the year after, then it really does operate like recurring revenue. But if revenue is really episodic, or they’re sort of a one-time spike on a project basis, and then it goes away. If you start operating as if that’s ARR, it could be extremely misleading around the health of your business, because you might be taking one-off projects, almost like consulting revenue streams, and treating it like it’s recurring software revenue.

Mark Stiving 

Right. And the real difference between the recurring revenue or, or repurchase however we want to look at is that I didn’t have to go out and win a new customer. Whereas if I have to go win a new customer is to start someone from scratch, that’s usually expensive, right? Customer acquisition costs are relatively high.

Kyle Poyar 

Exactly, exactly. And generally, you know, it’s businesses specifically have really great margins on an ongoing basis. And so, a lot of costs come down to sales and marketing route, cost of goods sold or kind of what their infrastructure looks like.

Mark Stiving 

Yep, absolutely. Okay, now for the hardest question of all, I want to talk about credits. AWS charges on credits, and I kind of get it and I could kind of justify AWS doing it mostly because Amazon has built a reputation of low margin, they’re going to, you know, they’re doing a cost plus with a relatively low margin pricing, and that feels reasonable to me. But I think most other companies who are doing credits are essentially trying to cover their AWS or as your costs on top of trying to get a little bit of value for what they serve. So, I see credits as a cost-plus pricing mechanism. And it’s confusing to their customers and our customers don’t know what they’re doing. So, tell me where I’m wrong?

Kyle Poyar 

Well, I guess let’s get back. So, with credits, a lot of the reason why that has been invented is, there’s multiple different metrics that a company wants to use to set pricing. And so, in Snowflakes case, you might be based on gigabytes of data volume, plus compute power. And the more of those metrics that you have, the harder it is for a customer to understand their usage, because all of a sudden, they have to figure out your usage for each of these metrics separately, it can feel like they’re being nickeled and dimed. It can feel like they’re overpaying. If they commit to a certain level for a discount, they might make an over commitment in one area and under commit another area, which can be really difficult for sales reps to explain. And so, for folks that have these kinds of complex pricing mechanisms, a lot of times you see them, say, hey, we’re actually selling on credit spaces where we think we’re going to need about $50,000 in credits, you can spend that $50,000 however you want across whatever metrics. Now, I think that it makes a lot of sense in an instance, where you’re selling multiple products that are delivering value in different ways to customers. And that way, customers have a lot of flexibility to consume whatever product that they want. And you’re not really just specifically locking them into one product. And I think it’s a way to, you know, help bring customers on with sudden sense of predictability, like they’re not going to have, they’re going to buy enough credits to last you know, several months and not see kind of shock overages, and then they can kind of figure out their next commitment from there. But I think it’s a good way to add this predictability, peace of mind and just a better customer experience for folks that have complex pricing mechanisms. Where I think it can run into trouble is, or folks can run triple is, exactly as you mentioned, when it’s really, they look at their specific costs, and all of the different drivers of their costs, as opposed to what’s really creating value for a customer. And they kind of do a mathematical formula on how we can take our costs, and every any certain way that our costs are accrued over time. And how do we make sure that we have no customers that are under a certain margin threshold, and it’s kind of truly cost-based pricing? To me, that’s not the best kind of way of thinking about credits. Because while you don’t want to have unprofitable customers, you really need to be simplifying the buying experience for them. And trying to align how you charge with how someone sees value, and how your cost structure is set up is really on you. It’s not the customer’s responsibility. And so, I like to not try to pass internal complexity onto a customer. It’s not their responsibility.

Mark Stiving 

Yep. Well, I’ll certainly agree with that. But I want to go back to I’m not sure I agree with the things you said that were good about credits. And so, I want you to explain to me, as a buyer, how can a buyer say these credits are related to the value I’m going to get? Or what I often do is I often look at two or three different customers who get drafted dramatically different amounts of value, are they truly paying different amounts, because of the value they get, or because of the usage they’re using?

Kyle Poyar 

Well, we could be thinking about this differently. Like if I were to take an example of Twilio as just an example. And I don’t necessarily know I’m not intimately familiar with how they charge but they have text message based products where the price is based on the number of messages that you send, they have email-based products through their purchase of SendGrid that are based on I think emails or API calls, they have purchased segment, which has its own pricing structure. And then they have other products within their arsenal, you could buy phone numbers, you could buy, you know, international text messages, as opposed to US-based text messages. And so, from a customer standpoint, they could do the Math and figure out how much of each line they need, and have this sort of Chinese menu approach of, I need 10,000 text messages in the US 5,000 in each of these markets, I need this many phone numbers, I need this much XYZ. Or you could say hey, you have really fair pricing, and we trusted, we’re only going to pay based on what we actually use and that’s great. But let’s just get started with like a retainer of 50,000 credits, and those, it’s more of like a $50,000 retainer, and that will be flexibly drawn down based on how much we consume at this rate that we think is fair, we agree to it. And you know, for doing that, we’re going to get a 20% discount. That all of a sudden makes the purchase process so much easier. And you’re not nickel and diming, or trying to get false certainty about something. And you’re able to have a very complicated multi-product sale in a way that feels less painful. And so, I guess in my mind, a good way of thinking about credits is building a retainer for a customer and having an agreed upon rate schedule at which they will draw down that retainer.

Mark Stiving  

Yeah, so I’m almost embarrassed to say what I was thinking while you were having that description. But it reminds me of going into one of those game arcades where I put dollars into a machine and I get tokens back, and I get to go spend tokens instead of spending dollars. So, in a way that they…

Kyle Poyar 

Was like, you had to choose for each of the games based on each of their pricing. How many times do you want to play? Well, I’m at a loss for arcade games these days, cruise in the US? That silly game? Yeah, I mean, if you were to go through each of those games, and have to figure out how many times you want to play them, what’s the cost? A lot of Math there. And it’s a little complicated for me to say, hey, we’re going to give you 10 bucks, turn these 10 bucks into tokens, and you know, play as much as you want. And then we’ll figure out if we want to give you more money.

Mark Stiving 

Yeah, and the nice thing is tokens don’t feel like real money. So, it’s a nice way to budget and get someone to spend their full $10. So exactly. Kyle, this has just been fascinating and as always, and I was sure it would be, let’s wrap with, what’s one piece of pricing advice you’d give our listeners that you think could have a big impact on their business?

Kyle Poyar 

Oh, a piece of pricing advice? Well, I’m trying to limit myself to just one. But if you have been a historically subscription-based, especially a seat-based subscription company, as a piece of homework, really do the work to figure out what are the one or two usage-based metrics that correspond with the value your customers see. You might find that, hey, these are things where the customers you keep or that spend more tend to consume more of that, as opposed to the ones who churn tend to, you know, consume less of it. And think about how you could maybe incorporate that as like a limit or a fence from one package to the next. It could be a limit on your free plan, your first year of a paid subscription, or even kind of all of your tiers. And those can pay more as they consume more of it. What that can do for you is a good way to test out usage-based pricing without kind of throwing your existing model out the window. And what a lot of folks will find is it drives more upgrade behavior, and more kind of natural extension among customers who’ve already been successful, without hurting your ability to lead your customers. And in an ideal world, it can even help you explain the value of your product. Because you can talk about this value-based metric that you use in pricing and how you’re able, how this is beneficial from a customer standpoint. So that would be my one piece of advice, especially on this topic of usage-based pricing.

Mark Stiving 

I think it was absolutely brilliant. So essentially start small, but start.

Kyle Poyar 

Exactly.

Mark Stiving 

Do something. So nice. Kyle, thank you so much for your time today. If anybody wants to contact you, how can they do that?

Kyle Poyar 

Well, as you know, Mark, I’m pretty prolific on LinkedIn. And so, I would suggest adding me and feel free to message me through that platform. Also, we’ll plug my newsletter. I write every other week on Substack called Growth Unhinged. And so, folks can subscribe and then reply. I get all the replies to the newsletter.

Mark Stiving  

Okay, now I have to ask, is that the same thing I get to my email or do I have to go sign up and subscribe?

Kyle Poyar 

The same thing you’re getting your email.

Mark Stiving 

Okay, good. Thanks. Episode 145 is all done. Thank you for listening. If you enjoyed this, would you please leave us a rating and a review? Reviews are extremely valuable to us. And if you have any questions or comments about this podcast or pricing in general, feel free to email me at mark@impactpricing.com. Now, go make an impact!

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