.png)
Estd 4.22.2023
In today's dynamic SaaS landscape, usage-based pricing (UBP) has emerged as a compelling alternative to traditional subscription models. While product and sales teams often champion UBP for its alignment with customer value, CFOs face a more complex calculation: how does usage-based pricing affect revenue predictability, forecasting accuracy, and financial planning? This article examines usage-based pricing specifically through the financial leader's perspective, offering insights on how CFOs can effectively navigate this increasingly popular pricing strategy.
The Growth of Usage-Based Pricing in SaaS
Usage-based pricing—where customers pay based on their actual consumption rather than a flat subscription fee—has gained significant traction. According to OpenView Partners' 2022 SaaS Benchmarks report, approximately 45% of SaaS companies now offer some form of usage-based pricing, up from just 34% in 2020. Furthermore, public companies with usage-based models have demonstrated 38% faster growth rates compared to their subscription-only counterparts.
For CFOs, however, this growth trend must be weighed against potential impacts on financial predictability and planning.
The Predictability Paradox
The primary concern for financial leaders regarding usage-based models is the perceived unpredictability of revenue streams. After years of SaaS financial models built around the stability of annual recurring revenue (ARR), usage-based approaches introduce new variables into forecasting.
Todd McElhatton, CFO at Zuora, notes: "The predictable nature of subscription revenue has been a cornerstone of SaaS financial planning. Usage-based models require a significant shift in our forecasting methodologies and how we communicate expectations to investors."
However, data suggests that the unpredictability of usage-based models may be overstated. A 2022 study by Bessemer Venture Partners found that mature usage-based businesses often demonstrate remarkably consistent consumption patterns at the portfolio level, with revenue variance typically falling within 5-10% of forecasts—comparable to many subscription businesses.
Forecasting Frameworks for Usage-Based Revenue
For CFOs implementing or considering usage-based pricing, developing robust forecasting frameworks becomes essential. Several approaches have proven effective:
1. Cohort-Based Analysis
By analyzing usage patterns of customer cohorts over time, CFOs can identify predictable growth trajectories. Snowflake, a leader in usage-based pricing, leverages sophisticated cohort analysis to demonstrate the predictability of their revenue to investors. Their "net revenue retention" consistently exceeds 170%, indicating that existing customers reliably increase their usage over time.
2. Usage Floor Commitments
Many companies successfully implement hybrid models that combine usage-based pricing with minimum commitments. Twilio and Stripe, for example, secure minimum revenue commitments while allowing for upside through additional usage. This approach provides a baseline of predictable revenue while maintaining the growth benefits of usage-based pricing.
3. Advanced Data Analytics
Modern financial planning tools now incorporate machine learning to improve usage forecasting accuracy. By analyzing historical consumption patterns, seasonal variations, and leading indicators, these systems can predict usage revenue with increasing precision.
Mark Garrett, former Adobe CFO who oversaw the company's transition from perpetual licenses to consumption-based Creative Cloud offerings, emphasizes: "The key is having granular visibility into usage metrics and the analytical capability to translate those metrics into financial projections."
Financial Benefits Beyond Predictability
While revenue predictability remains a primary concern, usage-based pricing offers several financial advantages that may outweigh forecasting challenges:
1. Improved Cash Flow Dynamics
Usage-based models often bill in arrears based on actual consumption, which initially might seem disadvantageous from a cash flow perspective compared to upfront annual subscriptions. However, many CFOs report that the elimination of discounting pressures and the natural expansion of customer usage over time ultimately enhance cash flow.
2. Reduced Customer Acquisition Costs
Companies employing usage-based pricing typically see lower customer acquisition costs, as customers can start small without significant upfront commitments. According to research from Paddle, UBP companies spend an average of 38% less on customer acquisition compared to pure subscription businesses.
3. Higher Valuation Multiples
Public markets have increasingly rewarded usage-based businesses with premium valuation multiples. Companies like Snowflake, Twilio, and MongoDB have achieved revenue multiples significantly higher than their subscription-based peers, reflecting investor confidence in their growth trajectories.
Communicating with Investors and Boards
For CFOs of usage-based businesses, effectively communicating financial performance and forecasts to investors and board members requires new metrics and narratives.
Key metrics to emphasize include:
- Net Dollar Retention (NDR): Demonstrating how existing customers increase usage over time
- Customer Cohort Growth Patterns: Showing predictable usage expansion within customer segments
- Consumption-Based Unit Economics: Highlighting improving margins as customer usage scales
Elastic CFO Janesh Moorjani explains: "We've developed specific dashboards and analyses that demonstrate the predictability of our consumption revenue. By educating investors on these patterns, we've been able to maintain confidence in our financial outlook despite the variable nature of our pricing model."
Implementing Effective Controls and Safeguards
Prudent CFOs implement several mechanisms to mitigate the potential volatility of usage-based revenue:
1. Usage Caps and Alerts
Many companies implement usage caps or automated alerts when customers approach certain thresholds, preventing unexpected consumption spikes that could impact service delivery costs.
2. Reserved Capacity Discounts
Offering discounts for customers who commit to minimum usage levels provides financial predictability while preserving the benefits of the usage-based approach.
3. Diversified Customer Base
Building a diversified portfolio of customers across industries and sizes helps smooth usage patterns, as different segments often demonstrate countercyclical consumption behaviors.
The Path Forward for Financial Leaders
Usage-based pricing represents both an opportunity and a challenge for SaaS CFOs. The financial leaders who succeed with this model will be those who:
- Invest in advanced analytics capabilities to accurately forecast usage patterns
- Develop hybrid pricing models that balance predictability with growth potential
- Create new financial narratives that help investors understand the value of usage-based metrics
- Build financial teams with the skills to model and analyze consumption data
Conclusion: Embracing Controlled Flexibility
The shift toward usage-based pricing reflects a broader market demand for more flexible, value-aligned business models. For CFOs, the goal isn't to resist this change but to implement it in ways that maintain sufficient predictability while capturing the growth benefits.
As Twilio CFO Khozema Shipchandler notes: "The question isn't whether usage-based pricing introduces variability—it does. The question is whether that variability is manageable and whether it's outweighed by the growth advantages. For us, the answer has been a clear yes."
By developing sophisticated forecasting methodologies, implementing appropriate safeguards, and educating investors on new metrics, finance leaders can successfully navigate the usage-based future—balancing predictability with the customer-centric flexibility that today's markets demand.