Recurring revenue is here to stay... But founders should embrace flexible payment options
As many of you are already familiar, most companies and users in the last decade have been moving away from legacy systems with on-site deployment to SaaS (Software as a Service) products. SaaS products are typically deployed in the cloud and allows the developer to make any updates to the platform/software automatically and push them to the end-user. Software as a Service has been on an incredible trend which has been only accelerated even further through the current environment of increased remote work. What sets SaaS - Software as a Service - platform apart has initially been its accessibility, convenience and access to variety of tools that would normally cost every layer of enterprises from start-up, scale-up, SME and Enterprises significant CAPEX dollars. Subscribers are able to access from any location and the product is constantly updated as part of their subscription plans which allows them to utilize latest technology stacks and required no capital expense to the contrary to the on-premise legacy solutions.
The accessibility that these products provided combined with ease of maintenance and cash flow convenience has made SaaS model immensely powerful. Earlier, using on-premise software, the user had to pay to purchase the software upfront and the product would be outdated within a certain time frame. This made SaaS a budget friendly option compared to the On-premise software even if the total cost could be higher at the end of the usage period. Given that SaaS products are now much more capable than before and further powered Artificial Intelligence tools and are updated much more frequently companies use them to make their employees more efficient and more importantly replacing the employees that are not adding significant cognitive value by software. It is much easier to change software plan or terminate a software subscription than employees, and software – usually – do not have additional expenses as well. Especially at a post-Covid-19 era, any fixed cost savings are particularly important.
All in all, we may think that SaaS provides businesses with almost every flexibility that they demand. The answer is probably not really, or not yet at least. The SaaS pricing models has already been a hotly debated topic but given the current environment, we believe the convenience and flexibility may not be enough and that too can be open to change.
SaaS Pricing is quite difficult to determine for many digital businesses for several reasons. The product must be priced fairly, and the payment options provided must appeal to the largest target addressable market as possible. Most SaaS businesses today are subscription basis billing either on a yearly or monthly period. This allows the company to, in one way, compound revenue. The theory of compounding works in such way that the most important metric for the SaaS company is its predictable revenue stream expressed in terms of MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue). These two metrics has been the main determinants of valuations and perhaps will be first question when the founder meets its prospective investors.
Any episodic payer (non-subscribers) do not contribute to the MRR, therefore it makes little sense for the SaaS company to provide offerings on anything other then subscription basis. MRR/ARR also makes it amazingly easy for an investor to calculate the average pay back of a single SaaS customer (Life time value of a customer) and hence how much you can spend to acquire any new customer (Customer Acquisition Cost). Furthermore, any episodic plan other then subscription model may result in your customers switching from subscriptions to episodic and provide in one sense lower predictable revenue stream and therefore a cannibalization of the MRR/ARR.
Therefore, all things considered, we could assume that SaaS business will never provide any other payment model other than subscription, but the answer is probably not that straightforward. This is where we believe competition can kick in. Following post-Covid-19 normalization period, companies will be more reluctant to shy away from anything fixed cost. The reason they are laying off people and moving to more efficient technology offerings is the flexibility. But if the SaaS business is only offering a fixed pricing, yearly contract, or yearly payment, how flexible is the service? With pay-per-use billing the customer can make a single purchase at a fixed price and may or may not conduct future business with the company.
Pay-per-use: When to Apply? Why to Utilize?
We believe that usage-based pricing models, like pay-per-use, will certainly have their place. More and more companies will appreciate the affordability and flexibility that the pay-per-use model will provide, especially in a very unpredictable environments and particularly if they would like to use the service once or twice which does not merit a subscription model.
Therefore, if a service with a limited lifetime – perhaps at a higher cost per usage – is available, that will allow increased customers for the company. Furthermore, it will be useful for the SaaS companies to get truly objective feedback on both their product and their pricing strategy. In the current super dynamic environment, we are in, adaptability is the biggest skill a technology company can have. We believe that SaaS (and also PaaS = Platform as a Service and IaaS = Infrastructure as a Service) companies will no longer be able to remain stagnant with limited pricing options and for the companies that adapt, usage-based pricing form will become a key differentiating factor.
As of this writing, Twilio, a cloud communications platform as a service company with a market cap of US$ 23.4 billion, released its financial results with a phenomenal growth in 2020 Q1. Most of the growth came mostly from their pay-as-you-go-pricing where they charge their users per minute or message and offer them volume and committed usage discounts. Other companies who have grasped this model are AWS, MessageBird and WordStream to give as an example.
It is still exceedingly difficult to determine the pricing of the PPU versus the subscription model as clearly subscription model will remain the more beneficial plan. However, the addition of the PPU model can be both a very valid sales tool and indeed a requirement of the more competitive environment. As per the investors, they might have to be prepared to be more open-minded about the payment models they are currently used to seeing in SaaS businesses which might indeed prove to be a key differentiator.