Cartoon of three business people struggling to pull an arrow into the growth direction.

Why there's no clear winning pricing strategy in B2B SaaS

by with No Comment Tech

Cartoon of three business people struggling to pull an arrow into the growth direction.

Image Credits: Nuthawut Somsuk / Getty Images

It’s been a long time since Salesforce helped change the world of technology by claiming it was going to end software. Its model of selling access to a managed service that was hosted on the cloud (what we generically call software as a service today, or SaaS) didn’t end software, of course, but it did turn the world away from buying software in a box.

The trade-offs were simple. Software offered as a service was cheaper upfront but could cost more over time. In return, vendors promised regular updates and you never had an out-of-date version. No matter how you feel about the subscription economy, the shift from buying Microsoft Office in a box to renewing your Microsoft 365 subscription online is now part of our past.

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Salesforce’s model of selling access to its software services on a subscription basis was imperfect. All business models are, but what some folks realized was that while SaaS and its ilk were tidy profit centers for vendors, their costs could wind up misaligned with buyers’ needs. For example, if you pay for more seats than you use, or some of your paid seats only use the service a little bit, you could wind up paying for more software than you really needed.

Enter usage-based pricing, which involves charging for software based on how much of it was consumed. Just like how SaaS products ate up older software sales models, some folks thought that consumption-based pricing would be the next thing. Indeed, Twilio grew to mammoth size on the back of the model, carving a Salesforce-like path forward for startups. From the “end of software” to “ask your developer,” it seemed the future of software pricing was up for grabs, especially during the last venture boom.

Then the economy turned and tech companies suddenly had to deal with customers looking to lower their bills. Based on our read of SaaS companies’ quarterly reports, it seems that while all software companies had some soul-searching to do mid-2022 onward, consumption-based models were hit the hardest. That’s perhaps why Salesforce’s founder is still its CEO, while Twilio’s isn’t.

Subscribe to TechCrunch+But what about the future? What should startups know today about how they charge for their software products, and how that choice will impact their growth prospects? New data from Maxio — formed out of the merger of two Battery Ventures–backed startups, SaaSOptics and Chargify — indicates that both consumption and subscription pricing have their advantages when it comes to growth, but not at the same time. Smaller software companies do better with subscription pricing, while consumption-based models perform better at larger scale. There’s no perfect answer, in other words, but the data should help founders make the right call for their company.

The new normal

Before we dive into the comparative performance of the two main SaaS pricing models, let’s talk about the business environment all SaaS startups operate in today: Whether they charge on a consumption or subscription basis, companies will need to get used to what many would have considered as subpar growth not so long ago.

Then again, the growth levels we are seeing may well be the new normal, and maybe hypergrowth was the anomaly all along. That’s certainly Maxio’s take:

Our analysis suggests the growth rates observed throughout 2023 are here to stay for the foreseeable future. We believe the market is returning to normalized growth levels after experiencing a period of abnormal growth and fluctuation. This period of abnormal growth continues to weigh heavily throughout the private technology and subscription sectors.

We are used to hearing that maybe we should just forget about 2021 altogether, but Maxio’s argument is backed by data, or at the very least, reasonably inferred from it.

“While we observed modest improvement in growth rates throughout Q2 and Q3 of 2023,” the report noted, “growth rates for subscription businesses processing up to $100MM leveled off and slightly declined to finish the year at 14% growth in Q4, a 6% decline from the same period  in Q4 2022.”

The fact that SaaS companies’ revenue growth didn’t pick up during 2023 seems to indicate that things are unlikely to return to ZIRP-era levels any time soon, even as inflation starts to show signs of slowing. However, there’s still a pretty wide range of growth rates that startups can expect, depending on their billing model, their sector and other variables.

Benchmarks

In Q4 2023, and in line with previous quarters, the average growth rate of B2B SaaS businesses with annual revenue of less than $1 million was much higher if they charged subscriptions (34%) than if they employed usage-based pricing (only 1%). However, the tables turn above the $1 million annual revenue threshold: Consumption-based businesses grew by 22% on average last quarter, compared to 16% for subscription-based ones.

But it’s relevant to also examine how growth varied each quarter for companies that used these models. For companies above the $1 million revenue threshold, Maxio found that those with consumption-based models saw their growth stall sooner in 2022, but after the market turned in 2023, they grew faster than companies with subscription-based models.

So, what to do if you are a startup? Data is descriptive in this case, not proscriptive. The report posits that consumption-based pricing results in more or less 0% growth for small companies. However, Jonathan Cochrane, Maxio’s VP of strategy, told TechCrunch+ that those figures could be partially impacted by some companies offering consumption-priced goods that Maxio can track, and other services that it can’t.

Even with that caveat, the data is pretty clear: The larger a consumption-based software company gets, the faster it grows until it crests the $50 million annual revenue mark. In contrast, subscription-based software companies often grow faster when scaling to annual revenue of $2 million, decelerate until they reach the $20 million to $50 million bracket, and then settle into middling growth thereafter.

Damned if you do, damned if you don’t, yeah? In a nutshell, there’s no perfect pricing model for all stages of a startup’s life. The trade-offs will hit you earlier, in the middle of the growth curve, or later. Perhaps the takeaway here is that founders should sort out what fundraising tranche is the hardest to land — Series A, Series C, etc. — and choose the pricing model that will allow them to be strongest at that point? Of course, that would only hold up as long as the market itself holds still, but that’s not likely to happen.

In closing, it may be fair to say that while SaaS killed software in a box, we will not see subscription-based pricing die at the hands of consumption-based pricing. Instead, given their contrasting strengths and weaknesses, we may wind up in a market that supports both.

Until the next model comes along, of course.

Winning wireless with American strengths

by with No Comment Tech

Image Credits: thitivong (opens in a new window)

Eric Schmidt

Contributor

Eric Schmidt was the CEO of Google from 2001 to 2011 and executive chairman of Google and its successor company, Alphabet, from 2011 to 2017.

America’s infrastructure needs a serious upgrade. That includes the nation’s digital infrastructure — the critical networks underpinning commerce, defense, transport, and public safety. It sustains innovation power — the ability to invent, adapt, and adopt new technologies — integral to our competitiveness and national security in the 21st century.

This nation has been the pacesetter of the digital era, with a sequence of game-changing innovations in cellular technology: 2G brought text; 3G brought mobile broadband and BlackBerry; 4G brought mobile video and the app stores. But now we are far behind in technologies like 5G, with less than half the speed of Bulgaria or Malaysia, and just 7% of South’s Korea’s number of 5G base stations per capita. While the Chinese technology firm Huawei’s global market dominance in 5G has been slowed somewhat by sanctions and export controls, it is not threatened by superior U.S. innovations.

Now, with the release of the first-ever National Spectrum Strategy, the Biden administration has shown it is taking America’s waning digital infrastructure seriously. The strategy — along with the broadband investments of the Infrastructure Investment and Jobs Act and the CHIPS and Science Act’s industrial policy — recognizes that telecommunications policy and infrastructure are critical for preserving American technology leadership. But despite these advances, our approach to spectrum innovation isn’t sufficient.

One problem is our failure to address the evolving telecommunications technology landscape. For example, accelerated mobile network deployment, now entering the 5G era, dominates the debate on spectrum policy and allocation. That made great sense in the 1990s and 2000s, when the cellular technology leaps mentioned above powered the smartphone revolution, but it makes less sense today.

While we should worry that the United States is so far behind in 5G, mobile networks are just one part of an increasingly complex communications system of data exchanges between people, computers, devices, apps, the cloud, and autonomous agents.

Hyperscale companies process two-thirds of global data traffic — including that flowing from mobile cellular networks — and own the undersea fiber-optic cables transmitting data between continents. Much communication happens via internet connections enabled by Wi-Fi, an unlicensed wireless technology. We spend 90% of our time, and consume 80% of data, indoors where mobile cellular coverage is less and less practical. Even looking at mobile network users alone, half or more of all smartphone data is transmitted over Wi-Fi, not the carrier’s spectrum.

Our spectrum policies don’t reflect this, and mobile network operators themselves acknowledge the present model does not encourage them to build. They are already slowing investment in 5G network deployments and signaling their disinterest in 6G investment. Europe’s third-largest telco, Orange, has gone further, saying: “5G is the last ‘G’ and we’re moving beyond Gs . . . Orange will not be marketing 6G when its form emerges.” As wireless use cases evolve, our spectrum management regime must keep pace.

We should further define the strategy to play to our strengths and avoid competing where we don’t have a chance of winning. Targeted government subsidies can be helpful and necessary, but we probably won’t see another round of substantial government investment soon, and we probably can’t or won’t outspend China anyway. We’re also unlikely to produce commodity communications equipment better or cheaper domestically, and shouldn’t embrace a government-directed command economy. We can pressure countries not to use Huawei systems, but absent a clear alternative that is cheaper or superior, this is tantamount to asking them to live in the past and give up the growth we know the digital economy brings.

But we do have comparative strengths on which to build, specifically in software, in competitive innovation, and in market shaping and design, that provide us a strategic opportunity to develop world-class digital infrastructure.

First, America excels at software development, and network architecture is increasingly software-defined, similar to how computing has been virtualized into the cloud. Even where non-American companies supply network hardware, American companies can compete if they excel at producing the software necessary to manage those networks. Open Radio Access Networks — which allow multiple vendors to build the mobile ecosystem — are a good start and will encourage innovation. We also need to make more “killer app” use cases for wireless technology. If we create more game-changing wireless applications — from advanced manufacturing, to smart cities, to autonomous transport, to remote sensing — we create demand that pulls digital infrastructure forward. Advancements in AI applications for network management will also increase the technical capacity for spectrum utilization.

Second, in response to competitive command economies, we could promote competitive access to spectrum in order to accelerate innovation. The National Spectrum Strategy reflects a refreshing openness to sharing of spectrum “by design,” but we can do more. As FCC chairwoman Jessica Rosenworcel articulated, we need to “turn spectrum scarcity into abundance.” Exclusive use increases scarcity and we should avoid it unless there is a clear and credible rationale.

Licensing innovation can foster innovation, as seen in the successful Citizens Broadband Radio Service experiment to share spectrum, with over 370,000 access points deployed. There are also opportunities in spectrum auction design — an American innovation the world has adopted that provides a useful mechanism for allocating spectrum usage rights. For example, Nobel winner Paul Milgrom and others have developed a concept called “depreciating licenses,” where auction winners declare a spectrum value that determines both an annual license fee and buyout price at which they agree to sell. When Congress restores the FCC’s auction authority — hopefully soon — it should consider how it can enable creative spectrum allocation tools to maximize public benefit.

At the same time, we need to devise policies to ensure we achieve the ultimate objective — a functional network. We should develop creative uses of funds that reduce service costs and incentivize fast and vast deployment. Perhaps auction payments could be set aside to provide low-cost loans for network development, with strict performance requirements and clawback provisions. While this may result in forgoing some auction revenue, the lasting economic value created in GDP, productivity, and new products would easily outweigh this shortfall, promoting best-in-class digital infrastructure.

America’s vast innovation potential has been a powerful engine for prosperity and security. But we can’t compete against our global peers with that engine throttled by last-generation digital infrastructure and policy. We must acknowledge new realities and play to our strengths to reverse digital infrastructure deterioration.