In the YouTube video "How Top SaaS Companies Use Tariffs to Optimize Usage-Based Pricing" from the channel "AI, SaaS & Agentic Pricing with Monetizely," the speaker provides a detailed explanation of how SaaS companies can implement effective tariff structures to balance usage-based pricing with revenue predictability. The video explores the challenges of unpredictable pricing models and offers strategic solutions through different tariff approaches.
The Challenge of Usage-Based Pricing
The rise of generative AI products and traditional infrastructure-as-a-service offerings has made usage-based pricing increasingly popular in the SaaS industry. However, this pricing model comes with significant challenges.
"The advent of new generative AI products as well as traditional infrastructure as a SaaS products have made usage based pricing and consumption based pricing very popular. But usage based pricing as well as highly variable pricing metric approaches tend to have a lot of unpredictability," explains the speaker.
This unpredictability creates ripple effects throughout an organization. It impacts balance sheet calculations, financial analysis, and sales compensation structures. Perhaps most importantly, it makes budgeting difficult for customers, potentially creating friction in the buying process.
Tariff Structures: The Solution to Pricing Unpredictability
To maintain the flexibility of usage-based pricing while providing the predictability that both vendors and customers need, SaaS companies can implement tariff structures. These frameworks create more stable revenue expectations while still allowing for consumption-based billing.
The video outlines two primary approaches:
Two-Part Tariff Structure
The two-part tariff is perhaps the most familiar model for many SaaS executives. As the speaker describes: "One is two-part tariffs where you have a fixed spend and then a usage fee on top. Let's say it would be a platform fee and over on top of the platform fee you are using let's say if your product was sold on a per gigabyte basis you will start to sell per gigabyte for example and then there will be some sort of volume discounts on top of that."
This model provides a baseline of predictable revenue through the platform fee, while still capturing additional value from high-usage customers through the variable component.
Three-Part Tariff Structure
The three-part tariff takes a different approach, focusing on usage commitments rather than platform fees.
"Another way to charge for this is a three-part tariff model where instead of the two parts, you're actually saying, 'Hey, commit to spending a certain amount in usage.' Right? So, in this case, what you actually end up doing is you increase the commitment of the customer to use the product," the speaker explains.
The structure then incentivizes customers to upgrade to higher tiers by making it economically beneficial: "And then what you do is you increase the overage fee such that it becomes more economically beneficial for the customer to buy the next package from you, the next three-part package for which the per unit fee is actually cheaper."
The Revenue Impact of Three-Part Tariffs
The video presents compelling evidence for the revenue benefits of three-part tariffs over two-part structures:
"So, three-part tariffs generally tend to have a much higher ARR per customer. In a 2013 study of 5,800 mobile subscribers, this study found that the three-part tariff structure drove a 19.7% increase in average revenue per usage over the traditional two-part plan."
This significant revenue uplift makes the three-part tariff particularly attractive for SaaS companies looking to optimize their pricing strategy.
Choosing the Right Tariff Structure Based on Market Position
Not all tariff structures work equally well for all companies. The speaker provides nuanced guidance based on a company's market position:
"It is generally expected that people want to lock in their usage earlier on if they trust your service. So, as long as you are a brand name, as long as they are depending on your service, then you can anticipate that the three-part tariff will be more useful."
However, for newer entrants, a different approach may be warranted: "However, if you are an upandcomer, then actually the three-part tariff may not be the best. I still suggest you try the two-part tariff or even a linear model if you if the customers think you are a risky proposition."
Implementing Strategic Pricing in Your SaaS Business
When considering how to implement these pricing strategies in your own SaaS business, several factors should be weighed:
- Market position: Established companies with strong customer trust can push more aggressively toward three-part tariffs.
- Customer budget cycles: Understanding how your customers budget and their tolerance for variability is critical.
- Value perception: The pricing structure should reflect how customers perceive and derive value from your product.
- Competitive landscape: Your pricing strategy should position you favorably against competitors while maximizing your revenue potential.
The right tariff structure can transform unpredictable usage-based billing into a more stable, predictable revenue model while still allowing customers the flexibility they desire and capturing the value of high-usage scenarios.
By thoughtfully implementing tariff structures that align with your market position and customer expectations, you can achieve the best of both worlds: the flexibility of usage-based pricing with the predictability that both your finance team and customers crave.