In a recent video titled "Your Pricing Model Is Killing Your Cashflow" by Monetizely's pricing consultant Ajit Pal Ghuman, the critical connection between pricing strategies and cash flow is explored in depth. The video examines why SaaS executives must consider cash flow impacts when designing pricing models, especially in today's high-interest rate environment and AI-driven, usage-based pricing landscape.
The Forgotten Connection Between Pricing and Cash Flow
When most companies approach pricing strategy, they focus primarily on revenue, margin, or growth objectives. However, they often overlook a critical factor: cash flow.
As Ajit explains in the video: "What people often miss is the importance and criticality of cash flow as a lifeblood of their business tied to pricing. They know the importance of cash flow in general, but somehow when a pricing project comes around, this need is not vocalized."
This oversight can be dangerous, especially in today's business environment. With the Federal Reserve maintaining high interest rates and usage-based pricing becoming increasingly common for AI products with high COGS, cash management has taken center stage.
The Monetization Supply Chain: How Pricing Impacts Everything
Pricing doesn't exist in isolation. Instead, it functions as what Ajit calls "the fulcrum of a lot of other downstream operational processes" within an organization. These include:
- How your sales team operates
- Your financial systems
- Financial planning
- Fundraising capabilities
Usage-based models create particular challenges for forecasting and financial planning. As Ajit points out: "If you have a usage-based model that is very variable, think of a pay-as-you-go usage plan, those have to be forecasted really well. They impact the SaaS metrics, success metrics historically that have been based on annual recurring revenue, monthly recurring revenue."
The Cash Flow Variability Problem
Usage-based pricing introduces two major challenges to cash flow management:
- Amount variability: Without fixed recurring revenue, the actual amount of cash coming in fluctuates month to month.
- Timing uncertainty: Traditional annual contracts guarantee payment upfront, while usage-based models typically involve invoicing after a billing period.
As Ajit states: "Both the variability of the cash as well as the timing of the cash creates a lot of havoc in your ability to hire, your ability to raise money. And at the end of the day, the public markets really value predictability."
Today's Market Forces Impacting Pricing and Cash Flow
Two major trends are reshaping how companies must approach pricing:
1. High Interest Rate Environment
The spike in interest rates since 2022 has drastically changed how SaaS companies are valued:
- Revenue multiples have plummeted from a median of 20x to around 7x
- M&A multiples have fallen even more drastically
- Free cash flow has become a priority again
"The regime changed from valuing company based on growth to based on cash," Ajit explains. "And actually they were running out of cash. They needed cash just to survive."
Companies with highly variable usage-based pricing models suffered the most during this shift, while those with traditional subscription models and long-term contracts weathered the storm better.
2. The AI Wave and Usage-Based Pricing Surge
The explosion of AI is pushing more companies toward usage-based pricing due to high COGS in generative AI products. However, this creates a fundamental tension with market expectations for predictability.
Ajit references Sam Altman's admission that OpenAI is losing money on its $200/month ChatGPT Pro subscription, highlighting the challenging economics of AI services.
The Market's Response: Hybrid Approaches
According to research by Maxio cited in the video, companies are finding a middle ground:
- 67% of software companies now use usage-based pricing
- Hybrid pricing adoption has surged to 21%
- Multi-year agreements have skyrocketed to 40% (up from 14% in 2022)
"Companies need predictability," Ajit explains. "So the pricing models may change but the need for predictability does not."
The Evolution of SaaS Metrics
The shift away from purely subscription-based models is forcing the industry to rethink fundamental SaaS metrics.
"What was very predictable now becomes very unpredictable," Ajit notes. Companies are developing "expected functions" with built-in variance to estimate recurring revenue, but the market's demand for predictable cash flow remains unchanged.
This has led to creative solutions like three-part tariffs and credit bundles that are "notionally saying that you have usage-based pricing but you need to lock in your spend and that is actually not very different from the subscription SaaS world."
The Balancing Act for Modern SaaS Companies
The tension between market demand for predictability and the push toward usage-based pricing creates a challenging balancing act for SaaS executives.
"Companies are not going to be able to offer usage-based pricing in their true nature," Ajit concludes. "They will still find a way to extract the cash margin because they have to. That's how their business is going to be running and that's how the market is valuing them."
Key Takeaways for SaaS Executives
- Recognize that your pricing strategy directly impacts both the variability and timing of your cash flow
- Consider hybrid models that balance usage-based components with predictable revenue streams
- Prioritize long-term contracts even within usage-based frameworks
- Develop new forecasting approaches that account for usage variability
- Align pricing strategy with your company's cash flow needs, not just revenue targets
In today's economic climate, the right pricing model isn't just about maximizing revenue—it's about ensuring your company's survival and ability to thrive through predictable cash flow management.