TL;DR
- Deciding between usage-based pricing vs subscription hinges on understanding your customers' needs and your operational flexibility.
- Consideration of customer satisfaction and business cost-effectiveness is key in choosing the right pricing model.
- With usage-based pricing, you can grow alongside your customers, charging them for the value they derive, though it may complicate budgeting and revenue forecasts.
- Subscriptions offer a win-win by locking in customers and smoothing out revenue streams, though they may not suit every customer's consumption habits.
- Your choice should reflect your product's nature, market demand, and how you envision building customer relationships.
- Implementing the right pricing model can significantly impact profits, as a 1% improvement in pricing can boost profits by over 11%.
- Ultimately, the best pricing model is one that supports your business strategy, encourages usage, and satisfies your customers.
Pricing is the most important aspect of your business. According to Profit Well, a 1% improvement in price optimization results in an average boost of 11.1% in profits. Traditionally, companies seem to opt for subscription-based pricing structures. However, in recent times, consumption-based or usage-based pricing models have grown popular. SaaS companies seem to be leaving behind traditional subscription pricing in favor of usage-based models as it better aligns with modern buying behavior and the value delivered by their products.
It is estimated that the average SaaS company spends only about 6 hours determining their pricing strategy. Taking the time to understand different pricing models and strategizing your pricing that best suits your business can go a long way in ensuring you don't leave money on the table. Between usage-based versus subscription-based pricing, which one is right for you? Let's explore!
What Is Consumption-Based Pricing?
Usage or consumption-based pricing is when the consumer / customer / user pays only for the amount of product or service they use instead of paying a flat rate. This pricing model is based on aligning the cost with the value and functionality the customers attain from the product or service.
Consumption-based pricing is popular among SaaS businesses that bill their clients based on a usage metric such as the number of users or bandwidth usage. Payment processing companies that charge a small percentage for the financial transactions they enable are also frequent users of consumption-based pricing.
Companies offering cloud computing and communication services also rely on the usage-based pricing model. Notable names using this pricing model include cloud computing organisations like Amazon Web Services and Microsoft Azure, as well as SaaS businesses such as Snowflake and Twilio.
Also Read: Feature-based vs. Tiered Pricing: Which One Is Right for Your Business?
Advantages and Drawbacks of Consumption-based Pricing
Usage-based pricing, also known as consumption-based pricing, charges customers based on their actual usage. Companies like Twilio and Snowflake have implemented a usage-based pricing model rather than a subscription-based model. And it worked great for them.
“The State of Usage-Based Pricing: 2nd Edition” has drafted a report based on OpenView’s 2022 Financial & Operating Benchmarks survey conducted in July-August 2022.
According to the survey, the report states that at least three out of five SaaS companies are currently incorporating a usage-based pricing model in some form. The survey also notes an increase in the number of SaaS companies integrating this pricing model into their tech infrastructure.
Another study conducted by Chargebee revealed that 63% of SaaS businesses have implemented some variant of usage-based pricing. Nearly 74% of SaaS businesses are projected to introduce more products based on this pricing model in 2023. Notably, even SaaS startups with Annual Recurring Revenue (ARR) as low as $3-25 million are actively exploring usage-based pricing considerations.
Advantages of a usage-based model
- Unlike other pricing structures, this can be more cost-effective for the business. For example, in subscription-based models, companies may not be able to charge enough to cover that high usage, thus costing the business more.
- There is no commitment to get started with a product. Customers can start with low initial usage and quickly increase it when they see the value derived from the product.
- Since customers pay for only what they use, they end up saving money. This helps build customer loyalty.
- Consumption-based pricing typically offers reductions/discounts for clients that exceed a usage level.
- Companies can grow with customers. As customers scale, their usage increases, leading to an upgrade.
- Concerning gross dollar retention, businesses that adopt usage-based pricing strategies considerably outpace their competitors.
Drawbacks of a usage-based model
- Since there is no commitment, customers can easily switch to using different products.
- Customer retention and satisfaction might be negatively affected by sticker shock, i.e., their bill ends up being higher than they anticipated.
- There might arise some difficulty for customers when it comes to budgeting with this type of pricing model. Users will have to compute the budget based on their usage rate. And usage tends to fluctuate every other month.
- Similarly, it would be difficult for a business to accurately forecast revenue.
Advantages and Drawbacks of Subscription-based Pricing
Subscription-based pricing is a popular payment method wherein users are charged flat fees for access to a predetermined set of services over a specific period of time. This pricing model allows customers to pay a fixed recurring fee for ongoing access to a product or service, regardless of how much they use.
Customers gain several benefits from this pricing model. They can:
- Understand the simple and straightforward billing procedures
- Choose the option that easily aligns with their budget.
Companies, on the other hand, benefit from easy upselling opportunities, and predictable revenue.
Netflix is a classic example of a company that has successfully implemented the subscription-based model, allowing users to access a variety of content for a fixed monthly fee. The pricing model is also adopted by other organizations such as:
- Electronic publications
- E-commerce businesses
- Educational technology services
All these business models operate on subscription-based pricing, thus providing users with ongoing benefits in exchange for a standard fee.
Advantages of a subscription-based model
- It locks in your customers for a longer period. It reduces churn considerably. Moreover, SaaS companies tend to opt for an annual subscription plan as it is generally coupled with a discount offer. This creates a win-win situation for both the customer and the business. It enables customers to pay less and retains customers effectively.
- Businesses can also predict their revenue in the near future with some sense of accuracy since they already know who has subscribed to what.
- Regular monthly income allows for some stability for businesses.
- With subscriptions, businesses are assured of steady cash as memberships are periodically renewed.
- Customers can readily plan their budget for the month or year.
- By analyzing client consumption habits, they can effectively upsell.
Drawbacks of a subscription-based model
- High-usage customers may be getting more than what they are paying for while some low-usage customers may feel they’re not getting enough.
- There tends to be some lack of flexibility. Because of the agreed-upon service, it reduces the room for maneuvering as your company's demands evolve.
- Most software licenses are bought on a yearly contract basis, with the entire fee due upfront, regardless of whether the service is used for the whole year.
Also Read: 7 Best Practices to Follow When Implementing Usage-Based Pricing
Choosing the suitable pricing model for your business
Customer satisfaction and needs should serve as the primary motivation for any pricing model choice, as pricing is intrinsically linked to the assessed worth of your services and products. Make sure the framework is cost-effective and straightforward to execute. It should reflect your product value clearly and encourage increased usage.
Pick a consumption-based plan if you
- sell services that incur direct costs to you when consumed or outgoings increase in direct relation to customer usage rates, such as cloud storage
- accurately and easily break down your service offering into small, digestible chunks (like ridesharing, marketing automation platforms, cloud computing, etc.)
- have identified clear usage metrics that capture the value customers reap from using their products/services.
- are open to keeping a more agile approach to corporate operations
- sell products/ services that have demand fluctuations
Opt for the subscription plan if you
- want more say in the direction your product strategies take
- desire a consistent monthly revenue
- accurately plan for capacity within the confines of the available funds
- don't want to waste time constantly sourcing the technology and tools needed for new innovations
- are in search of a holistic approach to handling all aspects of product training and support
Consumption vs. Subscription, Which One Should Be Your Pick?
Your unique pricing model relies on the specifics of your company and how effectively you think these adapt to your aims. Do your research and select the one best suited to your business. Regardless of where you stand, this is a significant choice because pricing is still a key driver of revenue development and a method for strengthening connections with existing and potential customers.
If you have picked a usage-based pricing model to implement, then we are here to help. We are an usage-based billing platform that businesses can leverage to launch any pricing model in the shortest time possible. If you are curious and would like to take a look, sign up here. Or you can Schedule a demo!
