The Advantages, Drawbacks, and When to Implement Usage-Based Pricing Model

TL;DR

• Usage-based pricing (UBP) charges customers based on their consumption, attracting more clients and allowing monetization over time.
• Common models include pay-as-you-go, per-unit pricing, and usage-tier pricing, each catering to different business needs.
• The pros and cons of usage-based pricing highlight its flexibility and potential for customer satisfaction but also point to challenges in revenue predictability and customer retention.
• Incentives like discounts for exceeding usage thresholds can drive consumption and customer engagement.
• UBP is ideal for services that encourage customer growth, have fluctuating demands, or require precise consumption tracking, like SaaS and IaaS.
• Strategies to overcome challenges in UBP, such as implementing spending caps and user-access controls, are crucial for transparency and customer satisfaction.
• Despite its benefits in enhancing revenue, implementing UBP requires careful consideration of service scalability and customer usage patterns.

Why should you implement UBP? And when is the right opportunity to implement a SaaS usage-based pricing model for your business? Here are all the details!

What is Usage-based Pricing?

Let’s start at the very beginning.

In our previous articles, we have emphasized that there is a shifting trend to a usage-based pricing model. To recap, in usage-based pricing, customers are charged only for the number of goods or services they utilize. Since the price is closely related to the utility a customer gets, the usage-based pricing structure attracts more clients while keeping the capacity to monetize a client over time.

Future monetization will depend on charging customers based on how much they use a service. Changing to usage-based pricing strategies necessitates modifications to several of your operational processes. To assist you in deciding which type of pricing model is best for your company, we'll discuss the different models of usage-based pricing, what are some advantages of this model, and whether you should adopt UBP.

Let's jump right in!

Common Usage-based Pricing Models

Some usage-based pricing models include the following:

Pay-as-you-go

It charges businesses only for the resources they use. For example, phone carriers bill based on minutes used. It is ideal for businesses with variable demands.

Per-unit pricing

In this model, the amount charged is correlated to the quantity of a service or product purchased. Thus, the total price charged per period would be the quantity multiplied by the per-unit price. This concept is becoming increasingly prevalent as cloud services offer specific services like API gateways that bill per API call.

Usage-tier pricing

In this model, customers pay for only the services they need by choosing from one of the multiple tiers. Services are offered as incremental tiers based on different feature bundles and customers can upgrade their plans based on their needs.

Potential Perks and Drawbacks of Usage-based Pricing

There are two sides to the coin. Let's look at the benefits but also understand the drawbacks so you can make an informed decision about UBP.

Let's start with the benefits

1. Customers prefer it 

Many consumers prefer usage-based pricing owing to the transparency it provides. Just make payments for what you consume, no more, no less. Much like our water or electricity bills. It thus promotes customer satisfaction. It reduces the likelihood of customer churn.

2. Low barrier to entry 

Unlike a gym membership (we have all been there), there is little in the way of a monetary or contractual commitment from the customer before they begin using the service. Instead, they can ease their way in with a modest initial outlay and gradually ramp up their consumption. You get to share in your customer’s success as you scale with them.

3. Allows room for quick spikes in revenue

Possibility of sudden influxes of cash if customer usage suddenly skyrockets; more money is made in a shorter duration.

4. Incentivize usage with discounts

Providing a discount for exceeding a given use threshold is a common practice in usage-based pricing. It is similar to the bulk buy offers we encounter when we shop at our local supermarkets. It can serve as an incentive to increase consumption.

5. Reduce churn during the off-season

Enterprises with significant seasonal variations use usage-based pricing to retain consumers even during the off-season.

6. Higher net-dollar retention

Businesses can realize higher net retention compared to their peers with usage-based pricing. And the numbers seem to support this fact., according to the State of the Cloud 2021.

Now, for the downsides

1. Sticker shock can lead to churn

Imagine getting a monthly bill that has a higher bill value than you expected. It is bound to create dissatisfaction. Customers may decide to go with a different service as a result. That's why companies like AWS started offering spending caps to ensure customers aren't hit with an unexpectedly huge bill.

Businesses must be transparent about costs. Sending alerts when customers are about to be charged more than usual can be helpful too. Have user-access controls that allow admins to give the right permissions to their teams to use the product.

2. Lose customers easily 

Since there is no prior commitment to using your product, how do you keep your customers hooked long enough that they realize the value? Often, users switch to other products on a whim. They are constantly evaluating what is worth their money and whether the value of your product is worth it. In this case, business offers a great customer experience and less friction when a customer onboard stands a better chance. Also, ensure that the value metric their charges are linked to is clear and easy to understand.

3. Cannot predict revenue accurately

With customers changing their usage based on their needs, you can’t guarantee a steady flow of revenue. This makes it harder to forecast future revenue. But with the right tools, you can account for the unknowns and forecast revenue.

Also Read: Strategies to Overcome Challenges in Usage-Based Pricing

Optimum Implementation of Usage-Based Pricing

Now comes the important question. Who should implement usage-based pricing? Let's look at some factors to answer this question.

• Service Scalability is a significant consideration when selecting whether or not to provide UBP. Usage-based pricing is logical when your service actively encourages your clients to grow their market, revenue, and subscriptions. Some examples of UBP-friendly goods and services include,
• Utility and communications industries
• SaaS vendors
•  IaaS services also operate a consumption-based billing system.
• When you provide a service that your customers will only require occasionally, or if you sell anything in large quantities, you give a one-time or bulk service. Users can pay-per-use depending on their list size or buy bulk credits to use whenever they choose. Users always get precisely what they paid for. The usage-based pricing approach is ideal for companies that must provide precise service consumption breakdowns to their consumers. For example, Amazon Web Services (AWS) charges customers for the number of hours their virtual servers are used, the amount of data transferred, and the amount of storage consumed. Another example is that of a mobile phone company that might offer a 1GB data plan for $30 per month and a 5GB data plan for $50 per month.
• Services that fluctuate in demand throughout the year, such as those offered during unique marketing campaigns, can benefit from flexible pricing structures. Businesses with unpredictable or seasonal needs for the product or service might benefit significantly as it keeps customers from churning during the off-season. For instance, a consumption pricing model could be helpful for businesses that experience significant variability. The marketing software is a perfect example where campaigns revolve around specific times of the year or limited-time releases.

The Takeaway

Even while usage-based pricing (UBP) can enhance revenue for SaaS companies if appropriately implemented, the effort necessary must not be understated. But if you are willing to take the plunge, then we are here to help. We are an end-to-end metering and pricing infrastructure 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!