A Complete Guide to Usage-Based Pricing

TL;DR

• Usage-based pricing (UBP) is a flexible billing strategy, evolving from traditional metered services to encompass SaaS, IaaS, and cloud technologies, allowing you to pay only for what you use.
• UBP benefits both businesses and customers by making products more accessible, building trust, and allowing for pricing and service scalability based on actual consumption.
• Various UBP models exist, including Pay-as-you-Grow, Per-unit, Tiered, and Hybrid pricing, each offering different levels of flexibility and scalability to match your usage patterns.
• Implementing UBP comes with challenges, such as developing a fair pricing model and estimating revenue, but solutions like data analytics and transparent billing can mitigate these issues.
• For successful UBP implementation, consider your usage metrics carefully, align pricing with value, offer flexible pricing structures, invest in the right tools, and ensure your billing system is compatible.
• Togai's metering and pricing software offers a flexible solution for implementing UBP, significantly reducing launch time from months to days.

Learn about usage-based pricing, the types, and benefits, how to choose the right model & how to successfully implement it.

Usage-Based Pricing: An Introduction

Usage-based pricing (UBP) is a new term for an old pricing concept long used for metered services like water, electricity, and telephone.

With significant advances in the software industry, companies providing SaaS (Software as a Service), IaaS (Infrastructure as a Service), and cloud technologies rely on usage-based pricing for their billing purposes and as a customer retention strategy.

As the name implies, the user is billed on how much they use or consume the product. A classic example is your monthly electricity bill, where you are charged precisely for the quantity of electricity you’ve used in a month or fixed period.

It can be game-changing for markets with highly competitive pricing to charge customers for what they use. Usage-based pricing can be found across the SaaS stack, from infrastructure through applications. It started with the infrastructure companies and expanded to encompass the middleware and application layer as well.

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.

It is also beneficial when one provides service that customers will only require occasionally, or if you sell anything in large quantities, you give a one-time or bulk service. Further, UBP is the best choice for services that fluctuate in demand throughout the year as it keeps customers from churning during the off-season.

Read more: Is Usage-Based Pricing Right for Your Business and Strategies to Successfully Implement it

Is UBP as beneficial as it is popular? Of course, it is. Unlike flat-rate pricing, which fixes a flat price for the product, the UBP strategy cannot predict your biggest revenue accounts. However, the model has proven to be a win-win choice for businesses and their customers.

Benefits of Usage-Based Pricing

Benefits of Usage-Based Pricing for Businesses

• Make your product more accessible to customers.
• Easy to adjust pricing as the value of the product increases
• Build stronger trust and better customer-business relationships with your customer-centric pricing strategy
• Lower entry barrier that encourages new customers to try the product.
• Cost-effective choice for customers seeking affordably-priced products.
• Boost net-dollar retention
• Grow along with customers as they realize the value and increase their product usage
• Experiment with pricing and pick the model that best suits their business.
• Attract new customers and experience steady business growth.
• Higher customer satisfaction and retention due to flexibility.
• Track usage metrics, gain a greater understanding of your customers, and uncover new opportunities

Benefits of Usage-Based Pricing for Customers

Customers buying products with UBP are fortunate to enjoy:

• Gauge spending and make informed decisions regarding their investment.
• Ensure that they only pay for the value they receive.
• Absolute transparency without any hidden costs and ambiguous charges.
• More flexible to upgrade or downgrade.
• Accommodate changes in business needs and reduce the impact of unexpected spikes in demand.
• Try the product without committing to a long-term contract
• Lesser upfront costs.
• Lower cost of ownership.
• Better operational scalability.
• Better accuracy in billing structure.

Read more: Consume Less, Pay Less: The Perks of Consumption-based Pricing

Types of Usage-Based Pricing Models Available Today

The market is brimming with various UBP pricing models, allowing customers to modify their usage and companies to measure and bill the usage accurately. Some of the most common usage-based pricing models include

• Pay-as-you-Grow or Pay-as-you-Go

This pricing model allows businesses to pay only for the resources they use, making it apt for companies with unpredictable resource requirements and fluctuating needs.

For example, A cloud-based storage service charges customers based on the amount of data they store in your system.

• Per-unit pricing

In this UBP model, customers are charged a fixed fee per unit of resource consumed. A classic example of per-unit pricing is your electricity usage. Each unit of electricity is charged a particular price, and you pay the sum of the total units of electricity used for a stipulated period.

For example, a web-based email marketing service charges customers based on the number of emails they send. Their per-unit pricing model:

• $0.05 per email for up to 10,000 emails per month
• $0.04 per email for 10,001 to 50,000 emails per month
• $0.03 per email for 50,001 to 100,000 emails per month
• $0.02 per email for more than 100,000 emails per month

• Tiered pricing

In this model, the service or product is segmented into tiers with various allowances that customers can select based on their needs. As soon as the customer reaches or exceeds that allowance, they have the choice to move up to the next tier and the pricing associated with that tier.

For example, a mobile phone carrier might offer the following tiered pricing model for data usage:

• Tier 1: Up to 5GB of data for $30 per month
• Tier 2: 5GB to 10GB of data for $50 per month
• Tier 3: 10GB to 20GB of data for $70 per month
• Tier 4: 20GB or more of data for $100 per month

• Hybrid Pricing

It is a combination of recurrent and usage-based pricing. This model helps businesses to generate a minimum amount of revenue for providing access to a service.

An example of this model in practice is a music streaming service, such as Spotify or Apple Music. The service provides access to a large library of music for a monthly subscription fee, but also offers additional services such as offline listening or higher-quality audio streams for an additional fee. This hybrid pricing model provides customers with the flexibility to choose a basic plan with a recurring fee, while also allowing them to upgrade and pay for additional services as they need them.

Another example, a SaaS company offers a project management tool with the following hybrid pricing model:

• Flat fee: $50 per month for up to 5 users
• Per-user pricing: $10 per additional user per month
• Usage-based pricing: $0.50 per project task created

Read more: Types of Usage-based Pricing Models

Usage-based pricing is ideal for companies that experience variable usage patterns or where customers have different levels of need or demand. Many companies in various industries use a consumption-based pricing model, which is one of the pricing model examples, to provide customers with a flexible and cost-effective pricing option.

Who is using consumption-based pricing?

Usage-based pricing is in all layers of the tech stack. It started with the infrastructure layer. Today, it encompasses API-based products and application software, each with its unique API pricing model.

• Infrastructure as a Service (IaaS)

Consumption-based pricing helps cloud service providers maintain profit margins and cost advantages. Amazon Web Services, Pendo, Snowflake, Zapier, Google Cloud Platform, and IBM Cloud are some of the biggest IaaS providers achieving success with UBP.

• Application Programming Interface (API)

Popular APIs like HubSpot, Clearbit, Twilio, Salesforce, and Mailchimp are using usage-based pricing or some elements of UBP to charge for their services. Moreover, Zapier achieved the $140 million mark in Annual Recurring Revenue earlier in 2022. Their success proves that giving users the option to choose to pay as they go is beneficial to both customers and businesses.

• Software as a Service (SaaS)

SaaS companies that offer products with varying usage levels, such as CRM software or project management tools, can use usage-based pricing to align the cost with the value provided to customers. Usage-based pricing is common among SaaS providers such as Slack, Azure, Stripe, and Adobe Creative Cloud. This pricing model is beneficial to companies with a large customer base that drives volumes of usage. Moreover, the strategy is handy for customers who need to scale up and down their usage at any time.

Read more: 8 Best Examples of SaaS Usage-Based Pricing Models

Now, let's explore some challenges you might encounter while implementing UBP

Common challenges and solutions to alleviate

Businesses that implement usage-based pricing models need to be proactive about understanding their customers' needs and usage patterns, and flexible enough to adjust their pricing and offerings over time. Doing so can alleviate some of the common challenges you might face when implementing UBP. Let's delve into this more.

Challenge 1: Develop a transparent, and fair pricing model

Most companies choose ‘per seat’ pricing, However, a pricing metric needs to align with the customer value that you are providing.

‍Solution: Clearly understand your customers' needs and usage patterns, as well as an understanding of the competitive landscape. This includes understanding what features are most important to customers and how frequently they use them.

Challenge 2: Estimate your revenue

It becomes difficult to forecast revenue when your customer usage varies. Further, it cannot guarantee a steady flow of revenue, thus making it harder to predict future revenue. Businesses need to be able to accurately forecast demand and usage patterns to ensure that they are not undercharging or overcharging customers.

Solution: Businesses can use data analytics and modelling to analyze usage patterns and forecast demand. Offering multiple pricing tiers can help businesses better predict revenue because it allows them to more accurately forecast demand at each usage level. Also, setting clear usage limits and overage fees can better predict revenue because they know exactly how much customers will be charged if they exceed their usage limits. This can help prevent unexpected costs and revenue fluctuations.

Challenge 3: Prevent customer sticker shock and reduce churn

Usage-based pricing models can sometimes result in customers experiencing sticker shock if they are not aware of how pricing is calculated. Some customers with high usage may see an increase in their prices. This can cause customer dissatisfaction.

Solution: Businesses need to be transparent about how they calculate usage-based pricing and how they bill customers. This can help build trust and prevent customers from feeling like they're being taken advantage of. Provide robust customer support and education to help customers understand how pricing works and how to manage their usage effectively.

Implementing UBP requires careful consideration and thoughtful execution. So what are some key factors you need to consider? Let's take a look.

Key Factors to Consider for Implementing Usage-Based Pricing

As companies gear up to execute a usage-based pricing strategy, they should keep these key factors in mind:

Do not limit your thinking when choosing usage metrics

All pricing models require full-fledged research about the market and its consumers. User-based pricing is no exception to this rule. Determine how customers perceive the value of your product relative to other similar products and what they are willing to pay for that value.

Avoid limiting your focus to usage vectors influencing your current pricing. Instead, take into consideration all usage metrics that you might use to set prices in the future.

Align your pricing with your value metrics

The costs associated with usage-based pricing are typically determined by technical metrics like metered units, APIs, calls, and queries. Ideally, your understanding of how your customers use your product or service should inform what your value metrics could be. For example, the number of emails sent via an email marketing platform.

Offer flexible pricing structures

Implementing different price structures can help businesses increase sales, reach a wider range of customers, respond to market conditions, and manage costs more effectively. Think about how you can incentivize consumption. Hybrid systems that combine feature-based tiers with per-seat pricing based on actual usage are a great option to consider. Think about how your pricing model will accommodate changes in usage patterns and fluctuations in demand.

Invest in tools to implement UBP

Monitoring usage patterns can help you understand if your pricing model aligns with customer behavior. Further, it helps optimize your pricing model.

Infrastructure tools can help you collect and convert your raw usage data from multiple sources and provide insights to inform your pricing decisions. It would facilitate automating your pricing operations, thus allowing you to scale effectively.

Establish systems to monitor customers' usage

Usage-based pricing has the potential for unlimited consumption. But surprises in the billing amount can lead to customer dissatisfaction. Establish monitoring and reporting systems that will allow your customers to track and control the usage of your service or product.

Further, harness your customer and sales teams’ technical expertise to forecast the estimated usage of your solution. It will give your customers control over how much they use and pay.

Ensure your billing system supports the pricing model of your choice

Does your current billing system support the pricing model you have chosen? If not, consider exploring alternative billing systems that can accommodate your needs. Consider automating your billing system to make it more efficient and to reduce the risk of human error. Automation can also allow for more flexible and dynamic pricing options.

Additionally, you would need to accurately track usage and generate accurate reports on customer usage and billing. This is particularly important for usage-based pricing models. Before launching your pricing model, thoroughly test your billing system to ensure that it is accurate, reliable, and can handle any potential issues that may arise.

Moving Forward With Usage-based Pricing

Usage-based pricing boasts a steadily growing list of companies joining the trend because of it:

• Allows companies to create flexible billing options.
• Does not require any rigid, long-term contracts.
• Allows customers to scale and modify usage as per market demand.
• Offers pricing agility which is conducive for small businesses.
• Makes products and services more affordable and accessible to all customers.

Utilization-based pricing or usage-based pricing enables companies to continue serving customers while incorporating more artificial intelligence, leading to a greater percentage of customers being APIs rather than humans. By doing so, customers can avoid overpaying for services they may not use regularly and save money.

Togai’s metering and pricing software can help you understand your customers’ usage metrics and implement a consumption-based pricing strategy seamlessly.

If you are curious and would like to take a look, sign up here. Or you can schedule a demo!