Start learning about usage-based billing with this ultimate guide. Find out how it works, get useful tips, and see how this way of billing can help your business work better.
Table of contents
- What Is Usage-Based Billing and How Does it Work?
- Usage-Based Billing: Benefits & Challenges
- Usage-Based Billing Challenges
- Why Is Usage-Based Billing So Popular in the SaaS Industry?
- Which Other Industries Adopt Usage-Based Billing and Why
- Which Businesses Shouldn’t Adopt Usage-Based Billing and Why
- Real-World Examples of Usage-Based Billing
- Types of Usage-Based Pricing Models
- 3 Key Elements of a Usage-Based Billing Strategy
- What Software Is Required for Usage-Based Billing?
When searching for information on usage-based billing online, it seems like most sources still refer to it as “the next big thing” in pricing strategies.
Something that’s not quite here yet, a strategy still knocking on the door of widespread adoption.
However, while it’s true that it’s still evolving, usage-based billing is no longer the future of pricing strategies – it’s the present.
And not only is it no longer knocking on the door, but for many industries, it’s kicked down the door and completely taken over.
Now, there’s a long list of reasons why this happened, but it pretty much boils down to the fact that usage-based billing is a win-win strategy for both businesses and customers.
In this article, we will cover every area of usage-based billing, from what it is and how it works to whether it’s the right choice for your business and how to implement it.
Let’s dive in.
What Is Usage-Based Billing and How Does it Work?
Usage-based billing is a popular pricing model that charges customers based on the exact amount of resources they use. This way, they pay only for what they consume, rather than a fixed fee.
This model is particularly popular in industries where usage can vary widely, such as SaaS, communications, utilities, EV charging, media, and more.
But how exactly does usage-based billing work?
Well, it typically involves four main components:
• Defining a measurement unit: Companies determine how they’ll measure the value of their product or service, and specify the units (e.g. GB for data).
• Metering: Finding and implementing a system that will be used to track and measure the customer’s usage. This can be done through various methods, including software, sensors, or manual input.
• Rating: Once the company measures usage, they need to translate it into a monetary value. This is done through a rating system that applies predetermined rates based on the level of usage.
• Invoicing: Finally, the customer is billed based on their usage for the predetermined billing period. The invoice shows the usage charges broken down by the relevant time period (e.g. hourly, daily, or monthly).
Overall, by aligning cost with actual usage, usage-based billing offers a personalized and cost-effective pricing plan that benefits both businesses and consumers.
Usage-Based Billing: Benefits & Challenges
With 3 out of 5 SaaS companies now implementing some form of usage-based billing, it’s obvious that the benefits of this pricing strategy can’t be ignored.
And to help you better understand what usage-based billing brings to the table, we broke it down into both perspectives – customers and businesses.
Pros for Customers
First, let’s go through the benefits of usage-based billing for customers:
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• Cost-efficient: Customers with lower usage levels can save money with usage-based billing by only paying for the resources they use.
• Lower barriers to entry: There’s a lower barrier to entry for customers who may not be able to afford a large upfront cost and instead want to pay as they go.
• Customization and flexibility: Customers can choose the specific features or services they need and only pay for what they use. This allows them to adjust their usage based on their needs, which is great for those with fluctuating patterns.
Pros for Businesses
Here’s an overview of some of the main usage-based billing benefits for businesses:
• Improved retention: Flexible pricing models and fair pricing lead to an increase in customer retention and satisfaction.
• Better product development process: With valuable insights into customer usage patterns and behaviors, companies can use the data for better product development. They can analyze which features customers appreciate the most and create products that are more likely to be adopted by larger user bases.
• Reduced customer churn: Customers are more likely to continue using the product if they perceive it as valuable and fairly priced, which leads to a lower churn rate.
• Competitive advantage: Companies gain a competitive advantage by offering a more flexible and tailored pricing model. This can make it easier for them to get new customers and retain them in a crowded market.
• Increased cross-selling and upselling opportunities: With greater visibility into how customers are using their products, companies can identify opportunities for cross-selling and upselling a lot easier. The usage data can be leveraged to offer targeted recommendations and promotions, driving additional revenue growth.
• Greater agility and flexibility: Companies are more agile and responsive to changing market conditions and customer needs as they can adjust pricing as needed. They can meet evolving customer demands and stay ahead of the competition.
Usage-Based Billing Challenges
Now, even though the benefits heavily outweigh the challenges, the fact is that usage-based billing isn’t a universal billing solution that any company can implement.
So before making any final decisions, here are a few challenges of this pricing model you should consider:
• Creating an appropriate pricing plan: Not all products or services may be suitable for usage-based billing as it can be challenging to come up with the right value metric to assign a dollar value to usage. Some products may be too complex to implement usage-based pricing, requiring businesses to consider alternative billing models.
• Unpredictable revenue: Implementing usage-based billing can lead to revenue fluctuations for businesses, making accurate monthly recurring revenue (MRR) predictions difficult. Unlike fixed pricing models, usage-based billing isn’t as straightforward to forecast. Businesses must have contingency plans in place to manage potential revenue fluctuations.
• Potentially complex integration: Implementing usage-based billing may require significant changes to a company’s existing billing and payment infrastructure. Companies need to ensure that their systems can support usage-based billing and integrate seamlessly with other systems and processes.
Why Is Usage-Based Billing So Popular in the SaaS Industry?
Over the past couple of years, one of the industries where we’ve seen the biggest increase in usage-based billing adoption is SaaS, with over 60% of SaaS businesses implementing the strategy.
There are several reasons for this, but let’s look at some of the main ones.
Ability to Price Features with Different “Value Metrics”
Usage-based billing is used when a business has a clear unit of measurement associated with how much of its product or service a customer uses.
But in SaaS billing, it’s not just the quantity of resources that matters – it’s also the quality.
So aside from the rate of customer consumption, companies also need to consider the value associated with the product or service.
For example, a usage-based billing SaaS company may offer different features, with each one being priced differently based on the value metric. The “value metric” is essentially a measure of the customer’s perceived value of the product or service.
So, if your project management tool includes features like task automation and real-time collaboration, those features may be considered higher value than basic task management functionality.
Furthermore, different customer segments may place different values on different features of your product.
For instance, a small business may only need basic task management, while a larger enterprise may require more advanced collaboration features. By understanding these different value metrics, SaaS companies can create pricing tiers that are tailored to specific customer segments.
Another primary advantage of usage-based billing is that it allows SaaS companies to grow revenue and users faster.
As customers use more of the service, SaaS companies earn more money, and usage-based pricing demonstrates the value of the service instantly.
This also leads SaaS companies to take a product-led growth approach, which means the better they make the product, the more it is used, and the more revenue they make.
Easier to Scale
One more contributing factor is the need for scalability.
SaaS companies often have a large and diverse customer base, which can make it difficult to create a pricing model that works for everyone.
And the scalable pricing solution that usage-based billing provides allows businesses to customize it accordingly and meet the needs of different customers.
Helps Further Product Optimization and Development
Finally, usage-based billing allows SaaS companies to gather valuable usage data, which can be used to inform product development, marketing, and sales strategies.
By implementing a billing and usage tracking system to monitor usage patterns and behavior, companies can gain insights into customer needs and preferences, which can help them to improve their products.
Which Other Industries Adopt Usage-Based Billing and Why
Usage-based billing is not limited to SaaS and there are a bunch of other industries that have been utilizing it a lot longer.
However, you should know that the specific term “usage-based billing” is more prevalent in SaaS than in any other industry.
For these other industries, we more often hear “metered billing”, “consumption billing”, “pay-as-you-go”, and “pay-per-use”.
Now, let’s check out what these industries are:
• Communications: The communications industry has been using usage-based billing for years, particularly for mobile phone and internet services. These companies charge customers for the amount of data or talk time they use.
• Energy & Utility: Energy and utility companies that implement metered service charge customers for the amount of electricity, gas, or water they consume. The price per unit of consumption varies depending on the specific utility, region, and similar factors.
• EV Charging: This industry uses usage-based billing to charge EV owners for the amount of electricity they consume while charging their vehicles. There are two main types of EV charging billing used in the EV charging industry – time-based billing and energy-based billing.
• Media & Entertainment: The media and entertainment industry is also rapidly shifting from subscription billing to consumption-based billing for its various services, including streaming, pay-per-view, gaming, and music broadcasting.
• Logistics & Transportation: Logistics and transportation companies can charge customers based on the distance traveled, the weight of the cargo, and similar factors.
Which Businesses Shouldn’t Adopt Usage-Based Billing and Why
While usage-based billing is the perfect fit for numerous industries, it’s not a one-size-fits-all solution that anytype of business can implement.
Here are some examples of businesses that may not benefit from usage-based billing and why:
• Businesses with high fixed costs: Businesses that have high fixed costs may not be able to implement a usage-based billing system without incurring additional expenses. For example, for a manufacturing company whose costs aren’t directly tied to usage, it doesn’t make much sense to introduce usage-based pricing.
• Businesses with limited data: For usage-based billing to work, you need precise data to accurately measure usage and charge customers accordingly. Businesses that have limited data or struggle to collect accurate data may not be able to implement it properly.
• Businesses with low margins: If a business operates with thin profit margins, usage-based billing may not be the best choice, as it can be more difficult to predict revenue and manage costs. In these cases, a flat fee or subscription-based model is more predictable and financially stable.
• Businesses with low usage variability: Usage-based billing works best when there is wide variability in usage among customers. If a business’s customers tend to use the product or service at similar levels, this pricing isn’t as effective since there may not be significant differences in revenue between customers.
Real-World Examples of Usage-Based Billing
As we mentioned in the beginning, usage-based billing is no longer a futuristic concept, there are thousands of companies that have been using it with great success for years now.
Here are a few notable real-world usage-based pricing examples from the SaaS industry:
• Twilio: is a cloud communications platform that allows developers to add messaging, voice, and video capabilities to their applications. The company offers three types of usage-based pricing plans, including pay-as-you-go, volume discounts, and committed-use discounts.
• HubSpot: is a popular marketing and sales software platform that uses a multi-attribute pricing model. Customers are charged based on the specific services they need from HubSpot’s CRM.
• Dropbox: is a cloud storage and file-sharing service that offers cloud usage-based billing and charges customers based on the amount of storage they use each month.
Types of Usage-Based Pricing Models
When choosing whether to implement this strategy, companies also need to consider the different types of usage-based pricing models and determine which one best fits their customers and business type.
Here are the main models you need to know about:
• Per-unit pricing model: Customers pay for each unit of the product or service they use. It’s the most straightforward usage-based billing model.
• Tiered pricing model: This model offers different prices for different usage billing levels, with prices increasing as usage levels rise. This model is often used to incentivize customers to use more and reward high-volume users.
• Volume pricing model: Companies offer discounts for larger volumes of usage. The model encourages customers to use more and is a great option for B2B businesses.
• Overage pricing model: Charging customers for usage beyond a set limit or threshold. Customers can stay within a certain usage range, but they will be charged extra if they surpass the threshold.
• Tiered with overage pricing model: Combines elements of both tiered and overage billing models. Customers pay a base price for a certain amount of usage and then are charged a higher rate for any usage over that threshold.
• Multi-attribute pricing: This model takes into account multiple factors, such as usage, type of user, and value provided, to determine the pricing.
• Hybrid pricing model: Combines elements of different usage-based pricing models to create a customized pricing model that suits the needs of the business and its different customer segments.
3 Key Elements of a Usage-Based Billing Strategy
A usage-based billing strategy typically involves three key elements:
• Value metric: The measurement used to determine the customer’s usage of the product or service. It can be based on various factors such as the number of users, amount of data stored, or frequency of usage.
• Pricing model: This is the structure used to determine the price for the product or service based on the customer’s usage.
• Billing software: The software used to track and bill customers based on their usage. It’s important for it to be accurate and reliable to avoid disputes or overcharging.
What Software Is Required for Usage-Based Billing?
To implement this monetization model, companies typically require usage-based billing software that can monitor usage metrics and automate billing based on that usage.
This software should be able to handle complex billing scenarios and be able to integrate with the company’s existing systems, such as its CRM and accounting software, to ensure accurate billing and accounting.
For example, Tridens Monetization includes features such as finance management, usage tracking, billing and invoicing automation, reporting and analytics, and integrations with other complementary business systems.
The usage-based billing software may be offered as a standalone product or as a feature within a larger billing or subscription management platform.
In theory, you can also calculate usage-based billing manually, but this tends to be an extremely time-consuming process that can also lead to a ton of errors.
A software system that automates the tracking, calculation, and billing process is more efficient and accurate than any manual method.
Usage-based billing has proven to be an effective strategy for a variety of businesses across multiple industries.
From SaaS to EV charging, it’s changing the way businesses think about pricing.
And as the business landscape continues to evolve, it’s worth considering whether a usage-based billing model makes sense for your organization.
Will your customers be more receptive to a usage-based billing model? Would you gain a competitive advantage over others in your industry by incorporating this pricing structure?
These are questions worth pondering as you consider the future of your business and the needs of your customers.
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