Usage-Based Pricing Guide: What Companies Need to Know

Here’s everything you need to know about usage-based pricing.

Pricing is the lifeblood of modern businesses.

That’s why when choosing the right pricing strategy for your own organization, you need a scalpel approach, not a sledgehammer.

Now, while there is no one-size-fits-all solution, a strategy that’s been working for a large number of companies in the last few years (especially in SaaS) is usage based pricing.

Usage-based pricing works by charging customers based on how much they use a product or service, rather than a fixed flat rate.

From software providers to telecommunications companies and beyond, usage-based billing has become a go-to strategy for businesses that want to align their revenue with their customer’s usage patterns.

In this guide, we will explore the ins and outs of usage-based pricing and provide you with all the information you need to understand this innovative pricing model.

Usage-Based Pricing Definition & How This Pricing Strategy Works

Usage-based pricing is a pricing strategy that allows customers to pay for a product or service based on how much they actually use it.

Instead of paying a fixed fee with subscription-based pricing, customers only pay for the resources they’ve used during a set consumption billing period.

This pricing model is also often referred to as “metered billing” or “consumption-based pricing”, but these terms are mostly linked to industries like telecommunications and utility.

In the SaaS industry, the term you’ll hear most often is “usage based pricing”.

Now, usage-based pricing works a bit differently in each company depending on their specific products, processes, and the exact model they implement.

But it usually goes something like this:

A company first specifies measurement units for its product or service and then creates the pricing tiers for those units accordingly.

After they set the pricing tiers and unit prices, the company begins to measure customer usage and calculate charges. For the calculation part, the best option is to use usage-based billing software.  

While it’s technically possible to do it manually,  this approach is more prone to errors and can be extremely time-consuming and difficult to manage, especially as the number of customers and their usage increases.

When the billing cycle ends, the company sends invoices to the customers, charging them for the exact amount of resources they used.

Advantages and Disadvantages of Usage Based Pricing

Usage based pricing continues to grow in popularity, and the fact that it comes with a long list of advantages probably has something to do with it.

Now, to help you better understand these advantages, we decided to split them up into two categories – for businesses and for clients. 

Advantages for businesses:

• Enhanced customer insights: Businesses receive valuable insights into customer behavior and usage patterns. This data can be used to optimize product offerings, tailor marketing efforts, and identify new revenue opportunities.

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• Automated billing and invoicing: A usage-based billing system can track data and automatically calculate the total billing amount for customers at a set time frame. Depending on the provider, it can also automate the invoice generation process.

• Customer retention: Customers are more likely to continue using your product because they can see the direct correlation between usage and value. This also has a direct impact on the company’s churn rate. 

• Increased revenue: Businesses may experience greater revenue growth, as usage-based pricing can lead to increased adoption and product usage.

• More experimentation opportunities: Businesses can experiment with different pricing models, pricing tiers, and product offerings without committing to a long-term structure. Testing different variables can help quickly find a model that resonates best with the customers.

• Shorter buying cycles: It’s easier to persuade new customers to join when they know they’ll only pay for the resources they use.

Advantages for customers:

• More flexibility options: Since customers only pay for what they use, they have more flexibility and control over their costs. This can be particularly advantageous for those who have variable usage patterns and don’t want to pay for unused resources.

• Lower barrier of entry: Customers can start small and scale up their usage depending on their needs and budget, without making a large upfront investment.

• Discounts for increased usage: Customers with high usage needs are commonly offered discounts for their increased usage. This is especially valuable if you’re a business with entire teams that need to use a specific product/service. 

Now, while the benefits of this pricing strategy are undeniable, there are a few downsides that companies should be aware of before implementing it.

Here’s a short overview:

• Difficulty in pricing new products: It can be challenging to establish pricing tiers and unit prices for new products since the usage patterns are still unknown.

• Unreliable revenue forecasting: Since revenue is directly tied to usage, it can be challenging to predict it. Companies may experience fluctuations with the usage-based revenue model as customers’ usage patterns change, which can make it difficult to plan for future investments.

• Harder to compare plans: Customers may find it difficult to compare different pricing plans, especially if they have different billing periods, usage thresholds, or overage charges. This can make it challenging to choose the plan that best meets their needs at a reasonable cost.

Which Industries Use Usage-Based Pricing the Most?

There are a large number of industries that leverage usage-based pricing, but it’s most commonly associated with those that provide products that are used on a more variable basis.

Here are some industries where usage-based pricing is most commonly found:

• Software and SaaS: With 3 out of 5 SaaS companies implementing it, this is the industry where usage based pricing is seeing the biggest increase. SaaS usage based pricing typically works by charging customers based on the number of users, data storage, or computing resources they consume.

• Communications: Popular examples in the communications industry include mobile carriers that offer usage-based pricing plans that charge customers based on the number of voice minutes, text messages, or data used. Or, internet service providers that charge based on the amount of data customers use. 

• Energy & Utility: These companies charge customers based on their actual energy or utility consumption, such as water, electricity, or gas. 

• Media & Entertainment: Streaming services are the most prevalent example in this industry, with these companies charging customers based on the number of hours watched or the number of shows/movies watched per month. 

• EV Charging: As electric vehicles become more widespread, usage-based pricing has been adopted by EV charging stations. With this strategy, customers are usually charged based on the amount of energy consumed during the charging. 

Common Usage-Based Pricing Models Found in SaaS Companies 

When implementing this pricing strategy, businesses can choose from a variety of usage-based pricing models that are designed to fit different customer needs.

Here are some of the most common usage based pricing models:

• Per-unit pricing model: Customers are charged based on the number of units they use or consume.

• Tiered pricing model: Customers are charged different rates depending on the usage tier they fall under. They pay a lower rate for the first tier of usage and a higher rate for subsequent tiers. This model is also referred to as multi-tier pricing.

• Volume pricing model: The volume-based pricing model offers discounts to customers who use a larger volume of the product or service.

• Overage pricing model: Customers are charged an additional fee when they exceed a certain usage threshold.

• Tiered with overage pricing model: Combines the tiered and overage pricing models, charging customers based on the tier they fall into, with additional fees for usage beyond the highest tier.

• Multi-attribute pricing model: Customers are charged based on multiple attributes or usage factors. This can include usage intensity, features used, time of day, number of users, etc.

• Hybrid pricing model: This model combines several different usage based pricing models, such as transaction-based pricing or one-time purchase. For example, a software company might offer a subscription service with a usage-based pricing model for additional features or usage beyond the subscription level.

Factors to Consider When Implementing Usage Based Pricing to Make the Transition Smoother

When considering usage-based pricing implementation, there are several important factors to take into account:

• Understanding customer usage patterns: It’s important to have a clear understanding of how customers use your product or service. This can involve analyzing usage data to identify patterns and trends, as well as conducting surveys to gather direct customer feedback.

• Choosing the right pricing model: There are several different usage based pricing models and each has its own benefits and downsides, so it’s important to choose the one that best fits your product and your customers’ needs. If you’re stuck on this step, analyzing popular usage-based pricing examples is a good way to get some inspiration.

• Setting appropriate usage rates: Next up is to set appropriate usage rates that accurately reflect the value of the product. This involves conducting market research to understand pricing trends and customer expectations, as well as testing different pricing levels to find the optimal balance between revenue and customer satisfaction.

How Key Departments Can Help with the Implementation of Usage-based Pricing into Your Business

If you’re thinking about switching to this monetization strategy in your own business, remember that each department in your organization plays a vital role in the transition.

Here’s how your key departments can support the transition and make it smoother:

• Marketing: The marketing team can work on messaging and positioning to effectively communicate the value proposition of your new usage-based pricing model to potential customers.

• Sales: The sales team can develop pricing plans that align with the customer’s needs and preferences. They can also provide training to the sales reps on how to pitch the usage based pricing model and its benefits to customers.

• Finance: The finance team can analyze the company’s financial metrics to determine the best pricing strategy. They can also help in tracking and reporting usage metrics, to ensure an accurate usage billing process and revenue recognition.

• Customer Support: The customer support team plays a crucial role in providing ongoing support to customers who may have questions or concerns about the new pricing model.

The Takeaway

With 98% of SaaS companies connecting positive outcomes to making core changes in terms of pricing models, saying that picking the right strategy is “important” would be an understatement.

And when weighing in the options… usage-based pricing deserves an honorable spot on the scale.

Not only does usage based pricing offer customers a flexible and personalized payment structure, but it also allows companies to align their revenue with actual customer usage, resulting in a win-win situation for both parties.

Have you tried using usage-based pricing in your organization? If yes, what kind of results have you seen?

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