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Usage-Based Pricing Model: Definition, Benefits, and Implementation

Before implementing usage-based pricing, consider what these solutions are, how they work, and whether they are financially viable for your organization.

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Team Maxio

April 14, 2022

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Subscription-based pricing models seem to be a very straightforward offering. Most are set up to require a customer to pay a recurring monthly or annual fee to maintain access to the company’s proprietary software. That is the model that most software-as-a-service (SaaS) platforms operate on. However, there are several different pricing strategies that SaaS companies can select from to maximize their customers’ access and desire to continue service and still meet their financial growth goals.

One such method is usage-based pricing. It’s growing in its benefit to SaaS companies who want to provide their customers with options and need to build in more flexibility in their SaaS pricing. Before making a move, consider what these solutions are, how they work, and whether they are financially viable for your organization.

What is a usage-based pricing model?

In a usage-based pricing model, customers are charged based on their usage of a product/service within a given billing cycle (e.g. month, business quarter, year).

Usage-based pricing models are commonly used every day. When you pay for your Uber ride or pay your electric bill, you’ll pay based on how much you use that service. These subscription models are not necessarily new, but they can provide a much better alternative to the traditional subscription style where pricing structures are hard set for each period.

Various factors play a role in the best type of pricing structure for a SaaS product, including factors like the number of users, how often the product is likely to be used, and the cost expectations of the user.

Types of usage or consumption-based pricing models

Also known as consumption-based pricing models, usage-based pricing models fall into one of two categories: fixed rate pricing or usage-based pricing.

Fixed rate/fixed pricing

In this model, all users pay a specific, single price every month (quarter or year) for access to the software. No matter how much they use it, the number of users, or other functions, they pay a basic fee.

Revenue here is easy to determine since, with a fixed rate pricing model, the revenue remains the same from one billing cycle to the next, for the most part. The complications with this method are that they can leave you under-charging for a customer base that uses the product heavily or over-charging for a company that isn’t using it often (which could lead to cancellation of the subscription early).

Usage-based or metered pricing

This type of pricing structure aligns monetization with how your users consume the product or service. What makes this method a bit more unique (and complex) is that there are several ways to scale the pricing based on specific needs. Here are some key examples:

  • Tiered usage-based pricing: In tiered-pricing models, the consumer pays a specific rate based on specific quantity levels. The customer may pay, for example, a set amount of money for the first set of units and less for additional units of use. The customer pays $50 per unit for the first 10 units of use and then $40 per unit after.

  • Per unit usage-based pricing: This method is more direct, charging the customer a flat rate per unit, and that value is charged consistently. This could be based on the number of active integrations or minutes using a service, for example, with pricing set at a standard rate.

  • Volume usage-based pricing: This method breaks down the costs based on volume. The customer may pay $50 per unit for 10 units or $40 for 15 units.

  • Stair-step usage-based pricing: This method is much more elaborate, allowing for numerous flexible elements. For example, the pricing could be based on a range of use or mixed usage. This could be that the first 50 emails are free, then the next 1,000 are at a cost of $99 per month.

Usage-based pricing examples in SaaS

Usage-based pricing isn’t unique. It can be found throughout the SaaS industry in various integrations. Because of its versatility, it can be molded to fit various needs.

Take a look at any of these companies and their pricing strategy for some good examples of this:

  • Amazon Web Services (AWS)

  • Microsoft Azure

  • Snowflake

  • Datadog

  • Twilio

  • Slack

  • Zapier

Let’s take a few examples here.

Amazon Web Services is a good example of a pay-as-you-go option. Software companies using it have access to the individual services they need but don’t have to pay for what they don’t use. There are no long-term contracts in place or complex licensing considerations with this pricing structure. The hard part comes in when you want to use a lot of AWS’s services – the costs then add up.

Snowflake is another example of a consumption-based model. Customers only pay for what they use. The customer gains more flexibility in their use and can try out various features, but can also scale quickly when they need to do so. Less predictable, this method is attractive for some software companies that are planning to scale but are not there just yet.

When providers consider any of these applications, whether for CRM or other solutions, the key is to consider net dollar retention – what percentage of your revenue is retained month to month.

Benefits of the usage-based model for SaaS businesses

SaaS companies have numerous advantages for acquiring, retaining, and monetizing users. Flexible billing is by far one of the most influential advantages they can have to draw in their customers. To be customer-centric and to ensure customer success, companies must develop a strategy that meets customer needs—not just in services and products, but in pricing and usage as well.

Potential customers want to get hands-on with software before they make any significant investment in it. For product-led growth, SaaS companies will benefit from charging for use. This creates a much lower barrier of entry for new users. They’re able to get to know the product or service, even tell their colleagues about it, try it out in their department, and involve various stakeholders in the decision to extend their use.

For the customer, there are numerous advantages. They don’t feel restricted by being locked into a long-term recurring monthly payment even if they don’t use the product. They also want to be able to use the product in a way that works for them, as much or as little as they need, even as that changes month-to-month.

For SaaS businesses, this type of method may seem less ideal with reduced predictability, especially if the company is used to a business model in which they are meeting their business needs with consistent revenue month-to-month.

However, in 2021, metered usage pricing was used by 45% of SaaS companies, and a study by Openview partners showed that the fastest-growing companies are likely to use metered usage pricing as well.

The key, then, is ensuring the company is able to take full advantage of this business model to make it work for them.

There’s quite a bit to consider here. Customer retention is key, but getting new customers is necessary, and inviting them in without upfront payments could be ideal. How can you make usage-based business models work?

Prior to installing any usage-based method, companies need to understand customer usage. Then, they need to alter and update their billing methods to meet those expectations. Customer usage data is also referred to as “event data,” or customers’ specific actions within your application. SaaS businesses can use this event data to gain insights into how their product is being used by customers, where they can make product improvements, and how they can reiterate their pricing strategy.

Prerequisites of usage-based pricing

You may be ready to use this type of pricing structure. Many startups find this method highly attractive because of how readily sought-after it is by consumers, therefore allowing for a ramping up of customers faster. However, before using this method, there are two prerequisites to meet.

1. Your SaaS is compatible with a usage-based pricing model

Some software products are too simple for usage-based billing. On the other hand, some may be too complex to charge customers based on metered use.

For example, Basecamp’s entire value proposition revolves around its flat-fee pricing model. For a flat monthly fee, early-stage, remote-first, and hybrid companies can access a full suite of project management and communication tools to run their businesses online. Charging customers for metered usage would negate the value created by their bundle-style approach to pricing.

On the other hand, a company like Sprig has a suite of products that are too complex to be billed on a usage basis. For context, Sprig is a platform designed to streamline and improve the user-research process. Between user targeting, research analysis, data warehousing, and more, billing for all the individual actions taken within these tools would be extremely complicated.

2. You can track and recognize unpredictable revenue 

As customers’ usage fluctuates each month, you will need to ensure you’re monitoring changes in your business objectives in real time. These fluctuations in MRR create challenges for finance teams who still manage all their core financials in a spreadsheet. Instead, finance teams need to develop scalable financial operations to capture and recognize complex, usage-based revenue streams.

Choosing a pricing model

There are several factors SaaS companies must take into consideration when choosing a pricing model, but above all else, an ideal SaaS pricing model is one that is scalable and captures the full value of your product/service. Scalability is a primary concern among high-growth SaaS companies because flexible pricing options are needed to meet the expectations of different users.

Twilio is a great example of a SaaS company with a scalable and flexible pricing model. They offer a free trial, metered-usage “pay-as-you-go” pricing, and sales-negotiated contracts to name a few. These flexible pricing options have allowed them to capture new market segments and give their customers the option to scale with them as their product usage increases.

Another way to find the right pricing model is to identify your company’s value metrics—a.k.a., the measurable value that your product provides for your customers. Standard SaaS value and usage metrics such as churn, contraction MRR, and ARPU can be measured to determine customer satisfaction levels, and whether your customers find value in your SaaS. 

An increase in churn, a decrease in monthly revenue, and a loss in average revenue per user are all signs that you’re not delivering adequate value to your users—so how can SaaS companies turn these numbers around? 

By implementing usage-based pricing strategies, customers are only billed strictly based on the value they receive from your product/service. This metered-usage approach allows users to leverage the total value of your SaaS without being forced into a recurring monthly payment or an annual contract. 

As long as you’ve achieved product/market fit and your SaaS solves a unique customer pain, the addition of usage-based pricing to your billing model should positively affect your company’s value metrics (and its bottom line).

Implementing a usage-based pricing model

There are several ways to win using a usage-based pricing model as this model creates numerous opportunities for product and service optimization that supports ongoing revenue growth. Yet, it’s not always easy to execute, especially in some go-to-market strategies.

The complications typically arise in trying to track and charge enterprise accounts for their product usage. Product-led SaaS companies can struggle to bill their customers for usage—especially when the majority of their customer base is made up of thousands of individual users with varied usage.

To shed some light on this pricing problem, we’ve put together this ebook, How Product-Led Growth is Changing B2B SaaS. In it, you’ll learn:

  • How to choose and implement the right pricing model based on your GTM strategy

  • Why product-led growth is being adopted so rapidly

  • How to determine if product-led growth is right for you

  • Is Sales-led SaaS dying?

  • How PLG will affect your SaaS business

  • How to introduce a hybrid GTM strategy

Sound interesting? You can download the ebook here.

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