The next evolution of pricing models is not only here but revolutionizing how companies are billing for the products and services provided. Sometimes referred to as pay-as-you-go billing, usage-based pricing, or metered billing – a consumption-based pricing model charges based on what you use or consume. This provides customers with the potential to save a significant amount of money.
Historically this was the pricing model of choice for utility companies like electric, gas, and water. However, companies within other industries are adopting consumption-based pricing in record numbers. Originally pioneered by infrastructure companies like Amazon Web Services (AWS) and Azure, this pricing model has gained in popularity among software providers such as software-as-a-service (SaaS) organizations, as well as IT services, cloud computing, and storage companies. In fact, in 2018 the adoption rate for usage-based pricing was 27%, nearly doubling to 46% in 2022 – with an additional 15% of companies actively testing this pricing model.
What is Consumption-Based Pricing?
Simply put, consumption-based pricing allows customers to pay for only what they consume, and calculates pricing based on volume rather than other metrics such as number of users. For example, AWS offers a plan that allows customers to pay only for the computing power, storage, and other resources utilized during a billing period. Ride services companies like Uber and Lyft have also onboarded usage-based pricing and calculates charges based on the distance traveled, as well as the amount of time it takes to travel from point A to point B.
The consumption-based pricing model provides organizations with the flexibility to bill and rate on any aspect of the product or service – clicks, API calls, downloads, seats, text messages, minutes, bandwidth, utilities and more. It covers pretty much anything you can track.
At a glance, this pricing model appears easy enough to implement, however when you look at the variety of consumption-based pricing plans, as well as decisions the company needs to make such as minimum term and/or maximum capacity commitments, device limitations per account, and whether to take consumption-based pricing a step further by offering hybrid plans – and the complexities begin to mount.
Consumption-Based Pricing Models Explained
The most common consumption-based pricing models include:
- Per unit or pay-as-you-go: This pricing model allows customers to pay for only what they consume.
- Tiered pricing: Customers determine which tier best suits their needs. Once the customer reaches or exceeds the tier allowance, they are automatically moved to the next tier. Typically, the starter tier is provided for free.
- Volume pricing: A price-per-unit pricing model that is based on the highest tier the customer reaches during the billing cycle.
- Per-unit pricing: Also known as pay per use, this pricing strategy charges customers based on resources used such as API gateways which charge per API call.
- Multi-attribute: This pricing model charges customers based on a combination of a variety of metrics.
While not a comprehensive list, other consumption-based pricing models include subscription + pay-as-you-go, tiered with overage, pay-as-you-grow, and pay-as-you-save.
Consumption-Based Pricing Benefits and Disadvantages
Although not as straightforward as other pricing models like flat rate, consumption-based pricing is a win-win for businesses and customers alike.
- This model’s transparency makes it easy for the company to align cost with consumption.
- Simplifies the process of aligning recurring revenue with actual usage, which can aid in budgeting and forecasting.
- Provides the agility and flexibility to quickly respond to changing business, customer, and market trends.
- Enables businesses to grow faster with price points that are attractive to a larger customer base.
- Eliminates or shortens purchasing cycles.
- Improves customer retention by allowing customers to upgrade or downgrade based on their needs and budgets.
- Reduces revenue leakage, as you’re better able to optimize product and service usage.
- Allows you to quickly experiment and test various recurring revenue and consumption-based pricing combinations.
- Provides the ability to collect massive amounts of data, which can be used to determine how customers are using the products and services provided.
- Delivers a competitive advantage by enabling you to combine consumption-based pricing models with additional features or options to create differentiated packages and bundles.
- Increases investor appeal – on average, companies that incorporate a consumption-based pricing model trade at a 50% higher revenue multiple premium over their counterparts.
From a customer perspective, they can more easily equate value to price. In addition, a consumption-based pricing model empowers them to only take advantage of the features and options needed but gives them more control over their budgets.
Unlike basic subscription-based pricing models, usage fluctuation can result in a less predictable revenue stream. However, this doesn’t necessarily need to be a negative. While monthly revenue may rise and fall depending on if the company is retaining customers and/or acquiring new ones, annual revenue should remain stable or increase.
Additionally, without the right billing platform, billing can become substantially more complicated since consumption charges are typically billed in arrears. Finally, given ASC 606 and IFRS 15 revenue recognition rules, adhering to these regulations when handling consumption-based revenue recognition manually can be time-consuming and error-prone.
The Components of a Consumption-Based Pricing Model
Given that consumption-based pricing models are based on usage metrics, having the right data is essential. The following are the three components needed to help you track exact usage.
Primary to the success of a consumption-based pricing model is your ability to track the exact amount of usage. Metered billing (aka usage-based billing) incorporates a unit of usage (i.e., for electricity companies, this is watts and kilowatts) and charges a fixed amount per unit used.
Since all data isn’t always presented in the same format, a mediation engine is needed. This enables you to collect and convert raw usage data from multiple sources, filter unnecessary usage records, and route the information to be rated and billed.
For instance, in the case of Voice Over IP (VoIP), mediation captures and normalizes data such as call duration, the transfer of megabytes of data, pricing for video usage, and the number of text-based messages from short message services (SMS) or multimedia messaging services (MMS).
When data doesn’t come through a mediation engine, billing will intermittently measure usage throughout the billing period. At the end of the billing cycle, billing uses the usage information to determine the price, plans, how to charge, and other pricing variables such as discounts and promotions.
How to Determine if Consumption-Based Pricing is Right for Your Business
Whether adopting a consumption-based pricing model is right for your business may be as simple as looking at your industry, products, services, and competition. While this pricing strategy isn’t right for every business, here are some questions that can help you determine if you should consider usage-based pricing.
- Can you accurately and easily break down usage into units?
- Can customers easily predict, with a level of accuracy, their usage requirements?
- Is the usage and value of your products and services increasing?
If you answered yes to even one of these questions, it may be time to take a closer look at how you can incorporate consumption-based pricing into your pricing schemes.
Unlock Growth with Consumption-Based Pricing
While consumption-based pricing provides numerous benefits, as well as some potential pitfalls, when done well it can be a powerful tool to increase sales, drive operational efficiency, and improve customer loyalty. However, key to your success is a powerful billing solution – one that delivers automatic rating, data mediation, and invoicing.
Unlike other cloud and legacy billing solutions, BillingPlatform aggregates and analyzes usage data from any source and transforms it into revenue potential – in real-time. Our solution enables enterprises to support any business model with any combination of one-time charges, subscription, consumption, or hybrid-based billing – all on a single platform.
We provide what’s important for consumption-based pricing success – usage, tiered, subscription, overages, minimum commitment, etc. – to enable you to dynamically manage pricing and unlock your company’s full growth and revenue potential. Talk to our experts today if you’re ready to learn more!