A popular billing model, usage-based pricing (also referred to as metered services or pay-as-you-go pricing) is a consumption-based pricing model that allows customers to pay only for what they consume. Largely used among utility companies, rideshare companies, etc., this monetization model is also well-suited for software-as-a-service (SaaS) companies. However, to be successful you need to clearly capture precise units of measure. Accurately and easily associating how much of the product a customer uses during a billing cycle takes usage-based billing software.
While not new, its versatility makes this pricing model one that is adopted rapidly. In fact, OpenView’s State of Usage-Based Pricing Report determined that in 2023 approximately 61% of SaaS companies adopted usage-based pricing, up from 27% in 2018. While 15% of SaaS companies have largely implemented a usage-based pricing model, 46% take a hybrid approach. This approach can be implemented in a variety of ways, such as combining usage-based pricing with traditional subscription pricing or offering usage-based subscription plans. Further to its flexibility is the variety of available pricing models.
Gaining Flexibility With Usage-Based Pricing and Billing
Why is this pricing model becoming popular among SaaS companies, what are its benefits, and what challenges can you expect? Before taking a deep dive into this pricing strategy, let’s agree on the definition of usage-based billing. It’s a consumption-based pricing model in which customers are only charged when they use a product or service. While it’s not a one-size-fits-all pricing model, usage-based pricing offers many variations, giving you the flexibility to bill and rate the usage of your products based on virtually any metric. Additionally, it presents customers with exceptional transparency and SaaS companies with the agility needed to improve monetization and increase revenue.
Sending timely and accurate invoices is essential for the financial health of your business. Your billing platform needs to provide more across all aspects of your quote-to-cash (Q2C) processes. From mediation, payments, revenue recognition, collections, refunds, reporting and more. It’s essential that the usage-based billing software solution you choose provides all the capabilities needed for usage-based billing success.
Types of Usage-Based Pricing Models
This multidimensional monetization model offers a variety of pricing schemes, with the most common being the following:
Pay-as-you-go pricing model
Also referred to as per-unit pricing, this pricing model is best used for companies that have fluctuating business needs. A simple pricing scheme, it is based on the number of units consumed. To illustrate, let’s use an application programming interface (API) call usage example.
If two calls are made during a given billing cycle, the customer is billed $39.98 ($19.99 x 2 = $39.98). While uncomplicated by nature, discounts or other promotions have the potential to add a level of complexity.
Tiered pricing model
Considered to be the most advantageous usage-based pricing model for SaaS companies, customers pay in increments depending on usage. This pricing strategy allows you to offer multiple packages with fixed sets of features for a specific price. When a customer reaches or exceeds usage within the purchased tier, they are automatically moved to the next tier. Here’s an example of a tiered pricing scheme.
Since you’re able to offer a variety of packages that contain different features and functionality, this pricing model can be tailored to capture new market segments. And as previously mentioned, once a customer outgrows the current tier, you have a natural upgrade path that can improve upsell conversion rates and increase profitability.
Volume pricing models
Similar to tiered pricing, charges are based on the total usage at the end of the billing cycle. The difference between tiered pricing and volume pricing is all customers receive the same features and functionality, regardless of volume usage. This example is based on a cloud storage provider.
Let’s assume that during the billing period a customer used 198 GB of storage. Their invoice for that billing cycle would be $39.60 (198 GB x $0.20 = $39.60).
Are You Considering Usage-Based Pricing?
Price-per-seat (sometimes referred to as price-per-user) is the default pricing model for SaaS organizations. While this pricing model still makes sense when the software provided by the SaaS company only delivers discrete value, an increasing number of SaaS companies are pivoting from this traditional billing model to usage-based pricing schemes.
As usage-based pricing is directly tied to the value delivered to the customer, the transition from per-seat-pricing to usage-based pricing offers value not found in price-per-seat models. Further, price-per-seat isn’t compatible with today’s software and technology trends. For instance:
Automation: Since most software packages automate manual processes, businesses will require fewer seats – decreasing the SaaS company’s revenue and profitability.
Artificial Intelligence (AI): AI and more so Generative AI (GenAI) have the potential to eliminate the need for human intervention, making pricing that is tied to the number of users/seats unsuitable.
Application Programming Interface-first (API-first): While dependent on the type of software, value is increasingly tied to APIs rather than user interfaces (UI’s).
Does this mean that all SaaS companies should adopt usage-based pricing? Not necessarily. Look at the following questions to see if this pricing model is right for your SaaS organization.
- Can you break usage down into easily explained and understood units?
- Can you determine usage metrics that align to the value of your products, e.g., value metrics – the measurable value that your products or services provide to customers?
- Can you accurately track and measure usage?
- Do your costs increase or decrease based on the usage of your products or services?
- Can you track and recognize fluctuating revenue?
Usage-Based Pricing: Pro’s and Con’s
As with any pricing scheme, there are advantages and disadvantages. Read on to learn the highlights and lowlights of usage-based pricing and billing.
First the advantages…
- Delivers faster growth by providing better customer acquisition cost payback and higher net dollar retention rates.
- Provides pricing transparency by directly aligning cost with value received.
- Allows customers to start at a low cost, minimizing friction associated with adoption.
- Enables several users to access the product or service within an account, making the software more ubiquitous.
- Reduces churn by allowing customers to increase or decrease usage based on their needs.
- Expands the total addressable market (TAM) by making the product or service more accessible.
- Provides a better experience since customers aren’t charged for unused resources.
- Builds trust and loyalty through transparent billing, which shows financial accountability and customer commitment.
- Reduces company expenses through auto-renewals.
- Improves revenue potential since customers tend to underestimate usage and over time increase consumption.
And now the disadvantages…
- Can create revenue (cash flow) unpredictability since customers are free to decrease usage.
- Complex products/services may make it difficult to determine the right value metric and its associated price.
- With no contractual lock-in, customers can easily switch vendors.
- Customers may have difficulty in understanding the metrics used to calculate their usage.
- May require a significant amount of time and resources to collect needed data.
As touch upon in disadvantage #5, the billing process can, over time, increase in complexity. To overcome these challenges, you need the ability to collect and convert raw usage data from multiple sources. Doing that quickly and accurately requires an intelligent usage-based billing software solution.
Best Practices for Adopting Usage-Based Billing
To maximize your revenue potential and ensure customers are paying for exactly what they use, here’s six best practices that will help you successfully transition to usage-based pricing.
1) Determine your usage metric
As the basis for which your billing system will be developed, careful consideration is needed to ensure the usage metric closely aligns to the value your product provides to customers. For example, web storage companies charge based on GB, CRM software companies use number of users, sales software companies typically charge on a per user / per sales rep basis, email marketing companies charge on a per email basis, etc.
2) Track and measure usage
When it comes to usage or metered rating, the challenge is having the flexibility to map and monetize all data – regardless of the source or format. You need a way to define the details to support service usage on the fly, then route the usage data to the platform to determine 1) who the usage events belong to, 2) what products were used, 3) how much or the quantity of the service used, 4) when the service was used. The process of automating the collection of data, metering the data, and rating the data is known as mediation.
3) Provide customers with real-time access to usage
Your customers want and need transparency to usage information such as usage thresholds and pricing tiers. A customer portal empowers your customers to view usage, download statements, view past payments, pay bills, manage payment methods, and more.
4) Monitor usage patterns
By keeping close tabs on usage patterns, you’ll gain insights into how customers are using your products and services. This can help you understand if your pricing model supports customer behavior and aids in identifying trends and patterns that can be used to optimize pricing.
5) Review and adjust pricing
Not a one-and-done initiative, regular review of your pricing enables you to ensure your prices are competitive, that they are providing customers with the expected value for the money spent, and aids in making data-driven pricing decisions.
6) Invoice customers
You need to deliver accurate, timely, and easily understood invoices. Even with simple pricing models, billing can be challenging. Add usage-based pricing into the mix and your invoices can quickly become convoluted. Some things to keep in mind when it comes to invoicing is the total amount due, the billing time period, detailed unit information, and even customer notifications.
Does your current billing system provide the support needed to adopt a usage-based pricing model?
8 Usage-Based Billing Software Requirements
The inherent complexities of this pricing model makes manual effort not only time consuming but error prone. To help alleviate calculation errors and the potential of customer dissatisfaction and churn, SaaS companies are increasingly turning to intelligent automated billing solutions.
With the number of billing solutions currently on the market, obtaining the right one for your requirements takes a bit of forethought. For instance, billing solutions built for today’s usage-based billing requires the following capabilities:
- Automate all bill cycle processes. Accomplishing this requires the billing software to provide an integrated rules-based workflow engine; the ability to transition from simple one-time subscription-based pricing models to metered and usage-based plans; native APIs to sync information across applications; task and business process automation to streamline billing cycle processing, reduce manual errors, and minimize revenue leakage; application of surge/dynamic rating to handle pricing fluctuations based on capacity; ease of complementing subscription models with metered and usage-based pricing.
- Dynamic pricing for one-time charges, usage, tiered, subscription, overages, minimum commitments, etc.
- Gain access to the intelligence held in your data by integrating to all applications within your ecosystem.
- Built-in mediation that provides the ability to aggregate and analyze usage data from any source.
- Customer portal to monitor the entire payment journey – from payment initialization and tokenization, through payment processing and settlement to chargeback notifications.
- Adaptation to any market regulation or standard to protect customer data and minimize regulatory risk.
- Secure architecture, global compliance, role-based permissions, and audit history.
- Global expansion functionality that supports any language, currency, and industry.
Set Yourself Up for Usage-Based Billing Success
There are three requisites that an intelligent usage-based billing software solution should deliver. First, a solution that supports any product, any service, and any business model. Second, the agility to extend the platform to support changing business needs. Finally, total financial control that enables you to run the business with greater efficiency and accuracy.
With BillingPlatform you get an automated billing platform with built-in mediation that gives you the ability to automate any process, including billing, invoicing, payments, collections, provisioning, dunning, approvals, notifications, and more. Our industry-leading usage-based billing software solution enables you to bring any usage-based billing model to life, support and monetize innovative pricing models such as the Internet of Things (IoT), and ensures you don’t leave money on the table. Learn more about what sets us apart today!
