Usage-based, consumption, pay-per-use, or pay-as-you-go, regardless of the term you use to describe this pricing model, software as service (SaaS) companies are adopting it in record numbers. According to TechCrunch+, 45% of SaaS companies had a usage-based pricing model in 2021, an increase of 11% from 2020. Unsurprisingly, this trend shows no signs of slowing. In fact, 61% of SaaS companies that aren’t using usage-based pricing plan to launch, or at the very least, test this pricing model in the near future. The question becomes – why now?
The Rise of Usage-based Pricing
We live in a digital world where people and businesses are more connected than ever before. This level of connectivity has provided companies with insights into what buyers are purchasing, the frequency of purchases, and product usage. With this information in hand, businesses began digging deeper into the data to find ways to maximize product usage and profitability, while also delivering additional benefits to their target market. When looking through the lens of how to bill for these offerings, two flexible models emerge — subscription pricing and usage-based pricing.
To put these models into context, if you own a cellphone, purchase a streaming service, or use ride-share services, you’ve been exposed to at least one of these billing models (and in some cases both). Some businesses rely on subscription pricing exclusively. Others find that adding usage-based pricing to their subscription model provides greater financial benefits and higher customer retention. The reason: usage-based pricing offers flexibility, affordability, and a lower entry barrier.
The Difference: Subscription Billing vs. Usage-based Pricing Models
Subscription billing allows businesses to generate a predictable revenue stream, create ongoing relationships, build customer loyalty, open new revenue streams, and with the right strategy – reduce churn. Essentially, there are four types of subscription businesses – software (Slack), boxes (BarkBox), eCommerce (Dollar Shave Club), and accessibility (Netflix). From the customer’s perspective, they benefit from receiving the product or service on a regular basis. Since pricing remains the same billing cycle to billing cycle the shock that can come at the final bill is greatly reduced.
Usage-based pricing moves beyond simple subscription-based pricing by charging customers based on their use of your product. For example, Google Cloud Platform offers a pay-as-you-go pricing structure with no upfront fees, no termination charges, and pricing tiers that vary by product and usage. The advantage of subscription-based and usage-based pricing is that, when combined, the company can turn mediocre revenue into considerable profitability. Take, for instance, HubSpot. Initially, they offered three subscription packages, struggled with churn, and reported revenue that was below expectations. In 2011 they introduced usage-based pricing into their subscription model. Today, HubSpot is a leader in the inbound marketing, sales, and service software industry, with revenue that reached $1.3 billion in 2021. By combining subscription services and usage-based pricing, customers can increase or enhance their offerings as needed, and companies have a direct upgrade path that leads to customer loyalty and increased profitability.
At the enterprise level, usage-based pricing is commonly used for infrastructure services and cloud computing. Think of Amazon Web Services (AWS) where there’s a great deal of variation between individual customers and enterprise use. For example, with subscription billing the company may charge a flat rate for every 100 transactions. However, usage-based pricing allows the business to track the first 100 transactions, then charge for additional transactions at a different flat rate or at a percentage of the additional transactions.
Innovation has and continues to influence usage-based business models. Usage-based billing is the driving force behind a new economic model. Consider the Uber’s and Airbnb’s of the world, which have defined a new shared economy. With usage-based pricing, these companies can deliver services and charge the customer based on variables like time, distance traveled, nights reserved, or peak travel time.
Why Are Companies Switching to Usage-based Pricing?
Usage-based pricing offers agility, affordability, and minimal commitment, which translates to greater profitability.
For start-up companies or small and medium-sized businesses (SMBs), the lowest tier of a company’s offering typically meets their needs. However, as the business scales and grows, access to more products and services may be required. With usage-based pricing, instead of a customer outgrowing the capabilities and churning, companies can easily adapt and charge for additional usage.
Additionally, usage-based pricing provides businesses with the agility to anticipate customers’ future needs. By metering usage, a business can track and analyze product or service usage data. They can use this information to send real-time, targeted customer promotions based on their interests. A digital newspaper subscription service, for example, can track the number of articles a reader accesses. If the user exceeds their monthly article allowance, the newspaper can offer a-la-carte pricing for each article over the subscription amount.
Usage-based pricing gives customers an array of options that are aligned with the perceived value of the product or service. Amazon Web Services (AWS) offers a variety of products (e.g., EC2) priced so the customer pays for only what they use. This pricing strategy has made AWS more affordable than some of their competitors. Many of which lock customers into a pricing model that requires customers to purchase products or services that will either be underutilized or not used at all.
Back when music came on CDs, you’d have to purchase the entire CD for access to a single song. Now, with a streaming music subscription, you can purchase a single song and permanently add it to your music collection. When a product is available on-demand, in smaller increments, and without a large up-front investment, users are more likely to try the product. While this benefit opens the door to new customer personas, it also satisfies the customer’s desire to avoid the burden of ownership.
Boost Revenue with Usage-based Pricing
The benefits of a usage-based pricing model are numerous – shorter purchasing cycles, improved customer satisfaction, lower churn, ease of collecting customer data, greater investor appeal, improved revenue, etc. Here are the top three ways that usage-based pricing can increase your revenue and profitability.
- Rise above the growth ceiling: Other pricing models limit how fast you can grow. For instance, flat-rate pricing doesn’t take into consideration the additional needs of customers as they grow, nor does it align value with price. Usage-based pricing not only enables faster onboarding of new customers, but allows you to capture additional revenue as your customers’ needs grow and change.
- Increase net dollar retention: According to the State of the Cloud 2021, companies that use a usage-based pricing model average about 10% points higher in net dollar retention than companies that only deploy a subscription-based only pricing model.
- Expand target market: The low entry barrier and wide product selection broadens your target buyer persona, enabling you to quickly increase your customer base.
These revenue-boosting benefits are just the tip of the iceberg. As we touched on above, net dollar retention increases with usage-based pricing, and there’s even more to consider.
Comparison of usage-based public SaaS companies to the broader SaaS index*
|Usage-Based||Broader SaaS Index||Difference (%)|
|YoY Revenue Growth (Forecast)||29.9%||21.7%||+38%|
|Net Dollar Retention (NDR)||120%||110%||+9%|
|Revenue Scale ($, in Millions)||$578||$434||+33%|
|Rule of 40||31.4%||29.1%||+8%|
- Usage-based businesses see continued growth at scale (29.9% vs 21.7%) driven by best-in-class net dollar retention (120% vs 110%).
- They do this at even greater revenue scale with similar gross margin and rule of 40 profiles to their peers.
- As a result, usage-based businesses are valued at a substantial premium (21.6x vs 14.4x revenue multiple).
*Source: TechCrunch+ (Summary financials based on public comparables. All values are medians of the comparable sets. Based on data collected on 11/2020.)
Is Usage-based Pricing Right for You?
While the usage-based pricing model offers countless benefits for you and your customers, it’s not the right fit for every business. This win-win pricing model works best for companies already using a subscription-based pricing model, and others that have varying usage of their products or services. This is why other industries are now looking at how usage-based pricing can benefit them and their customers. All it takes is a bit of innovation!
BillingPlatform’s cloud-based billing solution offers the flexibility and ease of use that makes usage-based pricing easy to implement and efficient to maintain. Our usage-based billing software and built-in mediation capabilities give customers everything they need to implement a successful and profitable usage-based billing strategy. Ready to learn more? Our experts are ready to help!