With so many different billing models available, it’s not uncommon for us to hear the question: what is usage-based billing exactly? Also referred to as pay-per-use, pay-as-you-go or metered billing, usage-based billing is commonly described as a consumption-based pricing model in which customers are only charged for the product or service used. Simply put, you use a product or a service, the company providing the product or service measures your consumption, and you are billed based on your use, as well as a possible base amount. Largely driven by customer demand, an increasing number of businesses are incorporating usage-based billing models, and with good reason.
Since revenue is closely associated with usage of your products or services, usage-based billing naturally lends itself to the “land-and-expand” business strategy. In fact, companies that adopt this strategy tend to grow 38% faster. If we dig a bit deeper, we find two recently IPO’d companies that have done exceptionally well – thanks to usage-based billing. The first Agora Inc., a provider of communication software solutions, benefitted from revenue growth of 128% and net dollar retention (NDR) of 183%. Following close behind is Snowflake, a large software as a service (SaaS) company, that is growing at 121% year-over-year with 158% NDR.
Explained: What Is Usage-Based Billing?
When we’re asked, “What is usage-based billing,” essentially it allows companies to monetize the product or service used proportional to the amount consumed. Within usage-based billing models, there are various pricing alternatives to help ensure that you select the right one for your business and your customers. Let’s take a look at the most common usage-based billing models.
- Per-unit pricing: Also referred to as pay-as-you-go, this is the most common and simplest usage-based pricing model. Directly aligned to the number of users, customers are billed for what is used – no more, no less. For example, your SaaS company charges $10 per user or seat per month. If your customer has 10 users they would be charged $100.00 per month, however, if they have 250 users the monthly charge would be $2,500.
- Tiered pricing: Customers pay in increments depending on usage. Say you sell cloud storage, with the first 50 GB of storage costing $0.25 per GB. Once the customer reaches the 50 GB limit, they’re charged $0.23 per GB for the next 50 GB used. At 101 GB, the customer jumps to the next increment paying $0.21 per GB for up to 150 GB. To further explain, let’s say that a customer uses 75 GB in a month, they would be billed $18.25 (50 GB x $0.25 = $12.50 + 25 GB x $0.23 = $5.75).
- Volume pricing: This usage-based billing model is similar to tiered pricing, but with a twist. Instead of the customer paying a set incremental fee, they pay based on the highest tier reached. Let’s say there are 3 plans for API calls, with each subsequent plan offered at a lower rate. To illustrate, the first tier offers up to 2,000 API calls per month at $0.20 per call, when a customer reaches the second tier (2,001 – 4,000 API calls per month) they will be charged $0.10 per call, and the final tier (4,000+ calls per month), is rated at $0.05 per call. If 1,000 calls are made in a given month, the customer is charged $200 for that month, however, if 4,001 API calls were made that month, the bill would only be $200.05 – double the calls at virtually the same price.
When implementing a usage-based strategy, there are four steps you need to take into consideration.
1) Determine the product or service metric
This figure should take into consideration three attributes
- number of users/customers
- the amount of data, services, etc. a customer uses on average
- the number of sub-services or events a customer would process.
2) Collect, clean, and reconcile usage data
This step must encompass all databases where information is kept to ensure accurate records of usage (or events called) can be accounted for per each user. Referred to as mediation, this step can be complex and it’s recommended that a mediation engine that is native to your billing system is used.
3) Track and rate usage
This is accomplished by identifying user usage, summarizing usage records, and applying the pricing plan to calculate monthly charges. Depending on the sophistication of your pricing model, the frequencies and timing of rating may vary and become complex quickly – especially if you have a large subscriber base. This is where an advanced, yet easy-to-use billing system becomes a necessity.
4) Bill the customer
Typically done in arrears and at recurring intervals, the customer is invoiced for products or services consumed. The invoices sent need to clearly detail the charges so customers can quickly associate charges with products/services used.
Businesses that are successful at aligning price with usage set themselves up to seize market opportunities and increase revenue, while improving customer satisfaction.
Is Usage-Based Billing Right for You?
Providing a win-win scenario for the company and customers alike, usage-based billing offers customers a way to cost-effectively gain entry to the products and services needed, while providing companies with a recurring and profitable revenue stream. Although the many benefits are significant, usage-based billing isn’t designed for every company. If you’re still not sure if this billing model is right for your business, download our Usage-Based Billing – Is it Right for Your Business white paper for the information you need to make the right decision.
Regardless of the billing model you select, you need a sophisticated billing platform that provides support for all of your business requirements – any product, any service, any business model. BillingPlatform provides the only billing solution on the market today that enables businesses to support any combination of one-time charges, subscription, consumption, or hybrid-based billing – all on a single platform. Our experts are ready to answer any questions you have about what usage-based billing is, so reach out today.