The Different Kinds of Usage-Based Pricing Models

February 2, 2024
Pricing Models
Here at Wingback, we're big fans of usage-based pricing (UBP), as it has helped a lot of SaaS companies align their products' value with their customer base. But as one of the leading SaaS pricing models today, and customer needs and usage patterns differ, UBP has evolved to include numerous approaches with a lot of nuance. From a straightforward usage subscription model to hybrid pricing models, each variation offers its own unique advantages and designed to address specific customer usage needs.

Let's dive into the different flavors of usage-based pricing, including simple, block linear, volume, and tiered pricing. We'll break them down so you can understand how they work and how you can use them to enhance customer experience, retention, and revenue predictability for your SaaS business, no matter what stage.

Simple Usage-Based Pricing

This model epitomizes clarity and fairness by scaling costs in a linear manner with usage. Unlike its counterparts, which involve steps, tiers, or volume discounts, simple UBP maintains a constant rate for each unit of consumption, offering a direct correlation between service usage and cost.
The Essence of Simple Usage-Based Pricing
Simple UBP operates on the principle of paying exactly for what you use, with no thresholds, blocks, or tiered complexities. If a SaaS company charges $0.05 per API call under this model, then a customer making 1,000 API calls would pay $50, and one making 10,000 calls would pay $500. The cost directly reflects the volume of product usage, with each unit of service consumed priced identically.
Advantages of Simple Usage-Based Pricing
  • Transparency: Customers appreciate the straightforwardness. There's no need to decipher how billing works or to estimate where usage falls in relation to tier thresholds or block sizes.
  • Predictability: For both the provider and the customer, predictability improves with a linear pricing model. Customers can easily calculate their costs based on expected usage, while providers enjoy a steady, predictable revenue stream that mirrors customer engagement.
  • Fairness: This model is perceived as highly fair, as it directly ties cost to usage without penalizing customers for scaling their operations. Everyone pays the same rate for what they use, making it an equitable solution for businesses of all sizes.
Ideal Use Cases for Simple Usage-Based Pricing
Simple UBP shines for SaaS businesses where their services are easily quantifiable and where customer usage patterns are highly variable, yet predictable on an individual basis. It's particularly suitable for SaaS businesses offering services that can be clearly metered, such as cloud storage, data processing, or transaction processing services, where the linear correlation between usage and value is straightforward to the customer.
Example: SteamFlow Analytics
StreamFlow Analytics, a cloud-based data analytics platform, has carved a niche for itself by adopting a straightforward pricing model that scales linearly with usage, embodying the principles of transparency, predictability, and fairness. Their SaaS pricing model paid off: it led to a noticeable increase in customer acquisition and retention as startups and SMEs in particular found this offering appealing for its ease of understanding and direct correlation between cost and value.

Block Linear or Stair-Step Usage-Based Pricing

Let's say one of your usage metrics is based on the number of API calls made. Block linear pricing, also known as stair-step pricing, charges that usage in blocks or batches rather than 1-to-1. For example, the first 1,000 API calls might be free, and each subsequent block of 1,000 calls incurs a fixed charge of $19.99 and so on. This model creates a stair-step cost graph, where the price plateaus until the next block threshold is reached, then steps up. For customers, the appeal is akin to buying in bulk—purchase more, and you hit the next 'block', incurring an additional fixed cost. This model offers simplicity and predictability, making it a preferred choice for customers with stable and predictable usage patterns.

It's also common to combine this approach with a freemium pricing model by making the first "block" or stair-step free.
Example: CallStream
CallStream, a cloud communications platform, has adopted a block linear pricing model to simplify billing for their clients. Recognizing the variable nature of call volumes that their SMB customers experience, CallStream allows for the first 1,000 minutes of calls to be free each month, and then customers can purchase additional minutes in blocks of 1,000 at a fixed rate after they've crossed that threshold. This model has proven effective for CallStream, providing a straightforward way for customers to manage and predict their monthly expenses with fluctuating call needs.

Volume Usage-Based Pricing (Direct Tiers)

Volume pricing, or direct tier pricing, gives customers a discount on their "total bill" the more their volume increases. Under this model, all units consumed are priced retroactively based on whatever discount threshold a customer meets. For example, if you offer price breaks at every 1,000 API calls and a customer uses 3,000 API calls (let's say that's $0.012 per call), all 3,000 of those units will be charged at that reduced price even if the 1,000 threshold was $0.016 and the 2,000 threshold was $0.014. This pricing model rewards higher usage with lower incremental costs, encouraging customers to scale their service usage to hit the next price break.
Example: DataCrunch
DataCrunch, a SaaS company providing data analytics services, utilizes volume pricing to cater to its diverse user base, from startups to large enterprises. This model adjusts the price per data query as the volume of queries increases, encouraging more extensive use of their service. For example, the first 10,000 queries each month might cost $0.10 per query, with the price dropping to $0.08 for the next 10,000. This pricing strategy has been instrumental for DataCrunch, attracting high-volume users with the promise of lower incremental costs, while still offering competitive pricing for smaller customers.

Tiered Usage-Based Pricing (Cumulative Tiers)

Tiered pricing, or cumulative tier pricing, charges usage within each tier at a specific rate, not retroactively applying the tier's rate to all usage as in direct tier. Each range has a fixed price; for example, the first 1,000 API calls might be $0.02 each, the next 1,000 $0.018 each, and so on. So you'd be billed $20 for the first 1,000, and $18 for the second 1000, for a total of $38. This method calculates costs cumulatively across tiers, offering a balance between predictability and cost savings as product usage grows. It suits a wide range of customers, from those with moderate to high usage patterns, by providing a fair and transparent billing model that scales with actual usage.
Example: StoreSpace
StoreSpace, an online storage provider, offers a tiered pricing model that segments prices based on the amount of data stored. This model appeals to a wide range of customers by providing flexibility and scalability. For instance, the first 100GB of storage might be priced at $0.05 per GB, with the next 200GB at $0.045, and so on. This structure ensures that as customers' storage needs grow, the cost per GB decreases, rewarding loyalty and scaling usage. StoreSpace's tiered pricing has been a hit, particularly with businesses and individuals whose storage needs vary over time, offering them a cost-effective solution that scales with their requirements.

Why These Models Succeed

The success of these usage-based pricing models lies in their ability to closely align with customer usage patterns, offering both transparency and control over costs. Each model reflects a strategic approach to pricing offering fair, transparent, and predictable billing to the respective Ideal Customer Profiles (ICPs).

Block linear pricing, as seen with CallStream, provides predictability for businesses with varying call volumes. Volume pricing, utilized by DataCrunch, incentivizes increased usage with lower per-unit costs, appealing to heavy users. Lastly, tiered pricing, exemplified by StoreSpace, offers a balanced approach that rewards growing usage with better rates, suitable for a wide customer base.

Choosing the Right Model by Aligning with Value

By selecting and implementing a pricing model that matches the expectations of your ICPs, you effectively guarantee happy, loyal customers — thereby increasing your ACV and customer retention. Getting this right involves a thorough understanding of your customer base, their usage patterns, their value metrics, and how they perceive the value of your service. Engaging with your customers, analyzing usage data, customer satisfaction, and possibly experimenting with different pricing models can help you figure out how to model this value correctly.

The Pitfalls of Choosing the Wrong Usage-Based Pricing Model

Not selecting the right pricing model — or the right variation therein — can lead to significant challenges. The effectiveness of UBP for your SaaS business hinges not just on its adoption but on choosing the model that best aligns with the value customers derive from your service. Even when UBP overall is the right approach for your SaaS business, a mismatch between the pricing model and customer value perception can lead to adverse outcomes, like churn, poor CX and more.
Misalignment with Customer Usage Patterns
Choosing a pricing model that doesn't align with how customers use your service can create friction and dissatisfaction. For instance, a block linear pricing model might seem straightforward, but if your customers' usage varies significantly from month to month, they could end up paying for unused services or facing unexpectedly high bills. This misalignment can deter potential customers, encourage existing customers to seek alternatives, and ultimately, undermine your customer retention.
Customer Perception of Value
The core of UBP's success lies in its ability to scale pricing with perceived customer value. A poorly chosen pricing model or value metrics can distort this perception, leading customers to feel they're not getting their money's worth. For instance, a tiered pricing model that sharply increases costs with each tier might cause customers to perceive the service as too expensive as their needs grow, pushing them towards competitors with more favorable pricing structures. This not only affects customer acquisition and retention but can also tarnish your company's reputation in the market.
Operational Complexities
Implementing any UBP model without the right infrastructure and tech stack in place can introduce operational inefficiencies. Complex billing systems required to support inappropriate pricing models can strain resources, requiring significant investment in customer support and billing management. This can divert focus from core product development and innovation, stifling growth and competitive edge in a fast-moving market.

Depending on your SaaS pricing model, you may or may not face this issue: Super-simply subscription pricing is basic enough for a legacy solution like Stripe Billing, but more complex pricing models, including many UBP models and hybrid pricing require more sophisticated tools and infrastructure that older solutions simply weren't designed for.

Look for a more modern, forward-looking tool that's designed to handle these highly complex operations; Wingback is a great place to start.

Consider if Combining Pricing Models will Help

As you're debating what the right pricing model is for your specific use case, keep in mind that the best solution may be a "yes, and" approach. While a simple usage subscription pricing model is right for some SaaS companies, and freemium pricing is right for others, a hybrid pricing model combining these might be what aligns best for your customers.

Beware Metering & Entitlement Headaches

Obviously, if you're dealing with any kind of UBP model, you'll need to ensure you have a reliable way to collect customer usage data and in real time. It can cause massive technical debt on the backend as well as a poor CX if your system is not set up to accommodate a metered billing model. Customers don't want to get to the end of their billing cycle with sticker shock and discourage usage, where customers are afraid to use more of your product because they have no idea how much they've consumed and what tab they've run up. At the same time, you don't want basic-tier customers getting access to the premium levels of usage, or a premium user getting booted out of the system after a certain threshold.

You can avoid these pitfalls with a solid metering and entitlements solution that gives your customers a real-time view into their current usage so they can plan accordingly. If you don't have one picked out yet, check out Wingback.

Final Thoughts

The key message when you're looking at different consumption billing models is to find alignment between customer value and their usage patterns. But you can set yourself up for failure if you don't take the time to determine the best variation of UBP for your customers, choose the wrong pricing strategy, or if you jump to implementing without the right infrastructure set up to accommodate metering and billing.
While the shift towards usage-based pricing models reflects a broader move towards customer-centricity in SaaS, the success of this subscription model really hinges on selecting the right model and having the right tools in place. No matter what you do, be mindful of preventing sticker shock at the end of the billing cycle, and focus on making the customer's journey as delightful and fair as possible.
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