Usage-based pricing is becoming increasingly popular in SaaS companies, and for good reason: in general, customers seem to love it because they only have to pay for what they actually use. This can ultimately lead to a better customer experience, and therefore better customer retention.
At Wingback, we're a big fan of leveraging whatever pricing model helps align the value that customers receive with the price they pay. Usage-based pricing can often do just that -- but far too often, we also see companies that simply want to jump on the bandwagon and implement some form of product usage factor in their pricing strategy with no good reason. The result? It can also hurt your bottom line if you're not careful and properly considering the rationale for using it.
Here, we cover all the basics about usage-based pricing, including its benefits, challenges, and best practices for implementation, so you can determine whether it's the right call for your pricing structure, or whether to sit this trend out.
What is Usage-Based Pricing?
Usage-based pricing, also known as consumption pricing, is fairly straightforward and exactly as the name suggests: customers are charged based on their actual usage of a product or service during a billing period. This model is built on the idea that the more a customer uses a product or service, the more value they receive, and thus, the more they should pay. Usage-based pricing relies on specific usage metrics, such as data storage, API calls, or the number of lookups, to determine the price for each customer base.
Callout: Usage-Based Pricing vs. Other "Usage" Model Pricing
Usage based pricing can be sort of a catch-all term for any type of pay-as-you-go pricing structure, but technically it refers to SaaS pricing where the units of measure are high in volume and or can't always be measured to the nearest whole unit. Think of it like buying rice in the bulk bin at the market. You're probably not going to count this in grains of rice, or even in scoops -- you're going to measure it by weight. There's no real way to measure or charge this by "units" so instead you charge by how much a customer actually put into their bag by weight. The same logic is where usage-based pricing applies.
On the flip side, if the feature you're looking to monetize is often consumed in whole, countable units, that would be called "per-unit" pricing. In this analogy, per-unit pricing would make sense if you're selling whole bags of race, where someone can't buy a part of a bag, they must buy in units of 1 bag.
Usage-based pricing examples: Cloud storage
Per-unit pricing examples: Seats / users, API calls, GPT prompts
Each usage model has its place in modern pricing strategies. Different pricing models have their own benefits here, both for your customer experience and for your business model, so it's important to find the right pricing model to maximize value for your customers and in turn, revenue for your SaaS business.
Benefits of Usage-Based Pricing
Usage-based pricing enables businesses to charge customers based on the actual value they derive from the product or service. This value-driven approach helps customers understand the direct correlation between their costs and the benefits they receive, leading to increased trust and perceived fairness in the pricing model.
Encouraging Adoption and Expansion
With usage-based pricing, customers can start with lower costs as they begin using the product or service. This low barrier to entry can encourage adoption and make it easier for customers to try out the offering. As customers see the value in using the product more, they are more likely to expand their usage, driving additional revenue for the business.
Better Resource Allocation
Usage-based pricing can help businesses optimize their resource allocation by charging customers for the resources they actually consume. This approach encourages customers to use resources more efficiently and enables businesses to allocate resources based on actual demand, leading to better overall resource management and cost savings for both the business and its customers.
Enhanced Customer Segmentation
Usage-based pricing can provide valuable insights into customer behavior and usage patterns, enabling businesses to better segment their customers based on their specific needs and preferences. This enhanced customer segmentation can help businesses tailor their marketing, sales, and customer success efforts more effectively, leading to improved customer acquisition, retention, and growth.
Easier Upselling and Cross-Selling Opportunities
With usage-based pricing, businesses can more easily identify upselling and cross-selling opportunities based on customers' usage patterns and needs. For example, customers who consistently reach or exceed their usage limits may be prime candidates for an upsell to a higher-tier plan with increased usage allowances or additional features.
Challenges of Usage-Based Pricing
Choosing the Right Usage Metrics
Selecting the appropriate usage metrics is critical to the success of a usage-based pricing model. The chosen metrics should accurately reflect the value customers receive from the product, without discouraging them from using it. Identifying the right metrics may require thorough analysis of customer usage patterns and an understanding of the factors that drive customer value. One example of common usage metrics is storage, typically offered by cloud providers.
Hybrid pricing models can result in more complexity when it comes to invoicing versus traditional pricing models, as businesses need to track and calculate the product usage data for each customer during the billing cycle. This may require additional investment in billing systems and processes to ensure accurate and efficient invoicing. In addition, it can be exceedingly difficult to track their service usage in real time.
Some customers may prefer more traditional pricing models as they offer more predictability and simplicity when they're thinking through their software budgets. Any SaaS company that thinks this may be an issue should consider offering real time estimates of their SaaS usage can help avoid customers getting sticker shock.
Unpredictable Cash Flow
This may seem obvious, but it's worth stating: If you rely heavily on a usage based pricing, it can be almost impossible to have predictable revenue. Some companies overcome this uncertainty by adding in a recurring, fixed fee.
Fortunately, all of these barriers can be overcome with tools like Wingback,
which allow both parties to get real-time insight on their usage and deploy complex pricing plans without causing any billing headaches.
Different Versions of Usage-Based Pricing
Flat Fee + Usage-Based Pricing
What is Flat Fee + Usage-Based Pricing?
This pricing model combines a recurring flat fee with an additional usage-based fee. Each billing cycle, the company charges a certain base amount for the product and generates additional revenue based on how much customers are using it.
Why choose Flat Fee + Usage-Based Pricing?
By combining a flat fee with a usage-based component, businesses can ensure that even customers who use the product relatively little at first still pay for the base value provided by the product. As customers' usage increases, so does the revenue generated from the usage-based component, aligning the price with the value received.
Example: Cloud providers might charge a flat monthly fee for access to their platform, plus an additional fee based on the amount of cloud storage used.
Tiers + Usage-Based Pricing
What is Tiers + Usage-Based Pricing?
This pricing model combines a recurring fee for a specific pricing tier with a usage-based fee each billing period. Pricing tiers are different packages that customers can choose from, typically offering a set of features at varying price points.
Why choose Tiers + Usage-Based Pricing?
This model is ideal for businesses targeting different customer profiles, as it allows them to create tailored pricing tiers for each segment. By adding a usage-based fee on top of the tiered pricing, businesses can charge for both the base value of the product and the value that increases with usage.
Example: A project management tool might offer a basic tier with limited features and storage, a premium tier with additional features and more storage, and an enterprise tier with advanced features and unlimited storage. Each tier would also include a usage-based fee for additional data usage or API calls.
Per Seat + Usage-Based Pricing
What is Per Seat + Usage-Based Pricing?
This pricing model combines a per-seat fee with a usage-based fee, so there are two active variables each billing period. The "seat" refers to an individual user who has access to the software.
Why choose Per Seat + Usage-Based Pricing?
This model allows businesses to monetize both the number of users accessing the software and their usage of specific features. It ensures that customers pay for the value they receive based on the size of their team and the extent to which they use the product.
Example: A customer relationship management (CRM) tool might charge a per-seat fee for each user who has access to the platform, plus an additional fee based on the number of contacts managed or emails sent.
Tiers + Per Seat + Usage-Based Pricing
What is Tiers + Per Seat + Usage-Based Pricing?
This pricing model combines a recurring fee for a specific pricing tier, a per-seat fee, and a usage-based fee. This model allows businesses to monetize all three factors that provide value to customers: the base features of the product, the number of users, and the extent of usage.
Why choose Tiers + Per Seat + Usage-Based Pricing?
For businesses that cater to different customer segments and want to maximize revenue opportunities, this model offers the most comprehensive approach. By charging for each aspect of value, businesses can create tailored pricing packages that cater to the diverse needs of their customers.
Example: A marketing automation platform might offer different pricing tiers with varying feature sets, charge a per-seat fee for each user who has access to the platform, and include a usage-based fee for the number of emails sent or leads generated.
Examples of Companies That Successfully Implemented Usage-Based Pricing
In this section, we will explore examples of companies that have achieved success with usage-based pricing and discuss the factors that contributed to their success.
Slack is a popular team collaboration and communication platform that offers various pricing plans, each with a different set of features. While Slack charges per active user, they also include usage-based components, such as file storage limits, in their pricing model. For example, their free tier has a 5GB storage limit, while their paid plans offer more storage per user.
Why is Slack successful with this pricing model? Slack's hybrid pricing model provides customers with a choice of plans that cater to their specific needs while also aligning the price with usage-based value, such as storage. This allows businesses to select a plan based on their desired feature set and scale their storage usage as needed.
Zoom is a video conferencing platform that offers a range of pricing plans, each with different features and usage limits. Their pricing model includes a per-host fee and usage-based components such as the maximum number of participants, meeting duration, and cloud recording storage.
Why is Zoom successful with this pricing model? Zoom's combination of feature-based plans and usage-based components allows customers to choose a plan that best fits their requirements while also scaling their usage as needed. This flexible pricing model ensures that customers only pay for the features and usage they need, increasing customer satisfaction and retention.
Mailchimp is an email marketing platform that offers tiered pricing plans based on features and usage. While each plan comes with a different set of features, Mailchimp also includes usage-based components such as the number of subscribers and monthly email sends.
Why is Mailchimp successful with this pricing model? Mailchimp's hybrid pricing model caters to businesses with varying email marketing needs by offering plans with different feature sets and usage limits. Customers can choose a plan based on their desired features and scale their subscriber count and email sends as needed. This pricing model ensures that customers pay for the value they receive from the platform and have the flexibility to grow their usage over time.
Wistia is a video hosting and analytics platform that offers feature-based plans with usage-based components. Their pricing model includes different plans with varying features and usage limits, such as the number of videos hosted and monthly video bandwidth.
Why is Wistia successful with this pricing model? Wistia's combination of feature-based plans and a usage model allows customers to choose a plan that best fits their video hosting and analytics needs while also scaling their usage as needed. This flexible pricing model ensures that customers pay for the value they receive from the platform and have the flexibility to grow their usage over time.
Usage-based pricing can be a serious game-changer for a lot of SaaS companies by only asking customers to pay for the resources used, including fair pricing, increased customer satisfaction, and predictable revenue streams. However, implementing this pricing model requires careful consideration of customer usage patterns, the right usage metrics, and the necessary tools and systems to manage billing and reporting. Many SaaS businesses find that hybrid pricing models can help overcome the drawbacks of pure usage-based billing models, while also offering the benefits that traditional subscription pricing models aren't offering.