What is Usage-Based Pricing?
Usage-Based Pricing (UBP) is a consumption-based pricing model in which customers are charged based on the actual usage of a particular product or service.
Usage-based pricing (UBP) can help support more sustainable growth by aligning revenue with actual service usage. Therefore, customers pay in accordance with the actual consumption (or usage) of a product in the billing cycle rather than being charged a fixed, flat rate, irrespective of whether the product was used or not.
- The usage-based pricing (UBP) is a pricing model where customers are charged based on their actual usage (or consumption) of a product rather than a fixed rate.
- The usage-based pricing (UBP) model is characterized by flexibility and transparency—with costs aligned with consumption—which can lead to increased customer satisfaction and loyalty.
- The UBP pricing model is commonly used in industries such as cloud computing, telecommunications, utilities, and increasingly in SaaS, providing benefits like passive upselling and profit margin stability.
- The factors driving the rapid adoption of UBP pricing include improved technologies to measure real-time usage monitoring, the market demand for pricing flexibility, successful implementation by early adopters, and the ability to lower barriers to entry for potential customers.
How Does Usage-Based Pricing Work?
Usage-based pricing (UBP) is a pricing model where customers are billed based on their actual usage of a product or service, as opposed to paying a fixed rate.
The pricing model is cost-effective to implement for companies since there is minimal commitment required and the risk of overage charges is reduced (i.e. user exceeds the allotted usage limits).
Unlike traditional subscription pricing models that charge a fixed fee regardless of usage, the usage-based pricing (UBP) model offers flexibility to customers, where costs align with consumption.
The usage-based pricing (UBP) offers customers the option to pay according to how much they use a product.
The measured usage reflects how much value the customer derives from the product, with common metrics being the number of transactions processed, the amount of data stored, or the volume of resources consumed.
In effect, the pricing model can be appealing to both providers and customers because of the variable usage patterns, which ensures that customers see a direct correlation between their usage and costs, enhancing perceived value.
Because the billing is a function of actual usage that is quantifiable, the usage-based pricing model is often viewed positively by customers for its transparency.
Furthermore, managing to establish trust from customers is the initial step toward building customer loyalty, which coincides with creating a recurring revenue stream.
One side benefit to usage-based pricing is that the collection of data can help companies better understand and predict usage patterns—which enables more accurate sales forecasting, resource allocation, and improved operational efficiency—based on the derived practical insights into customer behavior and product utilization.
What are the Different Types of Subscription Pricing Models?
The two most common types of pricing models used by SaaS and subscription-based businesses are fixed-rate pricing and usage-based pricing (or metered billing).
Pricing Model | Description |
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Fixed-Rate Pricing |
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Usage-Based Pricing |
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Usage-Based Pricing vs. Subscription-Based Pricing: What is the Difference?
Usage-based pricing and subscription-based pricing are two distinct strategies that cater to different business needs and customer preferences.
- Usage-Based Pricing (UBP) ➝ Usage-based pricing—also known as “pay-as-you-go”—charges customers based on their actual usage of a product or service. The consumption-based pricing model is prevalent among utility companies, cloud service providers, telecommunication providers, and now increasingly SaaS vendors. The key characteristics of the pricing model include the variable billing structure, scalability, and transparency in costs. In short, customers pay only for what they use, leading to fluctuating monthly bills that can efficiently align with their consumption patterns. The pricing model encourages customers to optimize their usage, which can result in cost savings on both ends. However, the drawbacks to the pricing strategy are the unpredictable fluctuations in revenue and complicated billing systems (i.e. monitor usage per user), which can cause forecasting to become more unreliable.
- Subscription-Based Pricing ➝ In contrast, subscription-based pricing involves charging customers a recurring fee, typically on a monthly or annual basis, for continuous access to a product or service. The subscription-based model is widely adopted by SaaS companies, streaming services, and membership organizations (e.g. gyms). Subscription-based pricing is characterized by fixed costs based on a flat rate, ensuring customers are charged a consistent amount at regular intervals, which simplifies budgeting for both customers and providers. The pricing model can build long-term customer relationships and loyalty, contributing toward a steady and predictable revenue stream. The simplified billing process and the auto-renewal of subscriptions further enhance convenience for both parties. However, the downside is that customers might be paying for services not fully utilized, which can lead to an uptick in customer churn rates (i.e. subscription cancellations).
What are the Different Types of Usage-Based Pricing Models?
There are several variations of usage-based pricing, which are described in the subsequent table:
Variation | Description |
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Tiered Usage-Based Pricing |
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Per Unit Usage-Based Pricing |
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Volume Usage-Based Pricing |
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Stair-Step Usage-Based Pricing |
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Which Industries Use Usage-Based Pricing?
Industry | Description |
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Cloud Computing |
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Telecommunications |
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Utilities |
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Software as a Service (SaaS) |
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What Factors are Driving Adoption of Usage-Based Pricing?
Several factors contribute to the growing popularity of usage-based pricing (UBP):
- Real-Time Usage Monitoring ➝ The increasing capabilities to track usage closely and support dynamic pricing models stem from advancements in automation technologies, including APIs and AI, enabling precise tracking and billing of usage. The ongoing technological advancement reduces the administrative burden on both providers and customers, improving operating efficiency while facilitating real-time usage monitoring.
- Downside Protection ➝ The necessity of flexibility in the pricing plans offered to customers has become a critical factor for SaaS companies, with UBP offering resilience against churn and improved customer retention. The economic pressures and the need for cost efficiency have made flexible pricing models more attractive, especially amid the COVID-19 pandemic. Moreover, UBP can provide a competitive edge in tight markets by offering more appealing and adaptive pricing options.
- Widespread Adoption ➝ Early adopters have demonstrated there is plenty of demand for a flexible, usage-based pricing structure, encouraging wider adoption in the SaaS market. For example, companies that have successfully implemented UBP, such as Twilio and Datadog, serve as benchmarks for others to follow suit, considering the rate of customer acquisition and recent revenue growth.
- Lower Barrier ➝ Usage-based pricing (UBP) reduces upfront costs, making it easier for potential customers to test out a product. Lowering the financial barrier to entry allows customers to access the product and determine if the value of the product is worth committing to without a significant initial investment required. By reducing these barriers, UBP can improve trial and adoption rates, causing an expansion in the customer base (i.e. trial and paid customers). Companies can also target a broader range of customers, from early-stage startups to large enterprises.
What are the Benefits of Usage-Based Pricing?
- Passive Upselling ➝ The increased usage by a customer leads to higher spending without the need for more sales efforts. For instance, as the size of an enterprise client grows, usage of the product (and the need for more seats) is inevitable, which contributes to an increase in spending in direct proportion to the growth and development of the client. The passive upselling that occurs by itself enhances customer lifetime value (CLV) without the necessity for aggressive sales and marketing (S&M) tactics or spending on campaigns. The product becomes more deeply embedded into the operations of a customer once acquired, improving the overall stickiness (and thus, more recurring revenue).
- Customer Satisfaction ➝ The consumption-based pricing model aligns costs with usage, reducing concerns about overpaying for services not utilized. Therefore, customers view transparency favorably since each bill is directly based on their actual usage, leading to higher customer satisfaction and loyalty. The alignment of costs with usage facilitates a more positive customer relationship, namely around trust, since users understand the tradeoff is fair.
- Profit Margin Stability ➝ Because of the fact that usage based pricing connects customer billing (and revenue) to actual usage, that causes the company’s unit economics per customer to stabilize. The flexible pricing model helps companies maintain strong profit margins by directly correlating costs and revenues. In effect, a “buffer” is created that can mitigate the risk of revenue fluctuations, as increased usage causes revenue to rise, supporting more sustainable growth in revenue generation (i.e. periods of increased usage can offset periods of reduced usage).