This is a SaaS pricing model where billing reflects how much customers use your service or product.
Usage-based billing is among the most common subscription billing strategies companies use today; it is also known as metered, consumption-based, or pay as you go billing. Regardless of the name you choose, it is a pricing model which appeals to a wide range of customers and can be used across multiple industries to help drive recurring revenue and customer acquisition and retention.
This is a SaaS pricing model where billing reflects how much customers use your service or product. One advantage is that usage can be defined differently for various industries. Standard usage metrics depend on customer preferences and must align with perceived value. For instance, common metrics include the number of units, the amount of data, mileage covered, etc.
Companies often combine different metrics to arrive at flexible pricing that offers value based on different types of usage. Mixing different strategies allows your customers to have more options. However, it can come with additional complications, and implementation shouldn’t happen overnight. Finding the right price points and value metrics will require experimentation before settling on the best path forward.
Want to explore a specific aspect of usage-based billing? Skip ahead by clicking on the topic.
There are several different ways to charge for usage, so this list is to help you determine which approach might work best for you. The list below quickly summarises the various strategies, and you can click the pricing strategy of your choice to jump ahead:
A simple approach to usage-based billing, this strategy sets a fixed price per unit used. Combining well with other techniques such as volume-based pricing, you bill customers for the amount used of a service or product. The value metric for usage varies (e.g. data, users, events).
Companies sometimes choose per-seat or per-person pricing as the value metric to measure. However, there are several critical differences between this and other types of usage-based billing. Some of the pros and cons tend to differ. For instance, on the positive side, it’s easy for customers to calculate the cost and spot hikes in usage as it will be apparent that they’re adding users. But in general, companies will not reap the benefits of usage-based billing if they choose users as their only value metric.
Long-distance calls from Telus are an example of per-unit pricing where they bill per minute. You can see how simple their price page is, making it easy for customers to understand the value.
The volume pricing model allows the price per unit to fluctuate based on the final usage volume. So, the more units a customer uses, the less they pay per unit. Volume limits often tempt users to a higher bracket of usage and happily pay more knowing they get a better price per unit.
Volume limits make a lot of sense for services where the value metric is an event, for instance, a phone call. Many companies will charge a higher unit per call if you make only 30 calls in a month, but if you make over 100 calls in a month, the price per unit decreases—rewarding you for higher usage. Psychologically this leads to higher perceived value.
Phone plans are often an excellent example. If you look at Virgin Mobile’s phone plans, you see that the more you spend per month, the less you pay per unit of data. If you are in the market for a phone plan, it’s easy to see the value of paying more.
This pricing strategy allows customers to go over the usage limit of a particular package if they’ve chosen a specific volume of units per month. It introduces flexibility from the customer’s perspective; however, it can be tricky not to upset customers if they exceed their monthly allocated volume and do not expect the additional charge. Many companies charge an inflated or premium rate for usage that exceeds the package limits, which can be alarming for customers who ignore the fine print. It can result in them feeling penalized for using your service, which is not ideal.
For instance, if someone signs up for 2 GB per month of data but uses 3 GB. If they’re not aware of extra charges, it might feel unfair when the bill arrives. Companies should try to adopt overage pricing without making customers feel penalized, keeping rates fair and providing clear communication when users exceed volume limits.
Bike Share Toronto (in fact, bike share services worldwide) are an example of overage pricing. They work by charging customers an annual fee for an unlimited number of rides per year. However, the catch is that those rides should be under a set amount of time. So rather than unlimited use of the bike, customers pay for unlimited use of bikes in 30 or 45 minutes stints. After this, overage fees apply.
The use of tiered pricing for usage-based billing requires companies to package their product or service in tiers. Often this is done by assessing the volume of units used and dividing it into tiers. Price increases with each level but so too should perceived value. Often SaaS companies will combine different usage metrics in each tier, placing volume limits on each one.
It’s common to see this sort of pricing used by tech companies, but it has its uses elsewhere. Companies need to consider the psychology of the tiers they choose, as knowing which features or usage matters most to your customers will be critical.
Renderforest is an example of a company that uses different tiers to sell usage (they’re also an example of a company using almost every trick in the subscription pricing book). If you look at the breakdown of their tiers in the image below, you can see that the top four features in each level are usage-based and use volume limits to establish the cost. It’s easy for customers to understand why Pro is an attractive option in comparison to Lite. However, it’s also possible for smaller companies to trial the service for free before committing.
Often companies will make the premium or final tier level unlimited, but this can be problematic when it comes to heavy usage of your services. For example, if a company takes advantage of “unlimited” storage and exhausts resources, it may be hard to support usage over time. That’s why many are now introducing overage pricing on the final tier level. Overage gives users an attractive usage allowance in the top tiers while charging extra when users max out their usage allowance.
For example, classpass implements this by giving each tier a pre-defined number of credits for fitness classes per month. In every single tier, you have the option to go over your allowance for the month and buy more credits, effectively charging you for heavy usage. This method also helps upsell their higher tiers as customers who regularly purchase bonus credits can upgrade once they understand their usage habits. In addition, classpass does not fall into the trap of heavy users taking advantage of an “unlimited” tier which might cost more to manage over time.
When it comes to recognizing revenue, usage-based billing is one of the most straightforward billing models to manage. In most cases, users pay for the service as they consume it, and therefore the revenue can be recognized immediately with no need to defer until a later date.
One exception to this rule is when customers only use part of a set package in increments or billing is based on the percentage completion of a particular project.
For example, a customer signs up for 10 courses and pays a total of $1,000 in advance. Perhaps they take the courses over 10 months. In this situation, revenue would be deferred and recognized as they complete each course. If the customer completes one course a month, you would only recognize one course worth of income for that period, deferring the rest of the revenue until the service is delivered.
Similarly, when billing for project-based work like building a website, you might bill a lump sum upfront but set the deferral schedule to account for a set completion percentage per month. This approach allows you to account for slower months and recognize revenue more accurately and is vital for remaining compliant with accounting standards.
It perhaps comes as no surprise that companies will not implement usage-based billing effectively if they rush it. Here are the three critical elements of the billing model that you can’t afford to get wrong.
Market research and a firm understanding of the value your customers perceive in your product or service are both critical. It may take time to decide on your value metric or figure out how to combine various value metrics. The most important is aligning the perceived value with the chosen value metric. Standard value metrics include data, users, and the number of events.
Earlier in this article, you will find several examples of pricing strategies to help you implement an effective usage-based billing model. Once you’ve decided on your value metric, you will need to understand each of these to make an informed decision. Will you need to include overages? What kind of tiers would work best? Get creative with your strategy and look beyond your own industry’s examples. You may be surprised what you could borrow from successful SaaS companies.
Without a powerful recurring billing solution that allows you to bill for usage accurately, you may find that even the most exciting pricing strategies will fail. High customer churn rates result from poorly managed subscription services where it’s hard to understand invoices and customers do not have clear insight into their usage. Implementing a solution that allows you to accurately invoice customers without errors that might result in a bad customer experience is critical. As you scale, it will also be important that this solution can handle compliance for ASC 606 and IFRS 15.
Check out our guides to the other pricing models:
