What You Need to Know About Usage-Based Pricing

You know what Usage-Based Pricing is: your customers pay only for what they consume. But why they should care? Find out how your customers benefit and what you need to consider when implementing UBP.

What You Need to Know About Usage-Based Pricing
Photo by Tolga Ulkan / Unsplash

There's been a lot of buzz about SaaS companies switching to usage-based pricing models. For businesses with fewer resources, seat-based pricing can be a means of entry into the SaaS market. But today's SaaS buyers are looking for flexibility — subscribing to various cloud services that solve specific issues rather than buying a single product across the board.

In this post, I'll define usage-based pricing, how I see it in the market today, and why it's an approach that every SaaS business should consider.

What is usage-based pricing?

Usage-based pricing is a way to structure the pricing of your product or service based on how much the customer uses it. Usage-based pricing can be used for products and services with a clearly defined usage quantity, such as no. of users, the volume of data, or the amount of electricity and water consumed in more mainstream terms. Customers are billed according to how much they use, so customers who use more pay more. The cost per unit remains constant regardless of how much or how little an individual consumer uses.

A common example is a utility bill, where you pay for the amount of water or electricity you use (not including any additional fees). You might also see usage-based pricing when buying the internet. If your family streams video content in high definition, you will likely need to upgrade to a higher speed tier to avoid buffering videos.

How does usage-based pricing work?

Usage-based pricing is a billing model where the price depends on usage. The more a customer uses it, the more they pay for it. This is different from traditional pricing models, where you pay for a fixed number of users or specific features within the product.

This model is great for companies that want to offer customers flexibility and provide an equivalent amount of value to their users as they increase their use of your product. With this type of pricing, you can attract both large enterprise clients and smaller startups who won't be using your product at scale just yet.

What are the benefits of using usage-based pricing?

  • Usage-based pricing can help you increase your revenue. If your customers pay for what they use, you can price things more efficiently. You don't have to worry about tiered pricing because everybody is paying for precisely what they're using. This increases the revenues of the heaviest users and prevents you from cannibalizing the sales of users who don't fully use your product yet. This means that usage-based pricing allows you to increase your overall revenues and eliminate any upside-down pricing structure that might be currently in place.
  • Usage-based pricing can help you better understand your customers. By charging them based on how much they consume of your service, you get an excellent indication of how valuable they are to them and how frequently they use it. Is it once a year? Or is it once every few hours?

Usage-based pricing can allow you to segment your user base in a way that allows you to understand their usage pattern better and then develop new services or upgrades around those patterns that would be more appealing and more likely to stick with them rather than just having one price point across all customer bases regardless of their usage level or frequency. This will also allow you to then strategically add on additional features for specific groups at higher prices when needed, thus increasing further upsell opportunities among existing clients instead of always trying (and failing) to acquire new ones because their needs aren't being met by existing offerings already available out there today (which could take weeks if not months before getting implemented).

What to consider before you start using usage-based pricing?

At this point, you should have a good idea of whether your business is ready to adopt a usage-based pricing model and start the journey down that road. Before you make your decision and jump in head first, there are some things you should think about first:

  • Customer Lifetime Value. What's the value of each customer? If a customer pays you $10 per month but costs $20 per month to serve, usage-based pricing will not help your bottom line.
  • Churn Rate. If many users churn after using your product for free, it might be better to charge upfront rather than rely on freemium or free trials and hope that people will pay later.
  • Will Your Customers Pay for Usage? You need to figure out if usage-based pricing works for your customers and if they're willing to pay for it.
  • Alternative Pricing Models? If there are alternatives, how do they compare? Can you offer both models at once?

Examples of businesses using usage-based pricing successfully:

There are dozens of companies using usage-based pricing to date. There are a few examples:

  • Twilio, Zoom, Slack, and Stripe are charging based on the number of users or seats in their service.
  • Shopify, Hubspot, and Sendgrid charge based on a certain number of monthly visitors or emails sent.
  • Postmark, Mailgun, and Mailchimp charge based on the number of emails sent.

Usage-based pricing can be a powerful tool for growing your business.

Many companies offer usage-based pricing to their customers. These customers pay a fee per unit of data rather than a flat rate for one year's worth of service. Often, this is the only way for companies to gather valuable data about how frequently customers use the product or service and other demographic information. If a business wants to grow, it can develop its product or service and then offer it in a trial offer to new customers who also opt-in to receive email. The better these new users like the product or service they are using, they will be more likely to renew their subscriptions with the company at a higher price.

As your business grows with more subscribers and you find out how often your customers are using each feature of your products, you can develop new ways for your customers to access those features by changing usage fees accordingly. This allows subscribers to continue giving you feedback about which features people value most in your products and services, which helps you continually guide your users toward designing new services that allow them greater flexibility and control over their lives