"Usage-based pricing creates a transparent relationship where value scales directly with cost."
Subscription pricing has become the norm for many businesses over the past decade. The promise of predictable recurring revenue is certainly appealing. But look a bit closer and the wrinkles begin to show - inflexibility for customers, convoluted revenue streams for vendors. The siren song of simplicity turns into buyer's remorse.
In contrast, usage-based pricing has emerged as an alternative that better aligns costs to value delivered. Customers only pay for what they use. The technology landscape has primed businesses and users alike to embrace this pay-as-you-go model.
However, executing a pricing transition also brings challenges. Sudden change creates friction. The key is taking an incremental approach with the customer experience in mind.
In this guide, I'll cover the benefits of usage-based pricing and best practices on making the switch:
- How it matches cost to value
- Increased flexibility for customers
- Reduced wasted capacity and resources
- Simplified billing and revenue streams
- Strategies for implementation that ensure a smooth transition
Shifting pricing models brings growing pains but creates a win-win for vendors and customers long-term. The juice is worth the squeeze. Usage-based pricing is often the right model for the times if executed thoughtfully. Let's dig in on why it's worth making the switch.
1. Usage-Based Pricing Matches Costs with Value
The core benefit of usage-based pricing is that costs scale with value rather than a flat fee. Customers pay directly for utilization of a product or service. This creates a transparent relationship where customers receive value in direct proportion to what they pay.
Let's compare two hypothetical video hosting platforms:
- PlatForm A charges a flat $500/month for unlimited hosting
- PlatForm B charges $0.01 for each minute of video hosted
Now let's look at two hypothetical customers:
- Customer 1 hosts 100 hours of video per month
- Customer 2 hosts 10 hours of video per month
Here is what each customer would pay on the two platforms:
With the subscription pricing of PlatForm A, both customers pay the same amount regardless of utilization. But with the usage-based pricing of PlatForm B, costs directly align with the value provided.
This demonstrates a key advantage of usage-based pricing - value scales with cost. Customers only pay for what they actually use.
2. Usage-Based Pricing Increases Flexibility
Subscription pricing locks customers into a pre-defined package for a recurring period. This limited flexibility causes problems when usage fluctuates. Customers pay for unused capacity or get hit with surprise overage fees.
For example, consider a SaaS company that charges a flat $1,000/month for up to 1 million API calls. A customer that consistently uses 900K calls gets little value from the extra capacity they pay for. But if their usage spikes to 1.1 million calls in a month they get slammed with large overage fees.
With usage-based pricing, there are no nasty surprises or wasted capacity. Customers have full flexibility to use as much or as little as needed each month.
Our hypothetical SaaS company could charge $0.50 per 100K API calls instead of a flat monthly rate. This usage-based approach allows customers to scale up and down perfectly with their usage.
For vendors, usage-based pricing reduces churn by keeping pricing aligned with value. For customers, it enables aligning costs directly with business needs.
3. Usage-Based Pricing Reduces Wasted Capacity
Subscription fees often include large buffers for capacity that goes unused. Customers overpay and vendors waste resources.
For example, Adobe requires customers to commit to different tiers of creative cloud subscriptions based on number of users. A customer with 15 users pays the full 20 user price if they need any capacity beyond 10.
With usage-based pricing, customers would not overpay for unused seats. Adobe could charge based on actual users per month. Customers would save money and Adobe would reduce wasted capacity allocating unused seats.
This concept applies broadly across SaaS, infrastructure, services, and more. Usage-based pricing allows better optimization of capacity for both vendors and customers. Resources can be perfectly matched to demand instead of overprovisioning for unused buffers.
4. Usage-Based Pricing Simplifies Revenue Streams
subscription pricing often creates complexity with discounts, tiers, enterprise plans, and multiple product bundles. Usage-based pricing consolidates all of this into a single revenue stream aligned to utilization.
Let's look at a hypothetical CRM platform:
- 3 pricing tiers based on number of users
- 2 different feature bundles
- Enterprise contracts with custom bundles and discounts
- 15 different SKUs
Trying to optimize this mess creates headaches for sales reps, account managers, and finance teams. Usage-based pricing could simplify all of this complexity. The CRM could charge per seat used per month and charge for usage of different features.
For example, $5 per user per month, $10 per 100 emails sent, and $1 per API call. This aligns revenue directly with usage in an easy to understand model.
The pricing is easier to sell, onboard, bill, and forecast. Usage metrics offer clean measures of value delivered compared to convoluted SKUs.
Implementing Usage-Based Pricing
Shifting from subscription pricing to usage-based pricing takes thoughtful design and execution. Here are some best practices:
Pick clear usage metrics
The first step is choosing understandable metrics to charge against. These are often counts of well-defined events like API calls, emails sent, data processed, etc. Monitor usage to identify metrics that align with value. Avoid vague metrics like "light" vs "heavy" usage.
Structure rates effectively
Design pricing rates and tiers carefully based on usage data. Offer discounts for heavy usage to encourage growth. But don't leave too much money on the table. Balance simplicity and strategic flexibility.
Communicate pricing clearly
Educate customers early and often about the benefits of usage-based pricing. Be transparent about rates and how costs will scale with utilization. Show how they will save money compared to subscriptions.
Build reporting and analytics
Give customers tools to estimate costs, monitor usage, set budgets, and optimize spending. Allow self-service management and cost allocation across departments.
Migrate customers gradually
Help subscribers transition smoothly to usage-based pricing. Start by giving them visibility into usage metrics and potential costs. Offer hybrid plans to ease the shift. Support trials and piloting with minimal commitment.
With the right approach, usage-based pricing can transform customer relationships and business growth. Avoid common mistakes like outdated subscriptions that lock-in high fees for unused capacity. Leverage usage metrics that align pricing with value delivered. Help customers flexibly scale costs in line with needs. Simplify billing and operations through consolidated revenue streams.
Usage-based pricing creates a win-win for vendors and customers. Switching subscription services and products can seem daunting but delivers outsized benefits. Take the first step by carefully analyzing usage data and customer needs. With an incremental rollout and commitment to customer success, usage-based pricing provides a profitable path to sustainable growth.
1. What are the main benefits of usage-based pricing over subscription pricing?
The core benefits of usage-based pricing are:
- Costs scale directly with value and utilization rather than a flat fee
- Increased flexibility for customers as they only pay for what they use
- Reduced wasted capacity and overprovisioning of unused resources
- Simplified billing and revenue streams based on usage metrics rather than complex SKUs
Overall, usage-based pricing creates a transparent pricing model that aligns costs with actual value delivered to the customer.
2. How does usage-based pricing match cost to value?
With usage-based pricing, customers pay for the actual utilization of a product or service. If you use more, you pay more. This creates a proportional relationship where the cost scales up or down in direct alignment with the value received.
For example, a video hosting platform that charged per minute hosted would make customers that hosted more video pay more. This matches cost to the value provided.
3. Why does usage-based pricing increase flexibility?
Subscription pricing locks customers into predefined packages for set periods. This causes issues when usage fluctuates. Customers either overpay for unused capacity or get hit with overage fees.
Usage-based pricing enables customers to flexibly pay only for what they use each month. If usage decreases one month, costs decrease. If usage spikes, costs spike. This flexibility aligns pricing to changing business needs.
4. How can usage-based pricing reduce wasted capacity?
Subscriptions often include buffer capacity that goes unused and is wasted. For example, needing to pay for 20 user software licenses when only 15 are used.
With usage pricing, customers would not overpay for unused capacity. Instead, they would pay exactly for what gets used, say per active user account per month. This optimizes utilization and reduces wasted capacity.
5. What are the advantages of usage pricing for revenue streams?
Usage pricing consolidates all the complexities of subscriptions and SKUs into a single clear revenue stream based on utilization. Instead of multiple plans, discounts, and enterprise tiers, everything aligns to pay-per-use.
This simplifies billing, forecasting, accounting, and sales. Usage metrics provide a clean measure of value delivered compared to convoluted SKUs.
6. What metrics work best for usage-based pricing?
The best usage metrics are counts of well-defined events that directly align to value, like API calls, emails sent, users per month, storage used, data transferred, etc. Avoid vague metrics that are hard to quantify like "light" vs "heavy" usage.
Monitor actual usage to identify metrics that map clearly to delivery of value. Design pricing tiers and discounts around driving these usage metrics upward.
7. How should you structure usage rates and discounts?
Analyze usage data to find appropriate base rates. Offer discounts for heavy usage to encourage growth and loyalty. But don't discount too heavily where you leave money on the table.
Define clear usage tiers and metrics thresholds to simplify the model. But maintain flexibility to refine rates as needed based on continuously evolving data.
8. How do you communicate usage-based pricing effectively?
Educate users early and often about the benefits of usage pricing. Be transparent about exactly how rates apply and how costs will scale. Illustrate how usage pricing can save money compared to recurring subscriptions.
Provide usage estimation tools and self-service analytics. Proactively inform customers when usage and costs are trending up. Offer guidance on optimization.
9. What is the best way to migrate customers to usage pricing?
Support hybrid models at first to ease the transition. Give customers visibility into usage data and projected costs for transparency. Start usages pricing with new customers first. Offer existing subscribers pilot programs with discounts to try it out with minimal risk.
Gradually transition subscribers by highlighting the benefits and providing tools to estimate and optimize spend. Offer discounts for longer commitments to provide some revenue stability.
10. How does usage-based pricing support business growth?
The flexibility of usage pricing helps retain customers and aligns costs with value delivered. This makes growing accounts more profitable.
The simplified billing and transparent pricing also facilitate selling to new customers and expanding to new markets. Usage metrics provide clean signals for fine tuning the business model and identifying expansion opportunities.
Overall, usage-based pricing creates win-win relationships that fuel sustainable business growth through keeping customers happy. The incremental transition helps ensure a smooth path to unlocking this growth potential.