The Ultimate Guide to Usage-Based Pricing

Discover the power of usage-based pricing with our ultimate guide. Whether you're new to the concept or a seasoned pro, our guide covers everything you need to know about usage-based pricing. Learn how it can benefit your business and gain insights into its impact on revenue and customer retention.

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Usage-based pricing - where it came from, and why it's taken over

As the software industry continues advancing further from simply providing software towards delivering a service, we’re seeing increased interest in usage-based pricing (UBP; sometimes called consumption-based pricing).

How did this happen?

Part of the trend comes down to imitation, with a few early adopters in SaaS finding success and inspiring others to follow. At the same time, a few fundamental shifts have created an environment that is ideal for consumption pricing:

In this landscape, adoption of usage-based pricing has grown swiftly. According to OpenView’s 2023 State of Usage-Based Pricing report, 46% of SaaS companies already have a UBP model, 15% are actively testing it, and 4% expect to test UBP in the next 6-12 months. We expect these numbers to continue growing as more companies witness the success stories and the landscape of vendors supporting UBP deployment (like) continues to mature.

In this guide, we’ll cover everything you need to know about usage-based pricing, including the What, Why, How, Who and Where:

• What is usage-based pricing

• Why adopt usage based pricing

• How to implement usage based pricing

• Who is involved in making UBP successful

• Where to learn more about UBP

What is usage-based pricing?

With usage-based pricing the price a customer pays for a service is based on their consumption (or usage). So, instead of paying for how much they expect to need (an estimate of capacity) with subscriptions, they only have to pay for how much they actually use.

There are a variety of ways for UBP to be implemented. Some clearer examples range from charging based on resources consumed to the number of leads generated to the number of tasks or API calls. Other pricing models take more of a hybrid approach, layering UBP on top of their feature-based tiers or ‘seat’ fees.

UBP has been around for a long time in other contexts, for example with telecommunications, utilities, and logistics. Its application with B2B software, however, is newer.

See the diagram of the history of pricing for more details.

Hybrid pricing

Usage-based pricing is not an either/or option; companies don’t have to choose pure UBP or traditional pricing models. In actual application, it exists on a spectrum ranging between these two points, with most UBP adopters falling somewhere in the middle with elements of both subscription and consumption models. There are two directions of travel along the spectrum:

Businesses can move toward hybrid from both extremes:

Businesses who are moving from traditional subscriptions to hybrid by adding usage-based elements to their existing subscription pricing to create a hybrid model – or ‘Subscription 2.0’ pricing, as we like to call it. For them, the rationale is about better price discrimination, margin control and low-friction revenue expansion.

Businesses who are moving from pure UBP to hybrid. There are a number of reasonable objections to UBP; for example, a lack of predictability and cash flow challenges from invoicing in arrears. Some companies respond to these by adding subscription-like elements such as commitments with generous usage allowances (to help deliver predictability) and prepayments of those commitments (to help cash flow). This results in a “softer UBP” that is also effectively hybrid.

Hybrid has become a leading model for scaling businesses, as it gives companies flexibility to move customers up or down and even personalize pricing at scale. This is already widespread: OpenView research found that 61% of SaaS companies are currently leveraging a hybrid pricing model.

Example of Hybrid pricing : Take a look at ClickHouse’s pricing page. Their ‘Development’ tier offers a subscription element with usage add-ons, while ‘Production’ is fully usage-based and ‘Dedicated’ is capacity-based.

Examples of usage-based pricing strategies

Deploying hybrid models – As mentioned before, this is the most common application of UBP. An example of a hybrid model would be per-seat or tier-based pricing with the addition of usage limits (or extra fees for high consumption). Example: HubSpot.

Linking the price to resource consumption – This strategy is usually utilized lower in the stack where the product is the infrastructure resource itself (e.g., AWS, MongoDB, Snowflake) or a service that obviously consumes a lot of resources (e.g., Datadog or Sumo Logic).

Linking the price to product impact – In this strategy, the customer’s price is based on the impact the product had on their business. This can be effective as it links pricing to the customer’s success (“mutually assured success”, if you will). Examples include Paddle and Stripe pricing based on a share of revenue.

Discounting based on volume – Offering discounts to customers based on volume can encourage more usage, as it’s rewarding these customers with declining marginal costs of use (the opposite of diminishing returns). Example: Confluence.

Trading discounts for commitments – In this strategy, companies will decrease the variable usage price in exchange for the customer committing to a specified level of spend. For example, AWS Reserved Instances, Savings Plans and the Enterprise Discount Program all trade discounts for usage commitments.

If you want to go in to more depth with these examples try our article "5 Usage-Based Pricing Examples to Improve Your Pricing Strategy"

Why adopt usage-based pricing

Usage-based pricing works particularly well when it links costs to value received and allows fees to scale as customers grow. UBP isn’t right for every business – more on this later – but for those it works well for, the benefits of usage are significant.

Benefits of usage-based pricing

  1. Facilitates easier adoption: Potential customers face fewer barriers and minimal upfront costs with UBP, reducing capacity estimation requirements, mental load and the fear of loss. Easier adoption for individuals and companies means they can evaluate and experiment, expanding your market reach. Nearly half of SaaS companies using UBP say it has helped them acquire more customers.
  2. Enables costless upsell: UBP enables efficient PLG motions, creating opportunities to grow revenue without additional Sales effort. Instead of spending time on gatekeeping manual work, Sales can focus on value-adding activities like securing commitments, facilitating adoption and chasing new business.
  3. Enhances customer satisfaction: According to research from Bain & Company 4, 80% of customers reported better alignment with value received when paying based on consumption. This is especially true when the business chooses the right pricing metric to align with the customer’s objectives. Customers don’t have to worry about shelfware, wasteful spending or failing to maximize value from a product. Instead, they just scale their usage – and therefore spend – up or down depending on current needs.
  4. Improves margin control: For SaaS companies with significant costs driven by customer usage, UBP helps you gain tighter control over margins. The right pricing metric can link revenue and costs to usage, improving consistency of unit economics per customer.
  5. Increases logo churn resiliency: Usage-based pricing can be a pressure valve: Customers can choose to use less to spend less, making logo (i.e. complete) churn less likely. While that can mean fairly rapid revenue shrinkage in tough economic times, businesses retain logos better and have the potential to bounce back quickly as conditions improve. Enhancing customer satisfaction can inhibit churn even further. TL;DR: Not all churn is the same. Churning customers is much worse than having revenue shrink from the installed base.
  6. Increases NRR: Because of all the points above, businesses using a UBP model typically see higher Net Revenue Retention (the most important metric for software businesses). This is a massive impact and key metric to measure the success of the UBP strategy.

The model opposite illustrates how a business with

• 5% of customers in the high growth category and

• 10% churn could still achieve

• 13.6% for 10 year compound growth rate

— without booking any new business.

Todd Gardner Managing Director SaaS Advisors

As this model shows, the growth of the business is much more sensitive to modest changes in the High Growth segment than any other segment. If the business increased its pool of high growth customers from 5% to 6%, its ten-year growth rate would improve 1.5 percentage points to 15.1%. Conversely, were it to improve its churn from 10% to 9%, growth would only improve .2 percentage points. This is the asymmetric nature of growth customers vs. churned customers, and UBP is an amplifier on the much more powerful growth side.

Todd Gardner Managing Director SaaS Advisors

According to the same report from Bain & Company, two-thirds of SaaS companies with UBP models say it’s helping them increase revenue with existing customers.

Is usage-based pricing right for your SaaS business?

This is the billion dollar question, and you likely won’t find a straight response anywhere – with good reason. The short answer is that it depends – UBP is highly effective for many (as can be seen in the benefits discussed on the previous page), but it might not be the right pricing model for others. Understanding where UBP has been historically successful can help companies assess the pros and cons of deploying a usage-based pricing model. Based on research from Todd Gardner and conversations with SaaS experts, here are some company and product characteristics that lend themselves to usage-based pricing:

• Lower-in-the-stack products

• Other high COGS solutions

• Products linked to revenue

• Products capable of usage intensity growth

• Self-provisioning

As mentioned in a previous section, there are also ways to bring in elements of usage-based pricing into your existing pricing, creating a hybrid model. This is a great way to experiment with UBP if you’re a subscription business, or to bring in more predictability if your pricing model is exclusively usage-based.

How to implement and succeed at UBP?

Implementing and managing usage-based pricing requires the whole business to come together – from leadership to the board to key internal teams like Finance, Product, Engineering, Sales and Customer Success. Whether you’re handling this manually and struggling with a system built in house, or are looking to launch a new product with UBP, you need to have the right infrastructure and systems in place, with access to the right usage and commercial data.

Pricing is not a set-it-and-forget-it task or a box you can check off. This is especially true for usage-based strategies, which require businesses to make pricing an ongoing, active motion.

This chapter will walk you through the journey of UBP implementation, from selecting your pricing metric to building (or transitioning to) the right infrastructure to mitigation strategies for common challenges.

Selecting the best pricing metric

According to a 2021 survey from Coatue Partners, the hardest part of deploying usage-based pricing is finding the right metric. When including elements of UBP in your pricing model, it’s crucial to attach pricing to a usage metric that aligns with how customers glean value from the service and what success looks like to them. All of this ensures spend is connected with positive business outcomes, rather than a cost item to be managed downward. Fees also need to be simple to understand and not impossible to predict. If not, how their spend would scale becomes opaque, and that creates adoption (or additional commitment) friction.

To provide an example, let’s say you offer a backend-as-a-service to mobile games. If you price based on the number of players they attract, this overlaps well with their own metrics for success - it’s ‘good’ spend that is easy to understand, and forecasting is simple.

The tech stack you need to implement and manage UBP

The good news is that a majority of companies already have the tech stack needed for UBP implementation mostly in place and don’t have to make extensive changes. But UBP does require an additional component.

Marek Rubasinski, VP, Business Development & Partnerships, m3ter

A new category of pricing operations platforms has emerged – a solution that elegantly captures usage data, applies pricing, converts it to spend and then allows the data to be sent across systems and users to make the most of it.

Marek Rubasinski, VP, Business Development & Partnerships, m3ter

When you deploy UBP you need usage and spend data to be available throughout the business. This is a crucial enabler for multiple use cases: For billing to prepare invoices and recognize revenue in the right way, for sales agility in pricing negotiations, and more. We’ll go into more details on building out your UBP infrastructure in the next chapter: “Who is involved in making a UBP successful?"

Best practices for integrating the missing component

There are some best practices to keep in mind for integrating a new platform with existing systems. To fill the gap discussed above, you will crucially need:

  • Bi-directional integrations to your existing finance and CRM systems
  • An easy UI for Ops users, so they can set up and manage changes without overly relying on Engineering
  • Capability to easily manage pricing in a way that matches the flexibility and complexity of your own pricing and packaging
  • Alerting and events systems, to allow for automation

You can find more information in our article "5 Tips to Evaluate Usage-Based Pricing Vendors for Integrations"

If you do this well, you don’t just ensure that data is delivered everywhere it’s needed; you also create a platform that enables easy change and adaptation of pricing. Because of the weight of this decision, when considering a vendor solution for UBP, you should look carefully at how they think about, prioritize and support integrations.

Implications for operations and GTM

Since UBP’s application to B2B software is newer, it’s important to consider the implications of the pricing model for operational and Go-To-Market (GTM) capabilities. Here are four major areas affected by UBP:

Customer experience

With UBP, pricing is part of the product itself: customers need to understand their consumption and how that will translate to their spending. This requires transparency and trust, and a once-per-month invoice won’t cut it.

Instead, customers will want information on demand – for example, a running total and a forecast for their monthly bill, right within the product.

Sales and Customer Success performance

Customer-facing team members need usage data for inbound billing enquiries, but also to drive revenue growth. They should be able to respond to usage signals and be proactive about encouraging further adoption, upselling or securing commitments. When these teams are more informed, they can have more higher-quality, value-adding conversations.

Billing operations

Accurate invoicing can be a challenge with UBP, especially if Sales often does customized pricing for a significant portion of the customer base. This is because you need to bring usage data together with pricing terms to calculate the amount that goes on a bill. Many organizations have spreadsheet-based systems for billing or clunky tools built in house, which are time-consuming, prone to errors, risky for audits, difficult to change and not scalable. This process should be automated, which will help Finance, Sales, and Customer Success.

Reporting & KPIs

UBP has demanding requirements for reporting, oriented on the customer and their usage. Teams need to have ways to get visibility into spending, usage, costs of service, unit economics and who the outliers are (i.e. those with particularly good or bad gross margin performance). The pricing model also requires finance to track slightly different metrics, like NRR. Forecasting becomes trickier, so teams need accurate data and the right tools in place in order to accurately forecast revenue.

While these are certainly significant implications to consider, all of them come back to one core issue: Data.

All businesses with a UBP strategy need the foundational capability of data infrastructure. Having an effective way to meter usage data, apply pricing and utilize spend data across all operations in near real time is crucial; without it, UBP businesses can’t compete at the highest level and could actually hurt their relationships with customers due to inaccurate bills, exhausted finance teams and broken customer trust.

Onfido, a provider of state-of-the-art identity verification SaaS, already had a UBP strategy in place – but their legacy platform was struggling to handle 2.5X the events it was designed for. Reconciling data to answer customer questions was also painful every time.

m3ter helped Onfido prevent tens of thousands of dollars of revenue leakage each month. Want to know how?

Implications for Sales-led vs. Product-led sales channels

Businesses with both Sales-Led Growth (SLG) strategies and Product-Led growth (PLG) strategies can adopt UBP, but there are differences in how it’s implemented and the complexity that arises.

Purely SLG businesses have one particular advantage over PLG businesses (most of which still have SLG as well) when making a switch to UBP: They have less transparent pricing on the website and can more easily run pricing experiments with different customers, even running two pricing plans simultaneously as they transition to UBP. SLG companies will often be able to offer volume discounts to provide incentives to grow with a single provider.

However, there is a reason why many PLG businesses choose to couple usage elements with a freemium or self-service offering: UBP is the ultimate tactic for frictionless revenue growth, as it helps customers graduate through tiers or graduate to sales-led. Infrastructure providers like ClickHouse, AWS and others are good examples of this – many customers start self-serve and will want to talk to sales to get discounts as they scale. A best practice to enable this is to keep the same metric throughout channels and tiers to ensure a consistent customer experience and lower friction path.

Challenges & mitigation strategies

When implementing UBP, there are challenges commonly faced by businesses that require careful consideration. Below are some examples of these as well as mitigation strategies:

Predictability

This can be a challenge for both sides. Customers who place high value on predictability may be uncomfortable with the uncertainty of consumption-based pricing. Others may be fine with it, but could get angry if they end up with a surprise in their monthly bill due to a spike in usage or poor forecasting.

For the vendor, there can be revenue unpredictability and cash flow challenges. Because it’s dependent on variable usage, UBP has less predictable revenues than traditional pricing models. It could also create challenges for working capital, as it’s more likely to use payments in arrears rather than in advance.

Mitigation: For the customer – Deploy hybrid models to combine subscriptions with allowances and overage rates like Zapier. Consider ignoring infrequent usage spikes like Datadog. Provide the option to trade commitments for discounted variable rates to limit runaway costs, like AWS.

For the vendor – To an extent, both revenue unpredictability and cash flow challenges can be mitigated by trading commitments for discounts, but the built-in uncertainty can create obstacles for investment decisions or providing investor guidance.

Unclean data

UBP requires businesses to incorporate two types of data:

  • Usage data, based in your platform; and
  • Commercial data, e.g. accounts, products, plans, deals and pricing from your CRM or CPQ system.

The challenge is calculating the bill for every customer by bringing together their usage data with their pricing and having near real-time running totals that are accurate to the hour or even more frequently, rather than calculating invoices just once per month.

Mitigation: Manual UBP is a non-starter, especially as you scale. While you could try to build an involved custom solution, this is a drain on development resources and a slow, expensive and risky process. You’ll need a solution that sits between the customer, the finance stack and the platform and pricing systems, taking the heavy lifting off your Finance team and making BillingOps automated, efficient and scalable.

Sales compensation

Sales comp is one of the trickiest topics to tackle when moving toward UBP. Some of the biggest friction occurs when businesses charge by consumption but still incentivize Sales to maximize upfront committed spend.

Mitigation: This is an ongoing conversation in the industry with many points of view to consider (OpenView’s take has some great nuance.) The (unfortunately) ambiguous answer is that it’s not black and white, and every business with a current or future UBP model needs to have these conversations. (Sales comp would be a great topic for your pricing committee to work on.)

Weathering a downturn

As mentioned previously, UBP models are more susceptible to shrinking accounts than other pricing models, so although logo churn may be lower, decreased usage (and therefore revenue) can be a concern during a recession.

Mitigation: It may depend on how long the downturn is expected to last, but start by making a strategic decision about priorities during the period. If minimizing logo churn is most important, there are many ways to use UBP for this goal. If you are less worried about logos and more concerned about customers decreasing usage, focus on efforts to drive product adoption, keep customers happy and continue investing in the product to add value.

Who is involved in making a UBP strategy successful?

Undergoing a pricing transformation and moving to a usage-based strategy will impact a wide range of stakeholders. You’ll need to ensure all teams are aligned and working toward the same goal, while also preparing and getting support from your board. Most importantly, you’ll need to prepare your customers and overcome any objections or concerns they may have.

Internal teams

Finance, Product, Engineering, Sales and Customer Success

Without alignment of internal teams, a pricing transformation quickly falls apart. Each team has its own motives for taking on a pricing project, so you’ll need to develop a common understanding of what the business hopes to achieve.

There are five core teams in a pricing transformation, all of whom need to be aligned for a UBP strategy to succeed:

Your board

As reviewed in earlier chapters, UBP is a powerful tool to drive value and frictionless revenue growth, but it also requires effort and risk. If you are making the switch to UBP from a more traditional pricing model, or adding elements of usage to create a hybrid strategy, this will impact your financial profile and the board should be part of the conversation from the start.

Here's how you "Prepare your Board for UBP "

Your customers

When implementing a usage-based pricing model, you may be wondering how your customers are going to take the change. Remember: the core value proposition for UBP is very compelling; you just need to know how to respond to customer objections if they do arise and get them on board with the change. Customer objections to UBP typically fall into two categories:

  • Control and predictability
  • Incompatibility with organizational models and budgeting approaches

There are a number of ways to respond to and manage concerns in both of these categories; for example, simplifying pricing, choosing a pricing metric with strong ties to value, prioritizing transparency, getting customer feedback on pricing changes ahead of launch and more.

If you are handing a lot of "Customer Objections to UBP? Here's what to do! "

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