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Usage Based Pricing, the Holy Grail of SaaS Pricing?

Published on

November 7, 2023

Usage Based Pricing, the Holy Grail of SaaS Pricing?

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Usage-based pricing (UBP), also called “consumption-based pricing”, is one of the many SaaS pricing models. In a nutshell, it lets customers pay for a product based on their usage.

And the more value customers find in a product, the greater their usage will be. 

UBP is now widely used in SaaS, replacing traditional subscription and seat-based pricing models.

Other SaaS pricing models to look into:
- Freemium pricing
- Flat rate pricing
- Tiered pricing
- Per user pricing
- Feature based pricing
- Per active user pricing

What is a usage-based pricing model for SaaS?

Usage-based pricing allows customers to start using a product or service at a low cost, attracting more customers and enabling rapid user growth for some. Unlike other pricing models, user based pricing doesn't limit the number of users with access to the software, encouraging customers to explore new use cases and ultimately driving long-term success and higher customer lifetime value.

How did USB pricing become so popular with SaaS?

The adoption of usage-based pricing models in B2B SaaS has increased significantly in the past five years. It has become the new standard, with three out of five SaaS companies now implementing or testing this pricing model. This begs the question: how did we reach this point?

usage based pricing
3 out of 5 SaaS companies use usage-based pricing.

Think about SaaS users who are part of business or engineering team and want to try out a product before making a huge payment. SaaS companies have adapted to this shift by offering usage or consumption-based billing. This allows these customers to start using the product with little commitment. It will either be free or at a low cost, and they can gradually pay more as their usage increases.

The usage-based pricing model, which was first introduced by companies like AWS and Azure, has now gained popularity across the software industry. In today's software landscape, charging based on usage, rather than the number of users, has become the norm.

This is especially true for SaaS companies that are using innovative technologies that are well-suited for usage-based models:

  • Automation: Software automation is on the rise, making manual processes redundant. As a product becomes more successful, customers require fewer user seats. However, seat pricing does not reflect the value of automation.
  • AI: AI revolutionizes automation by eliminating the need for entire teams for ongoing tasks. Monetization must encompass more than just human users of a product.
  • API: The value of many high-growth software companies lies in the API, which allows software to communicate directly with other software. User interface is not necessary to derive value from this.

Usage-based and hybrid models are becoming increasingly prevalent throughout the software industry. These models, which were once primarily found in infrastructure services such as AWS, Azure, and GCP, are now being adopted and tested across all layers of the tech stack.

This includes both horizontal and vertical applications.

saas usage based pricing
Companies using usage-based pricing are everywhere

The benefits of using a usage-based pricing model…

Using the right pricing model is critical for any SaaS business. It affects your priorities, product choices, and revenue generation. Surprisingly, following the usage-based pricing approach could be the key to achieving over $100 million in annual recurring revenue.

The core principle of the usage-based pricing strategy is acknowledging that you can't predict who your biggest customers will be. By embracing this strategy, you take calculated risks in hopes of achieving significant results. To be successful, it's crucial to deliver an excellent experience for all users, regardless of their initial spending.

Companies in the SaaS industry that use usage-based pricing see faster growth. This is because they have better customer acquisition cost payback and higher net dollar retention rates. It's no wonder that more and more companies are adopting this pricing model.

👍 Low barriers to entry

Start at a low cost to easily attract customers. The key to winning customers in today's world is to quickly offer value without a high price tag. Demonstrating this value upfront is crucial for a successful product-driven approach.

Pricing is based on value - Choosing the right value metric for your UBP model is crucial. It enables your business to align the price paid with the value received, ensuring consistent growth tracking, effective communication of your product's value, and a certain level of predictability. Get this right, and usage-based pricing will be synonymous with value-based pricing.

👍 Allows several users to access the product with 1 account 

The UBP framework expands product accessibility, enabling more users to access the software. This encourages widespread usage and generates new applications.

By moving away from seat-based pricing, more individuals within a customer account are encouraged to integrate the product into their daily routines. When one group finds success, they are more likely to share their experiences with others in their organization or even beyond.

👍 Expands your total addressable market

Expanding your total addressable market (TAM) increases accessibility and unleashes untapped potential. UBP businesses benefit from reaching customers outside their ideal customer profile without extra marketing and sales effort. TAM expansion is profitable and can influence new feature development and go-to-market strategies.

👍 Users find it attractive

Usage-based pricing is appealing to many customers due to its straightforwardness. You only pay for what you use, similar to a mini fridge in a hotel. If you don't touch anything, you won't be charged. This eliminates the burden of paying for unused services, unlike a gym membership that charges a monthly fee regardless of how often you visit.

This pricing model also benefits businesses, as customers tend to underestimate their usage and start small but quickly increase their consumption.

pros of usage based pricing model
The pros of the usage-based pricing model

…and the drawbacks

👎 High prices can lead to unhappy customers and churn

Sticker shock can really ruin your customers' experience. It's a stressful and jarring situation that you definitely want to avoid. Unfortunately, it's a genuine concern with a usage-based pricing model, particularly if there's no limit on spending.

To prevent this, make sure to be completely upfront about costs. Set clear expectations from the beginning and send alerts when customers are about to incur extra charges. Implement usage controls to give customers peace of mind. For instance, empower senior employees to delegate or retract authority from their teams.

👎 Switching costs are low

Annual contracts lock customers in, while usage-based pricing offers flexibility. However, this means users can easily switch providers if they have a bad experience. With usage-based pricing, customers constantly evaluate the value of your product, potentially seeing unnecessary expenses as a waste.

To mitigate this, prioritize providing excellent customer experience, even to lower-paying customers. Empower support and service representatives to offer discounts to retain unhappy customers. Additionally, focus on building features that make it difficult for customers to switch providers, like AWS has done.

👎 Causes uncertain revenue and cash flow.

Customers have the freedom to adjust their usage as they please, making it impossible to ensure a consistent income stream. Additionally, predicting future revenue becomes more challenging as customers can reduce their spending at any time.

To address this issue, it is crucial to acknowledge that while some customers may decrease their usage, others may increase it. To better forecast revenue, it is recommended to invest significantly in data science and personnel. This will allow for better predictions, accounting for uncertainty and complex factors such as seasonal variations.

👎 Customers may find the scaling mechanism difficult to understand

Not familiar with the term "kilowatt-hour?" It's actually what determines your energy bills. If your customers don't understand this metric, it can lead to frustration and confusion.

To solve this issue, TechCrunch recommends selecting a usage metric that meets five criteria: value-based, flexible, scalable, predictable, and feasible. Another helpful tool is a pricing calculator that allows customers to estimate their spending.

usage based pricing saas
The cons of the usage-based pricing model

You should consider a usage-based pricing for your SaaS if:

Your SaaS product is compatible with a usage-based pricing model

Certain software tools are either too simplistic or overly complicated to warrant charging customers based on usage.

Basecamp offers a flat-fee pricing model that is the cornerstone of their value proposition. This means that early-stage, remote-first, and hybrid companies can pay a monthly fee to access a comprehensive set of project management and communication tools for running their online businesses. Charging customers based on usage would undermine the value of their bundled pricing approach.

Sprig offers a range of complex products that cannot be billed based on usage. Sprig is a platform that aims to enhance user-research processes. Managing billing for all the different actions performed within its tools would be very difficult.

You are able to easily monitor and identify unexpected revenue

Your revenue is impacted by the fluctuating usage of your customers on a monthly basis. This can be a challenge for finance teams that rely on spreadsheets for managing core financials.

To overcome this challenge, finance teams should focus on developing scalable financial operations that can effectively track and recognize revenue streams that are based on complex usage patterns.

2 examples of successful usage-based pricing models

usage based pricing model
Zapier use the usage-based pricing model successfully

Zapier, a productivity tool, reached a whopping $140 million in annual recurring revenue (ARR) this year. This company specializes in helping customers streamline their workload by automating repetitive tasks through user-friendly workflows.

While they offer a free version of their service, they primarily generate revenue from team-based plans and professionals with larger needs. Interestingly, once customers give Zapier a try, they often become hooked and want to do even more.

For high-tiered companies who have tasks exceeding 2,000,000 tasks per month, Zapier charges based on usage. On the other hand, lower-tiered plans are billed on an annual subscription basis.

usage-based pricing
Zoom also uses the usage-based pricing model

With features like video and audio conferencing, screen sharing, and virtual backgrounds, Zooms offers so many features.

They allow businesses to choose the perfect pricing plan. The cost depends on the number of hosts, participants, and meeting duration.

There is also a free Basic plan that allows meeting with up to 100 participants and unlimited one-on-one meetings.

Upgrades are available for added benefits with Paid plans offering larger meeting capacities, advanced admin controls, and extra integrations.

At Zoom, you only pay based on the number of users and the duration and capacity of your meetings.

📚 Recommended reading

👉 What is SaaS magic number?
👉 The guide to SaaS content marketing
👉 How to do SaaS SEO the right way
👉 The guide to SaaS psychological pricing

Laura Ballarin

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