What is Usage Based Pricing?

Usage based pricing is a consumption-based pricing model where customers are charged only when a product or a service is used. In most cases, the customer is expected to pay at the end of a billing cycle. In a flat subscription pricing model, customers are expected to pay a fixed price regardless of how much they use a particular service. However, the usage-based pricing model goes in favor of the customer as they are charged based on what service they consume. This type of pricing model can be referred to as metered services.

Metered services are not a new phenomenon most people who purchase metered services such as utility items i.e. electricity or water are familiar with how this works. Nowadays many SaaS based companies are adding usage-based pricing model as a reliable plan to accommodate customers.

This type of model sets up price based on what services are truly consumed/availed. With latest trend of finding better methods of connecting with customers, usage-based models are gaining widespread attention. They can enhance customer satisfaction and offer fair pricing for customers who wish to pay for what they use. Intermittent usage patterns of customers can be dealt with using this approach. By offering flexible and transparent pricing, this type of model creates a sense of trust and improves brand loyalty.

What is an Example of a Usage based model?

Some notable examples of Usage based models include the following:

SaaS Consumption Model:

Software providers provide plans with costs that depend on the number of users, the amount of data being processed, or accessed features.

Cloud Computing Pricing Model: Amazon Web Services (AWS), Google Cloud, and Azure consumption-based model price for the usage of cloud resources such as storage space and computational capacity.

Telecommunications: Fees for data use, call time, or messaging.

Utilities: Electric, gas, and water utilities tend to have a consumption billing scheme, where the household or company is billed for the amount consumed.

What are the types of Usage based pricing?

There are many types of usage-based pricing, and businesses can opt for the type best suited to the business niche. The types are:

Variable pricing Model

Variable pricing concentrates on consumption measurements. The costs vary depending on the precise amount or volume a customer utilizes. This approach is a staple in industries like utilities, where customers are charged per unit that they use (e.g. kilowatt-hours of electricity they use).

Tiered pricing model
This model is centered on thresholds, where the unit cost is decided by consumption but in relation to a particular cut-off. As an example, consider a situation where the unit cost of the first 100 units is different from that of the next 100 units. This framework creates an incentive for increased consumption but still has a usage-based methodology.

Dynamic pricing model
Market conditions, and in particular demand, are at the fore with dynamic pricing. Prices are not fixed but change in real-time. Ride-sharing services are a notable example of this, where fares may increase during rush hour or in locales witnessing high demand, depending on the balance of supply and demand.

Per-feature pricing model
This strategy is common in the software sector. Rather than charging users for an entire set of features, this model charges users only for those features they turn on and utilize, giving the user a sense of freedom and value.

What are the Steps to implement Usage based pricing?

Switching to a consumption-based pricing model entails a number of important steps:

Assess Product or Service Fit: Determine if your products or services are a good fit for consumption-based pricing. The best candidates are divisible and have quantifiable usage levels.

Know Your Customers’ Requirements: Examine customer usage behavior and requirements to create a pricing model that is valuable and offers transparency.

Establish a Pricing Plan: Design a tiered pricing plan according to usage levels that serves various customer segments.

Upgrade Technology Infrastructure: Make sure billing systems are able to measure accurately usage metrics and automate billing.

Inform Customers about Changes: Transparently inform current and potential customers about the new pricing model’s benefits and changes.

Monitor and Adjust: Periodically monitor the performance of the model and customer feedback, adjusting as required to keep pace with market requirements and operating expenses.

What are some pain points of Usage based pricing model?

Although there are many benefits associated with usage-based pricing model. There are certain challenges that businesses may face such as:

Customer Adoption: Certain customers might be resistant to changing their pricing models. Effective communication regarding the advantages and savings can make them feel more comfortable.
Revenue Predictability: 

Changing to usage-based billing can complicate revenue forecasting. Having minimum usage thresholds or base fees can reduce the impact of this.

Price Sensitivity: 

Balancing the price levels correctly to be competitive and yet profitable is an art that demands proper market research and continuous tweaking.
Billing Complexity: 

The shift from a flat rate to a usage-based system can make billing more complex. Businesses can invest in strong billing systems to deal with this complexity.

How does a Usage based Model benefit a customer?

A usage-based model implemented withing a company offers a myriad of benefits. These include:

Customer Centric approach

Paying for the level of product consumed instigates a sense of fairness and controlled expenditures. They feel cared for and valued as they enjoy a particular service.

Adaptability

As it appeals to a broad range of customers, it is expanding from cloud computing to other sectors as well. This proves that the pricing model is adaptable.

Strategic Implementation

Converting to a consumption-based system needs careful planning, communication with customers, and adaptations as per feedback and market forces.

Managing Challenges

Identify and prepare for billing sophistication and revenue foreseeability, utilizing technology and open communication to neutralize potential complications.

Cost Savings

Customers can significantly reduce their expenses by only paying for the services they actually use, rather than being locked into fixed pricing plans.

Reduction of financial wastage

This pricing strategy enables companies to reduce the cost wastage experienced in flat-rate models, where there is scope for under-utilization of resources. By matching resource allocation with user demand, companies can focus on sustainability and resource efficiency.

Using pay-as-you-grow strategy

This model reduces up-front expenses, and is especially helpful for startups and smaller organizations. Such companies can start out with services that they require and, as soon as they grow, increase their usage and attendant costs incrementally.

What are some reasons why SaaS businesses implement Usage based pricing?

SaaS businesses provide usage-based pricing as it allows them to increase revenue and users at a faster rate. The more their customers utilize their service, the more they make money. Usage-based pricing also enables any user within an organization to begin using a service.

On the other hand, if a company sells their software on a per-seat basis as a service, this tends not to take into consideration the level of use for each individual. In such a case, as usage increases, operating expense increases for the SaaS provider, but so doesn’t revenue. Usage-based pricing is also more typical for SaaS businesses since there are comparatively simpler metrics to track such as the number of data files transferred or stored, minutes of usage etc.

Value of Service

Another crucial advantage for SaaS businesses as well as their customers is that usage-based pricing expresses the value of the service immediately. If a customer is not satisfied with the service, they don’t pay for it and they don’t use it. This makes SaaS companies adopt a product-led growth strategy – the more they improve the product, the more it gets used, and the more money they earn.

What is Overage Fees?

In SaaS based business model, overage fees applies when users overuse their plan limits. Every plan has a set number of users and when suage goes beyond that, it results in additional charges. For instance, a cloud storage is limited to 600gb per month basis with $6 applied over the set limit. This enables customers to pay for the additional usage without having to upgrade their plan.

Some advantages of overage charges are:

Upfront payments: As customers pay upfront for a service used above limit, it goes as a sunk expense. Staying within the set limit allows customers to fully avail it without any additional fee.

Reduced turnover: As the costs do not hike to a great extent on additional consumption, it does not burden the customer to pay additional charges.

Perfect for Seasonal Changes
This model is ideal for companies with varying demands. Customers can manage peak seasons effectively without being locked into a higher plan throughout the year.

Supports Business Growth

For expanding businesses, particularly start-ups, overage charges are attractive. They provide scaling without the need for immediate, dramatic cost escalation, providing a buffer for growth.

Provides Competitive Advantage

Through providing overage charging, a SaaS business can differentiate from fixed-tiered businesses. This adaptability and customer-focused route can make them attractive to businesses looking for flexible pricing.

What is Billing Granularity?

Billing granularity is the level of detail at which usage is tracked, measured, and billed. It determines how frequently and precisely a customer’s usage is recorded and charged, accordingly.

Billing granularity can vary depending on the type of service, industry, or billing system.  Among some examples are:

1. Coarse granularity: Billing occurs at a high level, such as monthly or quarterly, with minimal detail about usage patterns.

1. Medium granularity: Billing occurs at a moderate level, such as daily or weekly, with some detail about usage patterns.

1. Fine granularity: Billing occurs at a detailed level, such as hourly, per-minute, or per-transaction, with precise tracking of usage patterns.

1. Real-time granularity: Billing occurs in real-time, with instant tracking and charging of usage.

What is Rate Limiting?

Rate limiting is a method of controlling network traffic. It limits how many times an individual can attempt the same thing in a given time period, e.g., attempting to log in to an account. Rate limiting can be used to prevent certain types of malicious bot traffic. It can also alleviate web server load. Rate limiting is not an ultimate solution for controlling bot traffic, though.

Benefits: Server-based rate limiting can prevent resource exhaustion and provide fair use of server resources. It can also be employed to handle peak loads and make the server responsive during high traffic.

Limitations: Rate limiting on the server side can be evaded by attackers who spread their requests on multiple servers. It may also deny legitimate traffic if the limit is too low or if the server is under heavy load.

Example of Rate Limiting

A streaming music service uses server-based rate limiting to block its API from receiving too many requests at times of high demand. The limit is 200 requests per second per server in order to distribute the use of server resources in a fair way and keep things responsive.

How to determine Revenue in Usage based billing?

Urgent or current recognition of revenue in usage-based billing is an important function for companies, ensuring proper accounting and reporting. UBB, also known as metered billing, is charging consumers based on the amount of service or product they consume.

Steps to calculate Revenue

The initial step in accounting for revenue is to establish a system of tracking the amount each customer has consumed the services or goods bought, the frequency of use, and the overall cost.

After gathering this information, companies then have to decide how much money has been made per customer’s use and how many times the money has been made.When implementing the tracking system for UBB, companies should also take into account how long it takes customers to utilize their products or services before they are charged.

Most companies charge customers on a regular basis, so they have a clear idea of when the revenue must be recognized. Revenue recognition also necessitates that companies account for any discounts that are given when charging customers for their products/services. This can include promotional discounts or seasonal discounts.

When determining how long it takes for a customer’s usage to be billed and accounted for as revenue, companies should include any fees that are charged to collect payments such as any transaction fee. These fees must be included in the total cost of delivering services/products because they can have an effect on how quickly and accurately companies recognize revenue.

Moreover, revenue recognition in UBB obliges businesses to monitor changes in accounting standards over time that might influence the manner in which revenues are reported on financial statements.