Recurring Billing

What is Usage-based Billing?

Also called metered billing or pay-as-you-go pricing, this allows customers to only pay for what they've used in each billing cycle.

Do you pay your internet bills or use Uber? Then you’re already an ace on how usage-based billing works from the consumer end. Basically:

  • You use a product or a service

  • The company providing the product/service has a metering system in place to measure your consumption

  • You probably pay a base amount plus the charges for what you’ve used every billing cycle

Understanding Pay-As-You-Go Pricing in SaaS

Traditionally, usage-based billing is adopted when a business has a clear unit of measurement associated with how much of its product or service a customer uses. Think of this usage in terms of a box of candy. You only pay for the number of candy pieces you’ve removed from the box within a period of time, it doesn’t matter how many people have access to the box or how long they took to eat them.

But in SaaS, this kind of pay-as-you-go pricing often includes additional dimensions. Because it’s not only the rate of customer consumption that matters, it’s also the value associated with the product which is called the value metric. (Was the candy tasty?)

And perhaps the candy comes in different flavors. Does each flavor match a customer base with enough demand and act as a gateway for a person to try other, higher-priced flavors? You get the idea.

Having a basic unit to measure usage that’s not the time or user/seat based is a primary differentiator of the usage-based billing model. Also, unlike the user-based model where customers pay in advance for increasing seats or usage time, pay-as-you-go only charges customers post usage.

Examples of companies that follow a usage-based billing model include Stripe, Zapier, Twilio, and Chargebee as well!

Prerequisites and Considerations for Usage-Based Billing

So you think usage-based billing may be just the ticket for you. What does setting it up to involve and in what ways can you expect it to provide value for your customers?

To implement a usage-based billing system, you need:

  • To figure out your equivalent of a piece of candy

  • A critical number of heavy users in your customer base for revenue stability. One of the downsides of this model is unpredictable revenue fluctuations based on customer usage

  • A good metering system or other accurate methods to collect user consumption data

  • Logic to convert the consumption data into readable billing information which is sent to a billing system for invoice creation

The rise in popularity of usage-based billing in SaaS has mainly been driven by customer demand and awareness:

  • For low to mid-volume users, it’s a better deal compared to flat rates as they aren’t charged for unconsumed resources

  • In the case of subscriptions that auto-renew, it saves a lot of money if the customer only has seasonal use for the product

  • The SaaS provider thus needs to work to ensure that the customer always finds good value in the product/service

  • A fair billing policy also shows financial accountability and a commitment to the customer which builds trust and loyalty.

Pro Tip: Should you switch to usage-based billing from your current pricing model?

First, analyze customer behavior, purchase history, and your overheads to see if the switch is required and will provide an opportunity for higher revenue. If the answer to ‘Can my business survive/thrive with unpredictable recurring revenue?’ is negative, a switch is not advisable.

While offering greater flexibility, [usage-based billing] will likely be more expensive per unit than committed volumes, and so must be carefully analyzed and limited to the most appropriate, cost-effective scenarios. It will force some SaaS pricing metric changes for existing customers, as some SaaS metrics are not well aligned to usage-based charging.

There’s no formula for calculating if a pricing model will work for you (it’s a skillset that entrepreneurs learn over time), but you should explore the possibility if you think it makes better sense in terms of revenue and customer retention.

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Additional Reads

Useful guides and expert opinions on the past, present and future of SaaS pricing models, and specifically, usage-based billing: