What is Usage-based Billing?

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 track usage.

• You then pay a fixed price plus the charges for what you’ve used every billing cycle.

Understanding Usage Based Pricing in SaaS

Traditionally, this monetization model 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 billing, this kind of usage based 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 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, usage based billing only charges customers post usage.

Examples of Usage-based Billing

In B2B SaaS, companies like Snowflake, Stripe, Zapier, Twilio, and more use metered billing. For instance, Snowflake tracks usage based on compute resources.

Similarly, Stripe implements usage-based pricing with per-unit billing where they bill their users per successful card charge. Zapier on the other hand has tiered usage pricing with each tier stipulating how many ‘tasks’ (a task as defined by Zapier: every time a Zap successfully moves data or takes action for you) are included in that tier.

How to Implement Usage-based Billing: Prerequisites and Considerations

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

• To figure out your value metric. For example, Datadog charges based on hosts, Salesforce on ‘sales agents’, Hubspot on marketing contacts, and the like.

• 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 metered billing system that can accurately monitor and administer user consumption data, and convert it into readable billing information for invoice creation.

With Chargebee's metered billing solution, you can flawlessly charge your customers based on their usage of your products and services. Uncomplicate metered billing by:

• Automating your billing workflow

• Aggregating daily usage data

• Iterating your pricing model with usage-based charges

Benefits of Usage-based Billing

The rise in popularity of usage-based billing in SaaS businesses has mainly been driven by two core reasons:

Better Customer Experience

For low to mid-volume users, it’s a better deal compared to flat rates as they aren’t charged for unconsumed resources. Additionally, in the case of subscription billing that auto-renews, it saves a lot of money if the customer only has seasonal use for the product. Finally, a transparent billing policy also shows financial accountability and a commitment to the customer which builds trust and loyalty.

Revenue Growth

To align price points with usage in real time means good optimization in terms of customer success, upsell opportunities, and overall revenue. 

Research suggests that public companies implementing usage-based pricing are growing more efficiently and experiencing faster revenue growth than when compared to a larger list of 50 public high-growth SaaS companies (24.8x vs 17.7x).

Challenges of Usage-based Billing

There are two main challenges to implementing usage- based pricing:

Pricing Model Compatibility

Products may sometimes be too complex to implement usage-based pricing, since it’s difficult to come up with the right value metric and assign a dollar value to it. For instance, Pipedrive’s software has too many features wherein charges would have to be assigned to each individual action, which would be extremely complicated. 

Unpredictable Revenue

Accurate MRR prediction becomes a little difficult with usage-based billing. While most SaaS companies use the revenue data from their existing, new, and renewal contacts to forecast revenue, this might not be an accurate method when it comes to metered billing. Hence, it is important to understand whether your overheads fluctuate with usage before implementing usage based pricing.

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 model 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 subscribers, 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 MRR growth and customer retention.

For more information on the examples, benefits, and challenges of metered billing, visit our blog - What Is Metered Billing? 6 Things To Consider Before You Make The Switch.

Additional Reads

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

• Few things impact revenue as much as price. - A guide that starts out strong, and takes you through a comprehensive and clearly structured list of pricing models without veering off into the pedantic. We can’t recommend reading this enough. The ultimate guide to SaaS pricing models, strategies & psychological hacks.

• Here is an exhaustive teardown of how three well-known SaaS players test, learn, repeat, and ace their pricing games. How to Experiment with SaaS Pricing Strategies – Teardowns of Shopify, Zendesk, and StatusPage.

• After all, pricing is the center of your business. A 6-Point Checklist to Foolproof your SaaS Pricing Experiments.