Recurring Billing
What is Usage-based Billing?
As consumers, we already encounter usage-based billing in various aspects of our lives, such as electricity charges and Uber rides. In essence, the process works as follows:
You use a product or a service
The provider employs a metering system to monitor your sage
You pay for the usage each billing cycle.
Understanding Usage-Based Pricing in SaaS
Traditionally, businesses adopt the usage-based billing model when they can clearly measure how much of a product or service a customer uses.
However, in SaaS billing, usage-based pricing often encompasses additional dimensions. It’s not just the rate of customer consumption that is important; the value linked to the product, known as the value metric, also plays a crucial role.
A primary differentiator of usage-based billing is its use of a basic unit to measure usage that is not time or user/seat-based. In contrast to seat-based models, where customers pay upfront for additional licenses, usage-based billing offers two main options: a postpaid model, where customers are charged based on actual consumption after the fact, and a prepaid model, where customers make a prepayment that entitles them to a certain amount of usage, with the option to top up if they exceed their initial limits.
Adoption of Usage-Based Billing
Usage-based pricing, which was originally used by companies like AWS for their infrastructure services, is now widely used across all types of software companies.
Application SaaS: These companies offer software applications with pricing based on the usage of specific features or volume of interactions, such as Zendesk's customer interactions, HubSpot's marketing contacts, and Dropbox's storage.
Middleware SaaS: These companies provide services that integrate or connect other applications. Pricing is typically based on the volume of transactions, automated tasks, or communication services, such as Stripe's transaction fees, Zapier's task automation, and Twilio's messaging and call rates.
Infrastructure SaaS: These companies offer foundational cloud services with pricing based on the resources used, such as Snowflake's data processing, AWS's computing and data transfer, and Google Cloud Storage's data storage and access.
AI companies: These companies offer AI-driven solutions with pricing based on usage; foundational AI providers like OpenAI charge for access to their language models, while application-based AI providers like DeepL and Jasper charge for specific functionalities like translation or content generation.
Benefits of Usage-Based Billing
These core reasons have mainly driven the rise in popularity of usage-based billing:
Lower barrier of entry: From a customer’s point of view, a subscription company offering a flexible, pay-as-you-go model is much more attractive and economical than a rigid subscription fee that doesn’t consider product consumption.
Aligns pricing strategy with value: Since usage-based pricing is fundamentally driven by consumption, it ensures customers pay for what they value and use. This is especially important in times of economic uncertainty and rising inflation rates where customers exhibit prudent spending.
Better cost and margin structure: As companies automate more tasks through AI and other technologies, the need for human users (or licenses) to complete tasks is reducing. Hence, seat pricing fails to capture and monetize the true value of automation, undercharging customers and eroding your profit margins. Usage-based pricing offers a powerful alternative in this aspect as it aligns pricing with your value metrics.
Challenges of Usage-Based Billing
While it offers greater flexibility and better margins, there are some challenges with adopting a purely usage-based pricing model:
Unpredictable revenue: With usage-based billing, your revenue is tightly linked to the real-time consumption of your product, making Monthly Recurring Revenue (MRR) predictions challenging. Fluctuations in usage or seasonal variations can lead to significant revenue swings. While peak usage boosts revenue, it can also lead to unpredictable costs for your customers, potentially causing sticker shock and complicating budget planning.
Pricing model compatibility: Usage-based pricing isn't universally suitable for all subscription models. For SaaS platforms with numerous features, identifying a single or few metrics to base pricing on can be difficult. Additionally, this model may not align with long-term revenue growth objectives. For example, a platform like Netflix charging based on the amount of content watched could be attractive to customers but may not be a viable monetization strategy for the company.
Hybrid pricing models—a combination of usage and subscription fees—offer a better alternative. They combine the predictability of the recurring revenue model with the flexibility of consumption-based pricing.
Explore why hybrid pricing strategies find increasing relevance in SaaS.
Implementing Usage-Based Billing: Key Considerations
To successfully implement usage-based billing (UBB), consider the following steps:
Analyze feature usage: Examine feature usage patterns closely to identify your core revenue drivers. Focus on value metrics that reflect the value your platform delivers. Align these metrics with your revenue goals and ensure they support growth as usage increases.
Determine pricing structure: Decide how to price your value metrics—whether per unit, tiered, volume-based, or stairstep. Your choice will affect profit margins and customer perception of your pricing model.
Choose the right billing system: Select a metered billing system that accurately tracks and converts user consumption into invoices. Ensure the system can scale with your business, whether you opt for a subscription, usage-based, or hybrid model.
Automate billing: Streamline your billing process by automating the transfer of usage data to your billing platform, enhancing efficiency and accuracy.
Focus on these essential areas to develop a successful Usage-based billing (UBB) strategy. Want to get the most out of your pricing model?
Check out our in-depth guide on Hybrid and Usage-Based Billing for Subscriptions.
Chargebee’s metered billing solution simplifies the process by automating billing workflows, which reduces manual effort and minimizes errors. It aggregates usage data to ensure accurate billing so you can rely on precise charges. The platform also supports easy experimentation with different pricing and packaging options without extensive developer involvement, making finding the best monetization model for your business easier.
