What Is Usage-Based Pricing and Why Do Modern Startups Use It

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As the name suggests, usage-based pricing is a pricing model typically used by software-as-a-service (SaaS) companies that allows customers to pay for their subscription based on how much they use it.

Also known as consumption-based or pay-as-you-go pricing, usage-based pricing is becoming a preferred pricing model in the SaaS industry.

In fact, OpenView's 2021 usage-based pricing study indicated that 45% of SaaS companies had adopted 'some form' of this pricing model. In the 2023 edition, published in February, it was found that three out of five SaaS startups had implemented some version of this pricing strategy.

This trend aligns with the findings of a recent Chargebee study, which reported that 63% of SaaS companies now incorporate some aspect of usage-based pricing into their models.

In this post, let’s understand what usage-based pricing exactly means, its benefits, and examples of SaaS companies that have implemented it perfectly.

Understanding usage-based pricing

Usage-based pricing is a billing model where customers are charged based on the actual consumption or utilization of a product or service. The metric(s) used to measure usage relates to how the user is extracting value from the product.

UBP

Thus, unlike fixed or subscription-based pricing, usage-based pricing fluctuates depending on usage metrics such as the volume of data processed, the number of users, the storage used, or the frequency of usage.

Before the era of SaaS, usage-based pricing has been in use in a variety of industries. We all encounter usage-based pricing on a monthly basis when we settle our water or electricity bills.

The concept of usage-based pricing found its roots early in the domain of communications service providers, including telephone and connectivity operators.

Rather than restricting customers to a handful of fixed-rate plans, telecommunications companies have long embraced the versatility of usage-based pricing, allowing for a multitude of scenarios — you have the flexibility to choose options such as pay-as-you-go, monthly billing, pay based on the countries you call, and more.

In today’s super-competitive times where customer-centricity is paramount, usage-based pricing resonates with the "pay for value received" philosophy.

Why startups are opting for usage-based pricing

As the numbers corroborated in the introduction, the adoption of usage-based pricing has become increasingly prevalent among modern startups, and for good reason.

Here are some of the compelling benefits of usage-based pricing models over traditional approaches:

1. Shorter buying cycles

Usage-based pricing can simplify decision-making for customers, leading to shorter buying cycles. With clear pay-as-you-go options, customers can swiftly try, evaluate, and commit to a product. This minimizes friction to product adoption, driving initial interest and engagement.

2. Better agility

Startups thrive on adaptability. Usage-based pricing allows for rapid adjustments to pricing structures, enabling startups to respond swiftly to market changes and customer needs.

Plus, smaller customers often find that the basic tier of a product or service adequately fulfills their requirements. Yet, as their business expands, there may arise a need for broader access to additional products or services.

Instead of compelling customers to upgrade to a higher-priced product or service when the basic one no longer suffices, startups can offer usage tiers or charge based on each additional unit consumed.

3. Affordability for customers

Usage-based pricing makes your product more pocket-friendly for customers, as it ensures that they pay only for what they use. By offering a lower price point, you reduce a barrier to sign-ups and can attract a broader customer base, including customers who know they’ll use your product less frequently.

4. Minimal commitment from customers

Customers appreciate the minimal commitment required by usage-based pricing. They can opt in without locking into long-term contracts, making it easier for startups with little brand awareness to attract and retain users.

5. Scalability

Usage based pricing chart

As startups grow, so do their customers' needs. Usage-based pricing scales seamlessly, accommodating both small-scale users and enterprise-level clients without complex negotiations.

7. Increased customer satisfaction

Customers value transparency and the ability to control their costs. Usage-based pricing provides both, leading to increased customer satisfaction and loyalty. They don’t have to worry about overpaying for features or services they don’t need.

8. Reduced churn rates

By aligning costs with actual usage, startups can reduce churn rates. Customers are less likely to cancel services they find value in and can easily adjust their usage to match their needs.

9. Improved product focus

Usage-based pricing compels you to focus on customer’s usage patterns and behavioral data.

This data enables more informed decision-making into future product development, feature prioritization, and revenue marketing activities.

10. Greater investor appeal

Usage-based pricing models, with their potential for rapid revenue growth, improved customer acquisition and retention, and overall scalability, often appeal to investors. This can help startups secure funding and support for expansion.

Ultimately, in this day and age where customers want to ensure value for their money, usage-based pricing resonates with the frugal mindset. Customers appreciate paying based on their actual usage and the tangible benefits received.

The drawbacks of usage-based pricing

As with anything, all those advantages of usage-based pricing come with a few challenges, too. It’s important to keep the following considerations in mind to form a complete opinion about whether usage-based pricing is the right model for your startup.

1. Customer education

Educating customers about the pricing model is crucial. Startups need to provide resources and support to help customers understand and optimize their usage. Inadequate sales enablement and customer education can lead to confusion and dissatisfaction.

2. Granularity of metrics

Defining and measuring the right usage metrics is crucial. Startups must determine which metrics align with their value proposition and customer expectations. Overly complex metrics can confuse customers, while too simplified metrics may not accurately reflect the value delivered.

3. Pricing transparency

AWS pricing calculator

Maintaining transparency in pricing is essential for building trust with customers. Startups should clearly communicate how usage-based charges are calculated. Lack of transparency can lead to customer dissatisfaction and mistrust, potentially hurting instead of helping customer acquisition and retention.

4. Pricing structure

Startups must design a pricing structure that is fair, competitive, and aligns with market standards while covering their costs and ensuring profitability. Developing a pricing structure that satisfies both customers and the business can be a complex and iterative process.

5. Predictable revenue

While usage-based pricing can offer predictable cash flow, startups should assess how fluctuations in customer usage can impact revenue stability. Over-reliance on volatile usage patterns can make revenue projections less predictable.

All things considered, however, the benefits of usage-based pricing clearly outweigh the drawbacks. And so, it’s no surprise that more and more startups, particularly SaaS, are adopting this pricing model.

Examples of usage-based pricing in SaaS

To gain a better understanding of how usage-based pricing can drive success for startups, let's explore real-world case studies of companies that have successfully implemented this pricing model.

1. Dropbox

One of the biggest cloud storage and file-sharing platforms, Dropbox incorporates a tiered usage-based pricing model that charges customers based on the amount of storage used and the number of users.

Dropbox

This provides customers with more control over their costs. Its freemium structure has the paid plans starting at 2 TB of storage space and a single user, and the prices go up as storage space and the number of users go up. The Basic plan offers 2 GB of free storage, helping acquisition.

2. Twilio

A popular cloud communications platform, Twilio’s pricing model is a perfect example of effective usage-based pricing.

Using Twilio's web service APIs, individuals and businesses can engage in a range of communication activities, including making and receiving phone calls, sending and receiving text messages, etc.

Twilio

Twilio provides customers with the flexibility to choose their preferred pricing structure, which includes pay-as-you-go, volume discounts, committed use discounts, or a combination of these options. Notably, Twilio's SMS product is priced "per SMS," aligning the cost directly with the value customers derive from each text message sent or received.

3. Amazon Web Services

AWS, Amazon's cloud computing platform, pioneered pay-as-you-go pricing in the cloud industry. It charges users based on their actual usage of computing resources, storage, and data transfer. 

Due to the number of product categories the pricing structure is a bit complex, so Amazon offers a pricing calculator to help businesses configure a cost estimate that fits their unique business needs.

AWS

AWS's usage-based pricing model transformed the way organizations use and scale their IT infrastructure, making cloud computing accessible and cost-effective. It played a pivotal role in AWS's industry dominance.

While these examples aren’t startups anymore, they highlight the versatility and effectiveness of usage-based pricing across various industries. From cloud storage to communication services to cloud computing, companies have harnessed this model to attract customers and drive growth.

Wrapping up

In the dynamic landscape of modern startups, where flexibility, scalability, and customer-centricity are paramount, usage-based pricing has emerged as a compelling pricing model.

Usage-based pricing empowers startups to scale efficiently, align costs with revenue, and cater to diverse customer segments. It reflects the evolving expectations of customers who seek value for their investment.

Ultimately, it represents a strategic shift in pricing strategies for startups. By embracing this model with a clear understanding of its intricacies and challenges, you can position your brand for growth, differentiation, and sustained success in today's competitive business landscape.

About the author 

Peter Keszegh

Most people write this part in the third person but I won't. You're at the right place if you want to start or grow your online business. When I'm not busy scaling up my own or other people' businesses, you'll find me trying out new things and discovering new places. Connect with me on Facebook, just let me know how I can help.

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