Core Concepts: Usage-Based Pricing
By Gregory Ronczewski, Director of Product Design at Ibbaka. See his skill profile.
Definitions
TechTarget
"Usage-based pricing is a consumption-based pricing model in which customers are only charged when they use a product or service. The customer is billed at the end of the billing cycle, which is different from a subscription model, in which the user is charged a fee regardless of how often they use the service."
OpenView Partners
"Usage-based pricing allows customers to pay for products according to how much they use or consume it. This approach is starting to replace more common subscription- and seat-based pricing models, especially when it comes to SaaS products."
Usage-based pricing is especially attractive for SaaS products and for Product Led Growth (PLG). It allows the user to start small and naturally grow usage as they gather experience and get value. There are additional nuances that may be introduced. For instance, the FaaS model (Function-as-a-service) allows for a very granular application of fees customized for each user. The fact that usage-based pricing aligns directly price with consumption is one of the significant advantages of this model.
The challenge with usage-based pricing is predictability, for both buyer (who wants to be able to predict the cost) and the seller (who needs to be able to predict revenues. Success with usage based pricing requires that companies get better at prediction.
Not every service is suitable for usage-based pricing. Solutions that take a long time to deliver value, or that need to co-ordinate the actions of different users, may be better off with more conventional subscription models.
The customer journey will look different from subscription or product-based offers. Planning and using the right metrics will help communicate products' value and land many new users.
"Through a usage-based model, today’s modern consumers get the flexibility, transparency, and perception of value that they demand—and, as customers grow into your offering with increased usage, your revenue grows as well." - zuora.com
Overall, this is not a new concept. Everyone is familiar with electricity or water usage bills. Some rental accommodations include heat and hot water, while electricity is usually not part of the lease agreement. In addition, we see intelligent, low-consumption appliances supporting our desire to turn off unnecessary lights and save on the next bill. The same is true when it comes to water consumption. I live on an island with limited water supplies, so for the summer months, the municipality sends a technician to read our water meter every month. There is a flat fee for using the municipal water supply, but if a household exceeds the monthly limit, the cost is high, and I learned about it the hard way. Perhaps water is not the ideal example. How about the cell phone service? I am told that I have a sweet deal on my cell phone - for $57 a month, I have 11 Gig of data, unlimited minutes for calling in Canada and a set of additional perks. However, I am rarely using my cell phone. So frankly, with the way I use the service, pricing by the minute or even by the second will save me a lot money.
At Ibbaka, we believe that usage-based pricing leads to a higher willingness to pay by reducing the risk to the buyer. Here is a post by Steven Forth, "How to introduce usage-based-pricing." Also, please check our Value Pricing Dashboard , a critical tool for managing usage-based pricing .
More reading for you
Core Concepts for Pricing and Customer Value Management
Usage-Based Pricing (this post)
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Pocket Price Waterfall
Price Elasticity of Demand
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