Usage-based Pricing: What is It and How to Implement it [+ Examples]

What is usage-based pricing?

Usage-based pricing is a consumption-based pricing model where customers are charged based on how much they use the product. Other pricing models generally bill a flat subscription fee at the end of each billing cycle, regardless of how much the product was actually used.

Benefits of usage-based pricing models

There are a few key benefits of usage-priced for both customers and software companies:

• Lower barrier to entry. Usage-based pricing makes your product easier to adopt since new customers can get started at minimal cost and then expand their usage as their business grows over time.
• Higher customer satisfaction. Offering a usage-based pricing structure that adapts to the customer’s evolving needs will lead to better satisfaction scores. Customers on a pay-as-you-go subscription will never feel like they’re wasting money on features that they aren’t ready to use.
• Better retention rates. Because customers have more control over their subscription costs with a usage-based model, they’ll be less likely to cancel their plan due to financial constraints. This is why SaaS companies with a usage-based pricing model tend to have higher retention rates.
• Seamless account expansion. Instead of having to actively pitch upsells to users, customers on a usage-based pricing subscription will naturally upgrade their plans as their product adoption progresses.

Types of usage-based pricing models

There are multiple pricing models that fall under the usage-based pricing strategy umbrella. 46% of SaaS companies have already adopted usage-based pricing in some capacity with another 15% actively testing it and 4% planning to test it in the next 12 months.

Slack, HubSpot, Twilio, Zapier, Shopify, Mailchimp, Intercom, and Hotjar are just a few examples of companies. SaaS businesses with usage-based pricing also tend to have higher annual revenue growth than the industry average (17% vs 13%).

Let’s take a closer look at the six types of usage-based pricing that you can choose from:

Usage-based pricing with tiers

Usage-based pricing with tiered subscription models maximizes customer retention by reducing the cost of additional usage. A fixed subscription price gives customers a monthly allowance for X amount of units (or whatever usage metric you’re using) then charge less for additional units or capacity.

Usage-based pricing per unit

Usage-based pricing with a per-unit model relies on usage metrics to tie resource consumption to the total billable amount. One example would be cloud providers like Sumo Logic which charge customers by the GB of cloud storage they use or how many data points per minute (DPM) they average.

Volume usage-based pricing

Volumetric usage-based pricing has the price per unit decline as the volume grows. This pricing strategy incentivizes high-volume product usage as the bulk discounts will reduce the average amount that customers pay for each unit.

Kissmetrics is a prime example as they reduce the cost per event as the event volume increases:

Usage-based pricing that links to impact

Another variation of usage-based pricing uses the magnitude of customer success or the business impact that the product has had to determine the subscription cost. This is most common for SaaS companies in the fintech space, such as Stripe, Paddle, and other payment-related software solutions.

Pre-payment for usage

The main drawback that’s inherent to how usage-based pricing works is the fact that variable pricing can get annoying for both the SaaS business and its new customers. By getting new customers to commit to (and pay for) a certain level of usage at the start, it’ll reduce the variability in pricing.

Pre-payment for pay-as-you-go plans could be on a monthly or annual basis.

Hybrid usage-based billing

Hybrid pricing models are a combination of traditional subscriptions and consumption-based pricing models. A hybrid model charge per user or based on which features are needed but also incorporate usage limits into the pricing model.

Jira is known for using usage-based pricing on certain subscription tiers:

When should you go for a usage-based pricing model?

Usage-based billing isn’t the right pricing model for every SaaS company (or target audience) but there are a few scenarios where it’s a nearly perfect fit:

• Variable usage. If your existing customers have varying usage patterns then it can be challenging to accurately predict their usage needs. Adopting a usage-based model will take the guesswork out of each annual contract and keep costs based on the value each customer receives.
• Scalable features. Products with features that can be easily scaled up or down as the needs of a customer change are ideal candidates for consumption-based pricing models.
• High stickiness. Any product that becomes extremely sticky upon being adopted and sees usage steadily increase over time (such as cloud hosting or storage) can maximize revenue growth with a usage-based model.

How to implement a usage-based pricing model for SaaS companies?

Before we look at any usage-based pricing examples, let’s look at the steps you need to take to deploy this pricing strategy for your own business in the SaaS industry. These include identifying your value metrics, communicating the pricing structure to customers, and adding contextual in-app upsell triggers.

Identify your value metrics

Knowing what the common use cases and most popular features are will help you identify the aspects of the product that customers value most. Product usage analytics and in-app surveys can help you gather usage data or set value metrics that serve as a foundation for the following steps.

Communicate your pricing structure on the pricing page

Many customers prefer a usage-based subscription model, but only if you transparently communicate what will be included in each tier. Clearly highlight the benefits that each tier offers so customers understand the value they’ll receive and have realistic expectations going in.

Consider adding a subscription calculator to your pricing page to help new customers get an idea of how much their plan will cost based on their projected usage. Alternatively, you could include example calculations that help leads get a feel for the consumption-based model.

Set up customer usage limit to trigger upgrade prompts

Implementing usage-based pricing can be as simple as setting usage limits that trigger upgrade prompts for customers. Usage limits can be set by tagging features, tracking events, or limiting the capacity (GB, DPM, MAU, etc.) of each subscription tier.

Once a customer reaches that limit, a contextual in-app upsell prompt will get them to upgrade.

Track and monitor product usage across segments

Tracking usage data across different segments (through feature tagging or event tracking) will provide actionable insights into user behavior. For instance, you’ll be able to see which features user groups favor and how usage frequency varies from segment to segment.

Userpilot lets you identify the most commonly occurring event for different segments so you can see if you’ve selected the appropriate value metrics:

Measure and iterate your usage-based pricing strategy

Whenever you update the product or release new features, it’s essential that you continue to monitor usage and adjust your value metrics accordingly. This ensures that your subscription tiers and consumption pricing will always match the value that customers receive.

Examples of usage-based pricing in SaaS

There are plenty of examples of how this business model has thrived in the software industry. After all, SaaS pricing has a huge impact on net dollar retention — also known as net revenue retention or NRR — so let’s see how other companies have leveraged their SaaS pricing models.

Userpilot implements a hybrid pricing model

Userpilot uses a hybrid pricing model that applies usage limits to user segmentation, feature tagging, and survey responses. On the other hand, it offers unlimited event tracking on all three subscription tiers and uses flat prices for each plan.

Baremetrics links pricing to product impact

Baremetrics is a subscription analytics solution that helps SaaS businesses gather business insights.

Baremetrics uses impact-based pricing to tie the cost of a subscription to the amount of value a customer receives. The subscription cost varies based on how much revenue generation a company currently has (from $0 MRR to $1M MRR), with annual discounts for customers who commit long-term.

Note: Pricing based on a customer having more revenue has the added benefit of higher customer lifetime values (LTVs) that wouldn’t be possible with a flat-rate subscription.

Confluence goes for volume usage-based pricing

Confluence team workspace platform for companies who need remote collaboration.

Confluence uses a volumetric UBP model which means the subscription pricing is based on how many team members will be on the workspace. Seat-based pricing models like these help your customer base scale without feeling constrained by pricing rules or usage limits.

Datadog charges customers based on resource consumption

Datadog is a resource provider for cloud-computing/hosted applications.

Datadog’s subscription-based pricing charges customers depending on how many resources they consume. This ensures that its observability pipeline service is priced based on a customer’s success, and the annual fee reflects the value they receive.

Amazon EC2 applies pre-payment for usage

Amazon EC2 is a computing capacity service offered to Amazon Web Services customers.

Amazon EC2 uses a pre-payment approach to reduce the cost variability of each customer account and offers upfront discounts to incentivize larger commitments. EC2 also offers a free plan with 750 hours of Windows/Linux as long as customers only use micro instances.

Conclusion

As you can see, subscription-based pricing tied to customer adoption makes the sales process easier by offering lower starting price points and letting upsells come organically as usage increases.

If you look at any usage-based pricing report over time, you’ll see that the customer base ends up paying more in the long run but is happier about it because they know the cost is tied to their utilization.

Ready to take your customer engagement and product adoption to the next level? It’s time to get your free Userpilot demo today!