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Pricing and packaging for usage
Pricing and packaging for usage
04
What product managers need to know
As a product leader, you’ve surely wondered how you can get in on the action with usage. When you consider incorporating usage pricing into a product, it’s important to get two things right: pricing and packaging.
In this chapter, we’ll tell you what effective usage pricing and packaging looks like and what tools your business will need to help achieve success.
Pricing and packaging for usage models
Usage models are built around both pricing and packaging. Pricing is your price points and pricing models, while packaging is how features are bundled. Together, they are what enable the value and flexibility your customer expects and the predictability and strategy your business requires.
Let’s dig a little deeper into both pricing and packaging to better understand how they constitute the framework of usage.
A clear pricing strategy is mandatory
Usage-based pricing is at the core of any pure consumption business model. Providers must be able to measure how much product a customer uses in order to bill effectively. This concept may be referred to as a “value metric,” “unit of measure,” or “pricing basis.”
Your value metric is a usage attribute your company can track that also satisfies value alignment, leaves room for growth, and offers predictability for both the customer and your business. Common metrics are value-based, measurable, and controllable, such as number of users, amount of data consumed, or number of events.
After selecting a value metric, the next step is to determine a price per unit of consumption. This “rating logic” can be as simple as a flat price per usage event (like an API call) or as complex as multi-dimensional algorithms (like a combination of compute and storage).
Another critical pricing component is the notion of time — when a customer agrees to pay for their consumption of a product. Some of the most successful businesses have no more than 25% of their total revenue coming from usage models. They anchor pricing on a value metric first and then grow that pricing by combining pay-as-you-go models (low risk) with pre-paid models (high predictability), thereby driving recurring growth.
What are common usage pricing models?
There isn’t a one-size-fits-all model for usage pricing. As our data shows, you have to find the right level of usage-based pricing within an overall usage-based business model to maximize growth. To see the greatest recurring revenue growth, consider a combination of several models to achieve a hybrid consumption model.
Let’s take a look at the most common pricing models.
Per-unit or pay-as-you-go
This pure usage model allows customers to pay for what they use. This is a solid option for customers with unpredictable needs, and this method does allow for spikes in usage and those associated costs. This option gives the most flexibility for customers to consume only what they need. A pay-per-ride service like Chariot or pay-per-API offering like Amazon Web Services are great examples of this.
Volume
Volume pricing is used to charge a price based on the volume purchased. This kind of pricing can make a lot of sense for certain use cases, such as API calls for SaaS. For example, if you do 1-1000 API calls, you might charge $.10 (flat or per unit), but if you go from 1,001-10,000, you will charge $.15 each. This kind of pricing can be a great incentive for a consumer to use more of the product since the price per unit gets cheaper.
Tiered or step pricing
Tiered pricing is used to change pricing progressively as the volume increases. Like the volume pricing model, the tiered pricing model uses a price table to calculate the pricing. It differs from volume pricing in that the amount to charge varies progressively as volume increases, so different units may be priced differently depending on the tier they fall into.
Overage
This pricing model gives your customer a certain quantity of included units—for example, minutes for calls per month. If your customer exceeds the quantity of included units within the billing period, the amount used over the included units is charged on a per-unit basis based on the overage price.
Tiered with overage
This charge model is similar to the tiered charge model, except there is an overage charge for any units consumed above the ending units of the final tier.
Multi-attribute
This charge model charges customers through a variety of different metrics. For example, Zipcar charges customers through a combination of time of day, type of car, day of the week, and other attributes.
Pre-paid with drawdown
Customers pay upfront for a set of units (or hold a cash balance) that is drawn down from over a period of time. This offers flexibility for customers, in terms of choosing a prepaid amount, and revenue predictability for business.
Minimum commitment
This allows you to charge your customer at their commitment level on each invoice, even if they don’t fully consume the committed usage amount. With this model, businesses have a level of predictability into revenue expectations according to the customer’s commitment level.
Hybrid consumption
Recently, hybrid consumption models that combine predictable subscription approaches with more variable usage models have stepped to the forefront as drivers of recurring revenue.
Although the SaaS sector is still fine tuning these pricing and packaging strategies, the results are promising compared to non-usage models.
While pure usage revenue can be less predictable and more volatile, hybrid consumption models can be a good fit for SaaS offerings—particularly cloud services and generative AI. These hybrid, agile models can help provide predictability, while also improving value to the customer by tying pricing and payments more directly to usage and actual demand.
Packaging is an art
To stay competitive, businesses must continuously innovate their products and go-to-market strategies. They’re no longer delivering new products annually or even twice a year but are releasing new products quickly and often, refining them as they go. A fast-paced world requires businesses to develop fresh approaches to pricing and packaging.
Packaging allows businesses to quickly address market changes and shifting customer preferences without tinkering too much with pricing.
For example, when customers are first trying a product, they don’t yet have experience with it and want flexibility, so a pay-as-you-go package is a good offering for them to try different options. As they grow more confident using your product and see value, customers’ willingness to pay increases and they desire more predictability.
This evolution of packaging benefits businesses too. As you onboard customers and support a product-led growth (PLG) strategy with simpler pricing tactics, you can encourage commitment and recurring contracts by packaging multiple pricing models.
Create a culture of experimentation
The industry conversation around pricing and packaging has recently added an important consideration: experimentation. While everyone would love to say they have great pricing, the reality is businesses are always tinkering, thinking, “What can I do here? What can I do there? Are my customers really receiving value? Am I capitalizing on that value? Do they feel good about paying for the value they receive? When is the last time we’ve tinkered with pricing? How does that compare to our competitors?”
These questions are great starting points for building experiments around pricing and packaging to discover combinations and approaches that make sense for both your customers and your business.
You also need executive buy-in when it comes to technology that supports rapid experimentation with mix-and-match pricing and packaging, as well as leadership that encourages cross-functional collaboration between teams.
Surfacing offers is one example of pricing and packaging experimentation. Historically, it’s been focused in the media space — like going to a newspaper’s website for their premium articles and then hitting a paywall after a certain number of visits. But these strategies also exist for SaaS businesses, such as a free product trial that the company then attempts to convert into a paid subscription or an upleveled service.
Dynamically surfacing offers is just one method of pricing and packaging experimentation that can lead to increased revenue and improved customer service.
Best practices for experimentation
Experimenting with pricing and packaging has helped many businesses become better at usage-based pricing. Here’s an idea of what continuous fine-tuning looks like:
- Experimenting frequently: Avoid the “we did this last year” mindset and instead get comfortable with iterating as often as possible.
- Running tests: Learn from your data by split testing (also called A/B testing) different versions of it and evaluating based on metrics like conversion rates.
- Trying model variations: Start simply with pay-by-use approaches and then ramp up to something more complex like tier-based usage.
- Using specific tactics: Plan strategic experiments that are specific to where your business is on its value realization journey.
- Keeping customers in mind: Listen to what customer support and billing ops are hearing about the value of your offers.
Tip
Tools for usage success
Whether you’re just starting to test usage or you’re fine-tuning your strategy, you need a proven solution that provides a variety of out-of-the-box models — like pay-as-you-go, pre-paid with drawdown, minimum and maximum commit, and pooled usage pricing.
Look for a solution that supports pricing and packaging experimentation and iteration, without the need to rely on developer support or delay product rollouts.
Learn more about usage
Nailing pricing and packaging for usage requires both a smart tactical approach and the right technology to support it. In order to be successful and get your usage business model off the ground, you’ll need to secure executive buy-in.
In the next chapter, we’ll explore key considerations for CFOs as they begin investigating usage-based pricing.
