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The pros and cons of usage-based pricing
The pros and cons of usage-based pricing
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Looking at usage from every angle
Implementing usage-based pricing presents a unique set of advantages and challenges. In this chapter, we’ll explore the intricacies of these models, highlighting the pros and cons, as well as presenting practical solutions.
What are the advantages of a usage model?
An ever-increasing number of consumers and businesses have encountered usage-based pricing and billing—and they’re demanding more. In fact there has been a significant increase in the adoption of hybrid consumption models over the last 3 years.
Let’s explore some of the benefits of implementing a usage-based pricing model.
Customer-centric approach
Usage-based models focus on providing value that directly correlates with customer needs and usage, rather than imposing flat rates or bundles. Usage data can provide valuable insights into customer behavior and preferences. Companies can use this data to offer personalized upgrades or additional services tailored to the specific needs of each customer, enhancing the perceived value and differentiating their service in a crowded market.
This pricing model also allows businesses to cater to a wide range of customers, from startups to large enterprises, by offering plans that scale according to usage.
Differentiated value proposition
By targeting the right value metric and optimizing the level of usage pricing businesses can differentiate themselves from competitors and create a strong value proposition. Plus, usage-based models enable companies to quickly adapt to market changes and evolving customer needs without significant restructuring of their pricing strategies.
Recent Subscribed Institute research also indicates that SaaS companies employing usage-based models are maintaining a long-term revenue growth advantage over their non-usage counterparts.
Flexible and scalable growth
Because the barrier to entry is lower, customers can start small, see the product in action, and consider if they want to sign up for a more robust package when the time is right. As customer demand increases, businesses can then adjust resources in order to accommodate higher consumption levels.
Visibility and control
Customers value real-time usage visibility, enabling them to track daily progress, anticipate overages, and view billing charges. With the right technology in place, usage models can enable your business to push out threshold notifications. This allows customers to monitor their usage and spending, and ultimately, increases overall customer satisfaction.
Usage forecasting can also enable your business to monitor behavior and predict expansion opportunities for high-consumption customers.
Predictable revenue streams
While usage-based pricing models are typically associated with variable costs based on actual usage, companies can introduce predictability by linking prior commitment to customer spending habits. These hybrid consumption models can lead to higher YoY ARR growth across all company sizes.
This approach is often referred to as “committed usage” or “pre-paid consumption.” These strategies are fast emerging as the models of choice for companies launching AI and GenAI, due to their potential to drive growth and profitability even in the face of astronomical costs.
What are the challenges of a usage model?
Implementing a usage-based pricing strategy can also present its challenges. Companies need to balance value, while also having enough cash to cover costs. Pricing too high could put some customers off, while pricing too low will result in a loss.
Implementing usage-based pricing requires planning and consideration of the potential risks and challenges.
Surprise overages or shut-offs
Surprises lead to terrible customer experiences. For this reason, customers tend to dislike simple pay-as-you-go billing—it may not provide the predictability they require. The nature of usage pricing means that customers might not realize how much they’re using.
The answer is transparency and mediation—customers need to stay apprised of their consumption patterns. And if you can do it right, it’s not only a better experience, but can be a key growth lever as well.
Customers may overcommit
Usage-based pricing models may introduce a situation where customers end up overcommitting or pre-paying for too much. Businesses will then have to decide how to handle the extra credits, money, or units customers already paid you for.
Billing becomes substantially more complicated
Usage charges are typically billed in arrears, after the billing cycle. This may be different from the way your billing team operates today, if your customers are typically billed in advance.
This new process means that billing teams will have to ensure charges are calculated accurately, invoices are sent out on time, and billing operations are maintained for customers who may not be on a usage model. This often means that billing teams are having to work out of multiple systems to collect the data they need for accurate billing.
The role of Billing Operations will have to expand
In a traditional subscription model, a customer can’t dispute that they bought 5 seats after they sign the contract and pay the invoice. They might dispute the terms or proration calculations, but it basically ends there.
In a usage model tied to usage, there’s a myriad of opportunities for billing confusion and inaccuracies to spiral out of control and destroy customer experiences and bog down your support team. Billing Ops now will need to expand from deal support and invoice accuracy to forecasting, notification, and dispute defensibility.
Revenue recognition and reporting can hinder the success of the model
Under ASC606 and IFRS15, there are specific revenue recognition rules that accounting teams will need to adhere to. Without a system in place to handle complex usage revenue recognition, this will lead to manual efforts and hundreds of thousands of lines of spreadsheets to reconcile.
Related resources
How usage models contribute to business success
Learn the proven strategies and tools to launch and scale a usage pricing model. Our research has shown that SaaS companies using hybrid models outperform all other businesses when it comes to recurring growth.
Understanding the modern subscriber: A consumer perspective
New data highlights the importance of flexibility to choose from a variety of pricing models, tailored offerings and more in today’s recurring products and services, such as subscriptions
Learn more about usage
Getting started with usage-based pricing can feel overwhelming, especially if you don’t know which tools you’ll need or what currently exists in the market.
In the next chapter, we’ll break down the specific solutions your business will need to make your new usage model a success, across all of your teams and from start to finish.
