A usage-based billing model charges customers based on their consumption of a service or product, rather than based on a flat rate. It allows businesses to maximize revenue and customer satisfaction by scaling their pricing according to actual usage patterns. This billing strategy also demonstrates transparency and gives customers control over their spending. And for certain businesses, it can benefit both the service provider and the customer. This model is ideal for services where customer demand can vary greatly, such as cloud computing, utilities, and telecommunications.

In 2022, 61% of software-as-a-service (SaaS) companies had either adopted usage-based pricing or were actively testing it. Below, we’ll explain how usage-based billing works, how it compares to other billing models, and some hypothetical scenarios of successful usage-based billing.

What’s in this article?

• How does usage-based billing work?
  
• Usage-based billing vs. other billing models
  
• Benefits of usage-based billing
  
• Risks and challenges with usage-based billing
  
• Traits of a successful billing model
  
• Scenarios of successful usage-based billing models
  

How does usage-based billing work?

Usage-based billing tracks a customer’s consumption of a product or service and charges them accordingly. The provider implements a metering system to monitor how much of the product or service the customer is using. This could involve tracking relevant metrics such as data usage, minutes of call time, and application programming interface (API) calls. The provider also creates a pricing structure (e.g., a fixed rate per unit of consumption) and a billing cycle (e.g., monthly, annually).

At the end of each cycle, the model measures the customer’s usage and charges them based on the pricing structure. The provider then sends the customer an invoice showing how their charges reflect their usage. For example, a cloud storage provider might charge 10¢ per gigabyte of data stored and send the customer a bill for total usage at the end of each month.

Usage-based billing vs. other billing models

A business should choose a billing model based on the nature of its product or service, its target market, and its goals. Usage-based billing is ideal for businesses with scalable solutions and customers with variable needs, while subscription-based billing is suitable for predictable services and those who are investing in long-term customer relationships. Tiered billing offers a balance of choice and predictability, while flat-rate billing works best for simple products or services with limited scalability.

Here’s a closer look at how usage-based billing compares to other billing models.

Usage-based billing

Customers pay for only the actual amount of product or service they consume. This amount is measured in units such as data usage, minutes, transactions, and API calls. This model attracts price-sensitive customers with its lower barrier to entry and suits businesses with adjustable needs. It’s flexible, allowing customers to adjust usage based on their needs and to pay for only what they use.

But with usage-based billing, revenue can be unpredictable, as it fluctuates based on customer usage patterns. Additionally, it might increase labor costs to enable the complex metering and billing system. Businesses will also have to educate customers on usage patterns and billing.

Subscription-based billing

Customers pay a recurring fee (e.g., monthly, annually) for access to a product or service, regardless of usage. This model encourages long-term customer relationships, creates steady income for the provider, and is relatively simple to manage and understand.

But subscription-based billing might cause customers to pay for services they don’t fully use. It’s also less flexible than usage-based billing as it doesn’t support customers with adjustable needs. And the high up-front cost might be a barrier to entry for some customers.

Tiered billing

Customers pay a fixed fee based on the tier or package they choose, which usually includes different levels of features or usage allowances. This billing model allows customers to select the tier that best fits their needs, encourages them to upgrade to higher tiers, and makes revenue more predictable than with usage-based billing.

However, tiered billing has limited flexibility as customers might not use all the features of their chosen tier. Additionally, designing appropriate tiers can be challenging. Customers might also experience dissatisfaction if they exceed their tiers’ limits and receive charges.

Flat-rate billing

Customers pay a single, fixed price for a product or service, regardless of usage. This billing model is easy to budget for and comes with no surprises for customers. It also requires minimal billing infrastructure.

But flat-rate billing might cause low-usage customers to pay more than they should, and it doesn’t motivate providers to offer more features or usage. This billing model also doesn’t scale to accommodate businesses with growing needs.

Benefits of usage-based billing

Here’s how usage-based billing can benefit both customers and businesses.

Customers

• Cost control and flexibility: With usage-based billing, customers pay for only what they actually use. This makes it a cost-effective option for users with fluctuating or unpredictable needs. They can easily increase or decrease their usage without being locked into fixed fees.

• Fairness and transparency: By connecting billing to consumption, the model clarifies costs. It can also help mitigate hidden fees and surprises.

• Accessibility: With pay-as-you-go models, there’s a lower barrier to entry for new customers. Those with limited budgets or those who want to try a service can do so without making a big, up-front financial commitment.

Businesses

• Increased revenue: Usage-based billing can increase long-term revenue, especially for businesses with scalable solutions. As customers use more of the product or service, the provider’s revenue grows proportionally.

• Market differentiation: This billing tactic can be a unique selling point that attracts customers who value flexibility and cost control. It can also help businesses stand out from competitors who use more traditional pricing models.

• Internal motivation: Since usage-based billing ties revenue to consumption, it motivates businesses to deliver high-quality services and maximize customer satisfaction.

• Customer retention: Usage-based billing aligns the interests of customers and providers. Customers are more likely to stick with a service where they feel they are paying a fair price for their actual usage, and this can increase retention.

• Customer insight: Usage data collected through metering can provide valuable insight into customer behavior and preferences. Businesses can use this information to customize services, develop new features, and improve overall business strategies.

Risks and challenges with usage-based billing

Here are some risks and challenges commonly associated with usage-based billing:

• Unpredictable revenue: Unlike with flat-rate or subscription models that provide consistent revenue streams, usage-based billing’s revenue stream can fluctuate dramatically based on customer usage patterns. This can complicate financial planning and budgeting.

• Complex billing systems: Implementing a billing system that accurately tracks usage, calculates charges, and generates invoices can be technically challenging and costly. The system must handle large volumes of data accurately and securely, while its requirements can increase technical issues and maintenance costs.

• Billing shock: If customers’ usage unexpectedly increases and they receive higher charges than anticipated, they might experience billing shock. This can result in customer churn, especially if customers feel they do not have the adequate controls or alerts to monitor and manage their usage.

• Dependency on usage metrics: Usage-based billing models heavily depend on the ability to accurately and transparently measure usage. Any flaws or inaccuracies in metering can cause billing disputes and loss of customer trust.

• Administrative costs: Managing a usage-based billing system often involves higher administrative costs compared to simpler billing models. These include the costs of developing and maintaining the metering and billing infrastructure; running customer support to handle queries about usage and charges; and processing more complicated billing data.

• Market limitations: Not all markets or customer segments are suitable for usage-based billing. Some customers prefer the simplicity and predictability of flat-rate pricing, particularly in markets where budgeting consistency is more valued than flexibility.

• Compliance: Depending on the industry, usage-based billing might raise regulatory concerns related to data privacy, consumer protection, and fair billing practices. Complying with these regulations while implementing a usage-based model can be complex.

• Customer retention: Because the cost to customers can vary month to month, there might be less incentive for customers to remain loyal if they believe they can get a better deal elsewhere. This contrasts with subscription models, where customers might stay subscribed out of convenience even if not actively using the service.

• Demand management: In industries such as utilities and cloud computing where resource capacity is an issue, peak usage times can strain resources. Managing these peaks while maintaining service quality can be challenging.

Traits of a successful billing model

A good billing model supports both financial stability and customer satisfaction. Here are some traits commonly associated with successful billing models:

• Transparency: Customers should be able to easily understand how their charges are calculated and what they are paying for. Transparent billing practices reduce conflict and build customer trust and loyalty.

• Fairness: The billing model should charge customers in a way that feels equitable and justifiable based on their usage or subscription level. Fair pricing encourages higher acceptance and less resistance to paying bills.

• Flexibility: A good billing model adapts to different customer needs and consumption patterns. It should enable changes in service levels such as upgrades, downgrades, and add-ons without penalizing the customer for changing their service usage.

• Predictability: Customers appreciate predictability in their bills, especially in subscription or flat-rate models. Even in usage-based models, tools for monitoring and estimating costs can help customers better manage predictability in their budgets and increase their satisfaction.

• Scale: As a business grows, its billing model should be able to scale without major changes. It should be able to handle higher transaction volumes, more complicated customer needs, and different regional requirements without faltering.

• Automation: Effective billing models often use automation to mitigate errors and reduce the labor costs associated with billing processes. Automation can improve timely billing, accuracy, and consistency—building stronger customer relationships.

• Compliance: The billing model must comply with all relevant laws and regulations, including those related to consumer rights, data protection, and financial transactions. Compliance mitigates legal risks and assures customers that the business is reputable and trustworthy.

• Alignment with business goals: The billing model should align with the business’s broader goals, whether that’s encouraging long-term subscriptions, increasing service usage, or upselling premium features. It should support the overall business strategy rather than just serving as a revenue source.

Scenarios of successful usage-based billing models

Below, we’ll examine some scenarios of hypothetical companies achieving their key performance indicators (KPIs) through usage-based billing models. In these scenarios, these companies carefully analyze their customer usage patterns and identify challenges with their existing pricing models. Their usage-based solutions have the following positive results:

• Customers can customize their spending to their actual needs, increasing satisfaction and reducing churn.

• Companies can improve their revenue streams and increase profits by charging more accurately for the value they provide.

• Companies can better manage their infrastructure and reduce costs by incentivizing customers to use resources more efficiently.

• Customer trust increases, as users feel they are being charged fairly for their actual consumption.

Using hypothetical companies, here are some scenarios of how usage-based billing models can succeed.

SaaS productivity suite

A cloud-based writing and collaboration platform first has a tiered subscription model with a free tier and several paid plans. It notices that some users on lower tiers frequently exceed their usage limits, while others barely use theirs. To address this, the company introduces a usage-based component for premium features such as advanced grammar checking and plagiarism detection.

The company then tracks key metrics including average revenue per user (ARPU), customer churn rate, and the adoption rate of the usage-based option. ARPU now increases, particularly among high-usage customers. Churn rate decreases as users who previously felt constrained by the tier limits now have more flexibility. The usage-based option also attracts new customers who were hesitant to commit to a higher-priced plan.

Cloud storage provider

A company that provides cloud storage services initially has various storage plans with fixed monthly fees. But it realizes that many customers are not fully using their allocated storage space. To refine resource allocation and revenue, the business introduces a usage-based model where customers pay for only the storage space they consume.

Afterward, it monitors metrics including storage use, cost per gigabyte, and customer satisfaction scores. Storage use substantially improves as customers are incentivized to increase their usage, and the cost per gigabyte decreases due to better resource allocation. Customer satisfaction also increases, as they feel they are paying a fairer price based on their actual needs.

Telecommunications provider

A telecommunications company initially has unlimited data plans, but it faces challenges with network congestion and overuse. It switches to a tiered usage-based model with different data allowances that charges for exceeding the limit.

Afterward, the provider tracks metrics including average data usage per customer, network congestion levels, and ARPU. The usage-based model enables a more balanced distribution of data across the customer base and reduces network congestion. ARPU increases as heavy data users are now paying more accurately for their consumption. The company also introduces data-saving features and tools to help customers manage their usage.

API platform

A provider of financial data APIs has a subscription model with different tiers based on the number of API calls allowed. But it notices that usage patterns vary greatly among customers. It implements a usage-based pricing model where the customer pays per API call beyond their plan’s limit.

Afterward, the company tracks metrics including API call volume, revenue per API call, and customer satisfaction with the pricing model. The usage-based model increases revenue from high-usage customers, while also providing flexibility for those with lower usage needs. Customers appreciate the transparency of the pricing model and feel they are paying a fair price for the value they receive. The provider also introduces tools to help customers monitor their API usage and costs.

Cloud computing service

A cloud service provider with virtual computing resources implements a usage-based billing model where it charges customers based on central processing unit (CPU) hours used, gigabytes of storage occupied, and data transferred in and out of its platform. It charges 5¢ per CPU hour, 1¢ per GB of storage per month, and 2¢ per GB of data transferred. The company’s KPIs include resource use rate, customer churn rate, and ARPU.

Its new model increases the use rate by 40%, since customers are using as many resources as needed. The business also experiences a low annual churn rate of 5%, and it increases ARPU by 25% within a year.

Telecommunications company

A mobile network operator introduces a pay-as-you-go plan where users are charged based on the amount of minutes, text messages, and data they use. Its billing structure charges 10¢ per minute for calls, 1¢ per text, and 5¢ per megabyte (MB) of data. Its KPIs include customer acquisition rates, average usage per customer, and customer lifetime value (CLTV).

The company’s usage-based billing model attracts 100,000 new users in the first quarter after implementation. Average usage per customer increases by 30%, and CLTV rises significantly—suggesting that customers value the flexibility.

Utility provider

An electricity provider switches to a dynamic pricing model based on peak and off-peak usage to encourage energy conservation. Its billing structure charges at 8¢ per kilowatt-hour (kWh) during off-peak hours and 15¢ per kWh during peak hours. Its KPIs include peak demand reduction, customer satisfaction scores, and energy consumption patterns.

The company’s usage-based billing model reduces peak demand by 20% as customers shift heavy usage to off-peak hours. Satisfaction scores remain high and reflect customers’ approval of the cost savings. Consistent monitoring of consumption patterns shows more efficient energy use, aligning with the provider’s sustainability goals.

SaaS provider

A project management software company implements a monthly billing structure that charges $10 per user and $5 per active project. Its KPIs include monthly recurring revenue (MRR), churn rate, and adoption rate of additional features.

The company’s usage-based billing system increases MRR by 10% quarter over quarter. It also experiences a low churn rate of 3%, alongside high adoption rates for additional features. This indicates deep engagement and satisfaction with the pricing model among users.