Usage-based pricing responds directly to the needs of businesses and their customers. Unlike flat-rate or subscription methods, this approach sets prices based on the real consumption of products or services. As businesses search for ways to connect with audiences and adapt to market changes, usage-based pricing has grown quickly as a top choice among pricing models. From 2018 to 2022, the adoption rate for the usage-based pricing model among software-as-a-service (SaaS) companies grew from 27% to 46%.

This pricing model offers clear advantages in that it creates stable revenue opportunities for companies, while providing transparent pricing for users. Below, we'll break down the key aspects of usage-based pricing, how it functions and the best practices that businesses can adopt to maximise its benefits.

What's in this article?

• What is usage-based pricing?
  
• Types of usage-based pricing
  
• Usage-based pricing components
  
• When would you use usage-based pricing?
  
• How does usage-based pricing work?
  
• Benefits of usage-based pricing
  
• Usage-based pricing best practices
  

What is usage-based pricing?

Usage-based pricing is a billing approach in which charges correspond directly to a customer's consumption of a product or service. Unlike flat rates or subscription billing, this model hinges on specific metrics, such as data usage volume, hours of service access or quantity of items consumed. The result is a granular pricing system that adapts to each user's needs.

Types of usage-based pricing

Usage-based pricing comes in several distinct models, each tailored to specific business needs and customer consumption patterns. Common types include:

• Variable pricing
  Variable pricing focuses on consumption metrics. Costs fluctuate based on the exact quantity or volume that a customer uses. This model is a mainstay in sectors such as utilities, where customers pay for each unit that they consume (e.g. kilowatt-hours of electricity or gallons of water).

• Tiered pricing
  This model focuses on thresholds, where consumption determines the unit cost, but in relation to a specific cut-off. For instance, imagine a scenario where the unit cost for the first 100 units differs from that of the subsequent 100 units. This structure provides an incentive for higher consumption while still maintaining a usage-based approach.

• Dynamic pricing
  Market conditions, specifically demand, take centre stage with dynamic pricing. Prices are fluid and shift in real time. Ride-sharing platforms are a prominent example of this, as fares can rise during rush hour or in areas experiencing high demand, reflecting the balance (or imbalance) of supply and demand.

• Per-feature pricing
  This approach is prevalent in the software industry. Instead of charging users for a complete suite of features, this model bills users solely for the features that they activate and use, promoting a sense of autonomy and cost efficiency.

Usage-based pricing components

Usage-based pricing changes how customers are charged and also affects the fundamental components of the billing system. For businesses that are interested in switching to this pricing model, it's important to understand these elements. Here are the major components to consider:

• Measurement unit
  This is the unit that businesses use to gauge consumption. Depending on the service or product, this unit can differ. Cloud storage services might measure usage in gigabytes, while a telecommunication service might count minutes or texts.

• Billing cycle
  This defines how often customers see a bill – for instance, monthly, quarterly or annually. Throughout the cycle, usage is tracked. Then, when the cycle ends, customers receive a bill based on their consumption.

• Rate
  This denotes how much each measurement unit costs. While some services have fixed rates, others might change them based on factors such as volume.

• Usage tracker
  Every usage-based pricing model needs a reliable way to monitor consumption. This tool or system tracks usage, either in real time or close to it, guaranteeing that customers are billed correctly. Additionally, it can alert customers when they approach certain usage limits.

• Billing adjustments
  Sometimes customers are overcharged, or perhaps they qualify for a discount in one month. This component handles discrepancies, refunds and credits. It increases the chance that the billing process remains fair and transparent.

• Notifications
  To prevent surprises on the bill, many providers keep their users informed about their consumption. Businesses might send out alerts when users reach a specific level of usage or are close to a set threshold.

• Reporting
  Both businesses and users benefit from detailed reports on consumption. For businesses, these reports can help with forecasting and inventory management. For users, understanding their own patterns can help in budgeting and usage decisions.

Together, these components form the basic framework of any usage-based pricing system. Implementing these components effectively using a unified strategy is essential for a smooth and transparent billing experience.

When would you use usage-based pricing?

The choice to offer usage-based pricing reflects a strategic decision that businesses make to address the unique demands of their industry and the nature of the services that they deliver. Here are a few sectors where this model has gained traction in recent years:

• Software-as-a-service (SaaS)
  Some SaaS platforms let businesses pay according to the features that they tap into or the number of users that they have. This model appeals to companies with fluctuating demands or those that want to experiment with a software solution without committing to a full package.

• Utility providers
  Electricity, water and gas companies have long used this method for billing purposes, because of its innate fairness and because it incentivises users to conserve resources.

• Cloud service providers
  As reliance on cloud solutions grows, providers are billing users for the exact amount of storage or computing power that they use. Companies, especially startups or those with shifting needs, appreciate this model as it lets them adjust their usage without getting bogged down by a fixed cost.

• Telecommunication companies
  Pay-as-you-go plans, where users are billed for the actual number of minutes they use or texts they send, supports those who are wary of monthly plans or those who do not have consistent usage patterns.

• Streaming platforms
  Some services charge users based on the content that they select. Instead of a set monthly charge, a user might be billed per film or episode. This is a unique approach that caters to occasional viewers who aren't interested in regular subscriptions.

• Rental services
  Urban rentals such as bikes or scooters often use this model, which charges users for the precise amount of time that they've used the vehicle for. This makes the service more appealing to occasional riders or tourists.

• Data providers
  For businesses offering specific data application programming interfaces (APIs), billing might be tied to the number of data calls that a user or a business makes. This approach can be popular with developers or businesses that have variable data needs.

Ultimately, the value of usage-based pricing lies in its adaptable approach. It broadens service accessibility and resonates with diverse customers, from budget-conscious individuals to businesses with varied demands.

How does usage-based pricing work?

Usage-based pricing tailors its structure to match with the unique needs of each user. Here's a detailed breakdown:

• Monitoring and metering
  The foundation of this billing approach is the precise tracking of every user's consumption. This could encompass several different variables, such as the volume of data used, the duration that a service has been accessed for or the units of a resource consumed. With advancements in technology, tracking systems have evolved to capture these details with pinpoint accuracy, allowing for granular billing.

• Rate determination
  Each unit of consumption has an associated price point. Consider how a cloud storage provider might bill for every megabyte or gigabyte used. Similarly, a telecom operator might levy charges for every minute spent on calls or every text message sent. Determining these rates requires a deep understanding of market dynamics, operational costs and user behaviour.

• Billing cycles
  Regular intervals – whether daily, weekly or monthly – mark the periods when users are billed. The nature and demands of the service dictate the length and frequency of these cycles. Once the cycle has ended, the system compiles all user activities.

• Dynamic invoicing
  Once all of the consumption metrics for the cycle have been computed, the system generates a tailored invoice. It arrives at this by multiplying the quantity of aggregate units that have been consumed by the predetermined unit rate. As a result, each user receives an invoice that mirrors their specific interactions with the service during that period.

• Notifications and alerts
  To pre-empt any bill surprises, many providers have implemented mechanisms to send users timely warnings as they approach or exceed set consumption benchmarks. These alerts act as a cost-control measure for users, as well as a trust-building tool between them and the service provider.

• Payment methods
  Once the invoice has arrived in their inbox, users can choose from a range of payment options. These could range from traditional methods, such as credit cards and bank transfers, to more contemporary solutions, such as digital wallets.

• Disputes and adjustments
  With billing happening post-consumption, there's a chance that users might contest charges. Having a robust, transparent and user-friendly mechanism to address these concerns, rectify discrepancies and ensure customer satisfaction is of the utmost importance.

Usage-based pricing offers a dynamic and adaptive billing approach. It's constructed around the user's activity, leading to a more transparent, flexible and equitable billing system that resonates with both businesses and their users.

Benefits of usage-based pricing

Usage-based pricing offers a multitude of benefits that support the dynamic needs of businesses. Let's take a closer look at its advantages:

• Flexibility for customers
  Charging customers based on consumption equips them with the tools needed to manage and predict expenses more effectively. This model prevents overcharging for unused services, as well as underbudgeting. It appeals to a wide range of customers, from startups on a tight budget to larger corporations seeking granular cost controls.

• Transparency in billing
  Billing users for the exact amount of a product or service that they have consumed adds a layer of honesty and clarity to the process. This straightforward approach can instil a sense of trust and confidence by avoiding hidden charges. In turn, this can position a business as being a trustworthy leader in its field, while eliminating negative feedback.

• Adaptability to market changes
  Businesses that employ usage-based pricing retain the flexibility to tweak their pricing based on shifting market conditions, competitive pressures or changes in resource acquisition costs. Being nimble and responsive in pricing can be a cornerstone for businesses aiming to maintain an edge in a fluid market.

• Potential for increased revenue
  The pay-for-what-you-use concept can embolden users to experiment with additional features or services, potentially increasing their overall consumption. This expanded engagement can uplift revenues, especially when businesses roll out novel services, using the model to spur early adoption.

• Improved customer retention
  The bond between expenditure and received value plays a pivotal role in retaining customers. When customers discern tangible value in every pound spent, their loyalty to the brand or service intensifies. Over time, retaining an existing customer can prove to be more economical than onboarding a new one, which emphasises this advantage.

• Reduced financial waste
  This pricing approach helps businesses to cut down on the financial waste seen in flat-rate models, where there's potential for resource underutilisation. By aligning resource allocation with user demand, businesses can prioritise sustainability and resource efficiency.

• Adoption of a pay-as-you-grow approach
  This model eliminates hefty initial costs, and is particularly beneficial for startups and smaller entities. These businesses can begin their journey with services that they need and, as they expand, scale their usage and related expenses progressively. This modularity breaks down entry barriers, facilitating more organic growth trajectories and fostering innovation.

These advantages underscore the ways in which usage-based pricing is aligned with key business tenets of today, including rapid adaptability, transparency and a keen focus on customer needs.

Usage-based pricing best practices

Usage-based pricing is a transformative step in the way in which businesses approach their pricing and billing strategies. Adopting it without proper planning and execution can introduce unforeseen challenges. Here are some best practices to optimise the shift:

• Establish direct and open communication with customers: A transparent transition to usage-based pricing requires more than an announcement. Businesses should host webinars, generate comprehensive guides and facilitate Q&A sessions. A proactive approach to customer education, where potential concerns are addressed ahead of time, paves the way for a more accepted transition.

• Continually re-evaluate and refine pricing strategies: The dynamic nature of markets demands frequent evaluations of pricing structures. Staying on top of industry trends, competitor shifts and customer feedback regarding billing can guide informed decisions. It also ensures that your business remains relevant and appealing to its user base.

• Commit to comprehensive usage monitoring solutions: Precision in tracking customer usage transcends billing accuracy. Modern tracking tools should not only register every unit consumed, but also offer strategic insights into consumption behaviours. Such data can prove invaluable for future strategy development and targeted offerings.

• Supply customers with exhaustive billing insights: Elevate the billing experience by providing in-depth consumption analyses. Interactive dashboards or comprehensive monthly reports can shine a spotlight on consumption behaviours, granting users a deeper understanding and possibly unveiling opportunities for additional services.

• Place customers at the forefront of strategy: Showcase your dedication to customers beyond billing. Facilitating their growth, through tools or consultation sessions, can solidify your position as a growth partner.

• Offer flexible and scalable contract terms: While a one-size-fits-all approach offers operational simplicity, flexibility can be the deciding factor for certain customers. Tailored contracts, unique pricing tiers and customisable features can demonstrate adaptability and a willingness to support individual needs.

• Undertake systematic checks and evaluations: Periodic assessments of your billing processes can spotlight areas for improvement, from inaccuracies to inefficiencies. Regular evaluations can be used to rectify these issues and refine the billing process, thus uplifting the customer experience.

• Equip customers with the ability to monitor their usage: Give customers the tools that they need to monitor their usage autonomously, heightening the user experience and alleviating demands on customer support teams.

• Solicit customer feedback – and respond to it: Genuine feedback channels can yield important insights. Incorporating changes that are rooted in this feedback can demonstrate adaptability and a commitment to co-creation, deepening trust and the rapport with customers.

When done correctly, transitioning to usage-based pricing can communicate a company's commitment to transparency, fairness and customer satisfaction.

Learn more about how Stripe powers usage-based pricing for businesses.