Usage-based billing explained: How it works and how to optimize its benefits

  1. Introduction
  2. What is usage-based billing?
  3. Usage-based billing components
  4. When should you use usage-based billing?
  5. How does usage-based billing work?
  6. Benefits of usage-based billing
  7. Usage-based billing best practices

Usage-based billing charges customers based on their precise consumption patterns. This pricing framework is distinct from fixed fees or subscription models. As businesses search for pricing models that resonate with their audience and can adapt to market fluctuations, usage-based billing has emerged as a leading solution. Between 2018 and 2022, the number of software-as-a-service (SaaS) companies adopting the usage-based pricing model grew from 27% to 46%, increasing significantly in four years.

Usage-based billing offers a balanced approach to pricing by fostering revenue stability for businesses while giving customers a transparent pricing structure.

Here’s what you should know about usage-based billing: what it is, how it works, and best practices for maximizing the benefits of this billing model.

What’s in this article?

  • What is usage-based billing?
  • Usage-based billing components
  • When should you use usage-based billing?
  • How does usage-based billing work?
  • Benefits of usage-based billing
  • Usage-based billing best practices

What is usage-based billing?

Usage-based billing is a pricing strategy in which customers are billed based on their consumption of a particular product or service. The final bill directly corresponds to the amount of the product or service the customer has used. This approach to billing is found in a variety of sectors. Here are some different types of usage-based billing, and where they are used:

  • Variable pricing: The costs adjust according to the quantity or volume of consumption. Utilities such as water or electricity typically use this model, in which customers pay based on the number of units consumed.

  • Tiered pricing: This type of usage-based billing is based on consumption levels, and the unit price can change. For instance, the first 100 units might have a different price than the next 100 units.

  • Dynamic pricing: This model adjusts pricing in real time based on factors such as demand. For example, a ride-sharing service might charge customers more when they travel during peak times or in high-demand areas.

  • Per feature pricing: Some software solutions adopt this model, in which users pay only for the features they use. If they use only one or two features of a software suite, they’re only billed for those particular features.

Each of these models adjusts the billing structure based on the customer’s use of a product or service. The goal is to offer more flexibility and customization in billing, and to ensure customers feel that their expenses directly reflect their consumption.

Usage-based billing components

In usage-based billing, customers are charged based on their exact consumption of a service or product. If we break down the structure of this billing method, we can identify several key components:

  • Measurement unit: This is the fundamental unit by which usage is tracked. It can vary based on the product or service. For instance, for cloud storage services, the unit might be gigabytes, while for a telecommunication service, it might be minutes or texts.

  • Billing cycle: This refers to the regular interval at which the customer is billed. Common cycles include monthly, quarterly, or annually. During each cycle, the customer’s usage is monitored, and at the end of the cycle, the business bills them accordingly.

  • Rate: The amount charged per measurement unit. Depending on the service, rates might remain constant, or they could vary based on volume or other factors.

  • Usage tracker: A system or tool responsible for monitoring and recording the user’s consumption in real time or near real time. Usage tracking ensures accurate billing and can also serve to notify customers if they’re nearing a certain consumption threshold.

  • Billing adjustments: If there are any discrepancies, refunds, or credits that need to be applied to an account, businesses manage them in this component. This can also include any promotional rates or discounts applicable for a certain amount of usage.

  • Notifications: Often, providers will offer notifications for users to keep them informed about their usage levels. These can be proactive alerts to inform users when they’re nearing their typical usage levels or any predetermined thresholds.

  • Reporting: This allows businesses to generate detailed reports on customer usage patterns. For users, it can also provide insights into their consumption behaviors, helping them make informed decisions in the future.

Piecing these components together allows businesses to develop a metered billing system that is both transparent for the customer and manageable for the service provider.

When should you use usage-based billing?

Usage-based billing has found its footing in a variety of industries:

  • Software-as-a-service (SaaS)
    While many SaaS businesses offer monthly or yearly plans, some also have a usage-based model, in which businesses pay based on the features they use or the number of users. This is attractive for businesses that have seasonal operations or those just testing the waters with a new software solution.

  • Utility providers
    Electricity, water, and gas providers are seasoned in usage-based billing. Customers are billed for the exact amount of resources they consume, ensuring fairness and promoting conservation.

  • Cloud service providers
    Providers charge based on the amount of cloud storage that businesses and individuals use or the computing power they consume. This model allows users to scale their needs without committing to a fixed cost, which makes it ideal for startups and companies with fluctuating demands.

  • Telecommunication companies
    Some telecom companies offer pay-as-you-go phone plans where users are billed for the exact number of minutes they talk or the number of text messages they send. This appeals to users who don’t want monthly commitments or those with varying usage patterns.

  • Streaming platforms
    Some platforms might choose a model where users pay for the content they consume. Instead of a flat monthly fee, users are charged based on the number of movies or episodes they watch.

  • Rental services
    A bike or scooter rental company might charge users for the exact time they rent the vehicle, as opposed to a flat rate. This model encourages more people to use the service since they know they’re only paying for what they use.

  • Data providers
    Companies that offer application programming interfaces (APIs) for data (such as weather, financial data, or location services) might charge based on the number of API calls that a business makes. This model is particularly attractive for developers or businesses who might have variable demands.

Usage-based billing offers flexibility and makes services accessible to a broader audience. By allowing users to pay only for what they use, it can attract a wider range of customers, including those who are budget-conscious and those with fluctuating needs. This billing model also encourages responsible consumption, especially in sectors such as utilities. For businesses, it might provide a more predictable revenue stream, one that is directly linked to user consumption patterns.

How does usage-based billing work?

Usage-based billing is a flexible system tailored to individual consumption patterns. Here’s how it operates:

  • Monitoring and metering
    Usage-based billing relies on tracking a user’s consumption accurately. This could be in the form of data used, hours of service accessed, or units of a resource consumed.

  • Rate determination
    Companies set a specific rate for units of consumption. For example, a cloud storage provider might charge per gigabyte of data stored, or a telecommunication company might charge for every minute of call time.

  • Billing cycles
    Just like traditional billing methods, usage-based billing also has cycles. This could be daily, weekly, monthly, or any other period suitable for the service in question. At the end of each cycle, the user’s consumption is tallied.

  • Dynamic invoicing
    Once the consumption is calculated for the billing cycle, an invoice is generated based on the total units consumed multiplied by the unit rate. This results in users receiving different invoice amounts based on their individual usage.

  • Notifications and alerts
    To prevent unexpected bills, many companies offer notifications or alerts to users when they approach or exceed certain consumption thresholds. This helps users to monitor and control their spending.

  • Payment methods
    Just as with other billing methods, users can pay their invoices using a variety of payment methods such as credit cards, bank transfers, or digital wallets.

  • Disputes and adjustments
    Since users are billed after consumption, there may be instances where they dispute charges. It’s important for businesses to have a transparent process to address these concerns and make necessary adjustments.

Benefits of usage-based billing

  • Flexibility for customers
    Customers are charged based on their consumption, allowing them to better manage and predict their expenses. This means customers do not overpay for unused services or underestimate costs. For modern businesses, this flexibility is an excellent tool for attracting and retaining a diverse range of customers, from budget-conscious startups to larger entities that want precise cost management.

  • Transparency in billing
    Since users are billed only for what they consume, it brings a level of clarity and openness to the billing process, which can lead to greater trust. Just like hidden fees can lead to negative reviews and publicity, transparency can be a significant differentiator and reputation booster for businesses.

  • Adaptability to market changes
    This billing model allows businesses to quickly adjust pricing based on market demand, competition, or changes in resource costs. In a constantly evolving marketplace, the ability to pivot pricing strategies swiftly can be a key factor in staying competitive and relevant.

  • Potential for increased revenue
    When users pay only for what they use, they might be more inclined to try out new features or services. This can lead to higher overall consumption and increased revenue. As businesses introduce new offerings, a usage-based model can encourage early adoption and experimentation among users.

  • Improved customer retention
    A direct link between cost and value strengthens customer relationships. Happy customers are less likely to churn, so by engineering a relationship in which users feel confident and clear about the value they receive for every penny they spend, businesses can reduce churn and build long-term partnerships. Because retaining existing customers can be more cost-effective than acquiring new ones, this benefit is especially valuable for businesses in the long run.

  • Reduced financial waste
    Usage-based billing is a sustainable model that supports efficient resource management. For businesses, this model can minimize the losses associated with flat-rate services.

  • Adoption of a pay-as-you-grow approach
    Because startups and smaller businesses can adopt new services without a significant up-front cost, they stand to benefit significantly from this model. As the business’s needs increase, it can scale its usage and expenses proportionally. For newer industries and startups, this approach removes the barriers to entry, enabling dynamic growth and innovation.

In today’s business environment, characterized by rapid change, heightened customer expectations, and a push for both visibility and sustainability, each of these benefits holds important value for businesses.

Usage-based billing best practices

While usage-based billing offers several advantages, it can signify a departure from traditional billing methods. Implementing this new model without careful thought or without adequate preparation can lead to misunderstandings, customer dissatisfaction, and missed revenue opportunities. Here are some best practices to keep in mind as you get started:

  • Cultivate clear communication with customers: Before adopting usage-based billing, initiate a comprehensive education campaign for your customers. This means not just announcing the change far in advance, but also offering webinars, detailed guides, and Q&A sessions. Anticipate concerns and address them up front. By educating customers about how this model can benefit them and ensuring they fully grasp the nuances of their billing, you can lay the groundwork for a smoother transition and fewer surprises down the line.

  • Review and adjust pricing strategies regularly: Revisiting your pricing metrics on a regular basis is key. Monitor industry benchmarks, gather competitor intelligence, and track customer satisfaction related to billing. Making informed adjustments allows you to stay competitive, meet evolving customer needs, and maintain a strong position in the market.

  • Invest in robust tracking systems: An accurate and detailed tracking system enables you to harness data for strategic decision-making. Adopt technologies that offer precision in tracking customer usage, and provide actionable insights into consumption patterns. This dual functionality protects billing transparency while serving as a fountain of data-driven strategies.

  • Provide customers with detailed billing breakdowns: Offer customers a comprehensive breakdown of services used, not just a general invoice. Consider interactive dashboards or detailed monthly reports that offer insights into peak usage times, most used services, and more. This level of openness reduces disputes while showcasing the full array of services—and offering opportunities for upselling.

  • Prioritize a customer-centric approach: Position your company as a partner invested in your customers’ growth. Offer tools, consultations, and resources that help customers optimize their consumption. This will demonstrate that your commitment extends beyond billing to their overall success.

  • Offer flexibility in contract terms: While standardized contracts can streamline operations, showing adaptability can be appealing to users, especially for bigger clients with unique demands. This means occasionally crafting bespoke agreements, offering tiered pricing, or customizing features—all aimed at better supporting specific needs.

  • Conduct regular audits and assessments: Auditing the billing process consistently protects accuracy while unearthing patterns, anomalies, and inefficiencies that might otherwise go unnoticed.

  • Empower customers with self-monitoring tools: Providing tools that allow customers to track and manage their usage can be a strong value proposition. These tools can range from mobile apps to web dashboards. When customers feel in control, it elevates their experience and reduces the burden on customer support teams.

  • Encourage and act on customer feedback: Create avenues for customer feedback, such as surveys, feedback sessions, and open channels. More importantly, showing demonstrable changes based on this feedback fosters a sense of co-creation, solidifying trust and building a stronger rapport with users.

By transitioning to a usage-based billing model in a careful, intentional way, businesses can show customers that they value transparency and attention to detail, and are dedicated to providing a fair billing structure.

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

The content in this article is for general information and education purposes only and should not be construed as legal or tax advice. Stripe does not warrant or guarantee the accuracy, completeness, adequacy, or currency of the information in the article. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular situation.

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