Usage-based pricing (UBP) is seeing tremendous growth lately.
In 2021 alone 45% of SaaS companies leveraged the consumption-based pricing model. Interestingly, this figure has only grown (up from 34% in 2020 and 30% in 2019) and is expected to grow more.
This kind of growth makes sense though. Usage-based pricing makes it easy for customers to try your product, and businesses love it because it’s tied to a healthy Net Revenue Retention (NRR).
But here’s the thing: although usage-based pricing comes with its perks, it’s not for everyone.
So who is it specifically for, you ask? We sat down with Todd Gardner, a leading expert in SaaS finance, to ask him exactly that. Read on to find his answer.
But first, let’s recap: what is usage-based pricing?
Usage-based pricing, also known as consumption-based pricing, looks at customers’ use of your product to ask them to pay only what they’ve consumed.
According to Todd, “Usage-based pricing is what it sounds like. It uses some metric, maybe several metrics that get combined, and the customer is billed based on the amount they use. They can be billed in advance, in arrears, or it can be part of a larger contract. There are lots of different varieties.”
But why is usage-based pricing quickly becoming the cool kid on the playground?
It’s because it’s customer-centric and aligns with the modern buying behavior that focuses on paying for the value a product delivers — not a product that customers haven’t yet used.
Plus, instead of pushing users to pay an upfront value for their subscription, the usage-based pricing model is often free to start.
Which companies should use usage-based pricing?
Now, for the meaty bit. Usage-based pricing is for:
1. Companies selling resources like computing and storage
These companies (think: Snowflake, MongoDB, and Datadog) incur real, direct costs to provide services to their customers. For example, resources like bandwidth, computing, and storage.
“Those are relatively high cost of goods sold businesses,” Todd points out. “And literally that’s why they’ve adopted usage-based pricing.”
Since there are resources at work, users understand it costs the company money to provide the services, which convinces them that the pricing is justified.
2. Companies linked to user revenue
If your product is directly related to the amount of revenue your customers earn, then it’s worth considering UBP.
For example, Stripe takes a percentage of every purchase.
Todd notes, “These companies do have some direct costs. But I think the bigger driver here is how they align so well with [the] value [they offer to their customers].”
Elaborating on the example of an eCommerce store paying for a tool, Todd shares a user could think, “oh, my eCommerce store sold X! I’m happy to pay a percentage of that because I won’t be paying more for my store unless it’s generating more.”
3. Companies with a communication feature like SMS or email
For example, Twilio. Essentially, SaaS applications like this bear incremental costs to deliver their services. So it makes sense to price on a consumption basis.
When NOT to use usage-based pricing
It’s best not to use UBP if you can’t identify a value metric to charge for that will continue to grow as your customer’s business grows.
Learning companies, for example, should refrain from charging based on usage. Instead, seat-based pricing would suit them better.
The value that a learning company offers benefits an individual user. So if a customer finds value in your company and enrolls more of its employees to drive the same value (read: uses more seats by enrolling more users), you’ll generate more revenue based on the number of seats a customer uses.
Bonus: You can pair usage-based pricing with other pricing models. In fact, Todd observes, “Most usage-based pricing, now just over 50%, is done in combination with some other form of pricing.”
Want an example? Take HubSpot.
It uses seat-based pricing for its Sales tool because the value is being delivered to a person, a salesperson. And, as a bonus, as the customer grows and hires more salespeople, Hubspot will also benefit by selling more seats.
But, on their marketing side, HubSpot charges on a usage basis for marketing contacts. A company using their tool to get more contacts will drive more revenue so they’d be willing to pay more for the value they’re driving from HubSpot.
So should you use usage-based pricing for your SaaS business?
Start with understanding whether your SaaS application falls within any of the three categories that Todd thinks are the best fits for UBP.
Of course, you aren’t limited to sticking exclusively to the consumption-based pricing model. You can
always pair it with other models as HubSpot does.
The key, however, is to find the right value metric to charge for.