It is not surprising that usage-based pricing is seeing the hottest adoption rate amongst businesses. This trend is backed up by data, which shows that businesses adopting usage-based pricing tend to have better Net Dollar Retention (NDR) rates (122% versus 109%) and significantly lower Customer Acquisition Cost (CAC) (5 versus 8) than those that don’t, as reported by Kyle Poyar from OpenView.
It’s also a lever that businesses can pull to differentiate themselves from their competition and demonstrate that they are bringing added value to customers. At the same time, businesses can reap the benefits of driving incremental revenue beyond just steady subscription-based income.
However, when you peel the onion, there are many layers and nuances between each type of usage-based pricing model, and therefore it’s important for businesses to consider the best option for their business strategy.
Let’s explore the pros and cons of each of these usage-based pricing models:
1. Flat Rate
Under this model, customers pay a fixed rate each period for unlimited usage. This model is appealing to customers as it takes the complexity out of keeping track of their usage. At the same time, it is less administratively complex for businesses to manage this model. The only downside of this model is that businesses have less opportunity to drive incremental spend with customers. Furthermore, there may be a portion of customers who use well beyond their entitled usage. However, in the end, it should all balance out, as there will always be a portion of customers who underuse their service.
2. Minimum
For this model, customers pay a minimum charge each period for a base plan that gives them access to particular features, usage quotas and support services. The benefit of this model is that businesses have a way to entice customers to adopt their product with a low cost to entry, but then can drive incremental revenue through pitching additional one-time services or bundled-purchases over time. Consequently, managing customers through this journey and pushing upgrades takes a well thought out go-to-market strategy and execution, as it’s important not to bombard customers with new offers, but target them at crucial purchase consideration moments.
3. Pay-As-You-Go
This model refers to when customers only pay for the units they actually end up consuming at the end of each period. Many customers find this option favorable as they feel that they are truly paying for what they have actually used in reality. On the flip side, this can mean that businesses experience more volatile revenue cycles as there will be periods where customers have less usage than others. Moreover, it requires businesses to be accurately recording and ensuring that usage is accurately billed to the end customer.
4. Time-based
With the time-based model, customers are charged based on the particular time of day or date that they use their service. The benefit of this model is that businesses have the autonomy to fluctuate rates based on demand, charging higher rates during peak periods. Consequently, this model is perfect for businesses who operate in markets that experience seasonality. It does however require businesses to really forward plan and carefully monitor demand to be able to push rate increases at the optimal time.
5. Allowance
Similar to the flat-rate model, with the allowance model, customers pay a fixed rate each period. The key difference is that this model puts a certain limit on the quantity of goods, services, or usage events included. Many businesses then have the benefit of charging overages when a customer uses beyond their allotment for each period, driving an opportunity for increased revenue. This does come with the added responsibility for businesses to accurately monitor usage and accurately bill for overages as well.
6. Tiers
With tiered pricing, customers pay a discounted amount for the larger quantity they consume. For example, if a customer buys 100 units, they get charged $100 per unit. However, if they buy 200 units, they get charged $80 per unit. This can be a clever way for businesses to lure customers into purchasing additional units. At the same time, businesses need to ensure that the discounted income and added volume requirements doesn’t adversely affect their profit margin. It requires pricing and scenario analysis to determine the appropriate thresholds.
7. Tapers
Similar to tiered pricing, tapered pricing is a volume discount where the price is decreased at particular quantity thresholds. Hence, the key difference is that in tapered pricing, the discount does not apply to every item purchased, but rather, only a certain number of items within each tier. While this pricing model can be an effective way to drive customers to purchase additional units, it means that a business needs to have a billing platform that can manage complex rule-based and volume-based pricing to accurately apply the relevant charges.
8. Pooling
This pricing model is adopted when businesses want to offer a plan for multiple users, but not all users have the same usage. This way, a customer can get charged for a certain number of usage units, but they have the autonomy to split the usage differently between each department within their company. In this scenario, businesses just need to ensure that the usage between each department is clearly defined on the bill, to make settlement as streamlined as possible on the customer’s end.
9. Stored Value
Stored value models enable customers to preload their digital wallet or account with a specific value. The business then draws from that amount as the customer uses the product. Once the stored amount hits zero, the customer loses access to goods or services until they reload their account. This particular pricing model requires businesses to have an advanced billing solution that can manage digital wallets and accurately recognize revenue. It also requires the extra effort of setting up triggers and reminders to ensure customers are not defaulting on topping up their wallet.
10. Combination
The benefit of all the pricing models discussed above, is that they can be combined to truly offer customization that provides value to customers, and maximizes revenue.
However, in order for businesses to execute the above pricing models, it is imperative that they have an intelligent billing solution where they can easily configure, price, quote, rate usage, invoice for, and accurately recognize incoming revenue. Explore how OneBill can get you started with usage-based pricing today.
