In our previous article, “Usage-Based Pricing: What It Is and Why It Matters for SaaS” we introduced the concept of usage-based pricing and explored its fundamental benefits and challenges. We briefly touched on different pricing models, but understanding these models in detail is crucial for choosing the right approach for your business.
This article takes a deeper look at each type of usage-based pricing model, examining how they work, their specific advantages and challenges, and real-world examples of successful implementations. We’ll analyze how different companies have adapted these models to their unique needs and what factors influenced their choices.
Pure Usage-Based Pricing
Pure usage-based pricing is the simplest conceptual model, where customers pay only for what they use. Think of it like your home’s water bill – you pay for each gallon used, with no base fee.
Twilio exemplifies this approach by charging solely for messages sent and minutes of call time used.
This model works particularly well when your service has clear, measurable usage units that directly correlate with value. For instance, if you offer an email validation service, charging per email validated makes intuitive sense because each validation provides discrete value to the customer.
However, pure usage pricing comes with specific challenges. Revenue can be highly variable, and customers might hesitate to use your service without knowing exactly what their bill will be. You’ll need robust usage monitoring and clear reporting to help customers understand and predict their costs.
Hybrid Models: Base Plus Usage
Hybrid models combine a base subscription fee with usage-based charges. The base fee typically provides access to core features or a certain amount of included usage, while additional usage incurs extra charges.
Salesforce’s Data Cloud implements this approach effectively – customers pay a base subscription for access to the platform and additional fees based on data processing volume.
This model offers several advantages. The base fee provides more predictable baseline revenue for your SaaS business while giving customers access to essential features. The usage component allows revenue to scale with customer success. It’s particularly effective when your product has both fixed-cost components (like user accounts or support) and variable-cost elements (like API calls or storage).
For example, a project management tool might charge a base fee per user for access to the platform, then add usage charges for storage space or integrations used. This approach ensures you cover fixed costs while capturing additional value from power users.
Tiered Usage Pricing
Tiered usage pricing applies different rates based on usage volume. As usage increases, the per-unit price typically decreases.
Amazon S3 storage exemplifies this model – the per-gigabyte price drops as storage volume increases.
Tiering can be structured in two ways:
- Volume-based: The new rate applies to all usage once a tier is reached
- Graduated: Different rates apply to usage within each tier
For instance, an analytics platform might charge:
- First 1M events: $0.05 per 1000 events
- 1M-5M events: $0.04 per 1000 events
- Over 5M events: $0.03 per 1000 events
Tiered pricing encourages increased usage while making costs more predictable for larger customers. It’s particularly effective when your marginal costs decrease with scale or when you want to incentivize higher usage levels.
Package-Based Usage Pricing
Package-based usage pricing groups usage into predetermined bundles. Instead of paying for exact usage, customers buy packages of usage credits or units.
SendGrid uses this approach with email packages – customers purchase blocks of emails rather than paying for each individual email sent.
This model offers several benefits. It makes pricing simpler for customers to understand and budget for, while still maintaining the usage-based principle. It can also encourage higher usage since customers often want to fully utilize their purchased package.
For example, a video hosting service might sell packages of:
- 100 hours of video storage and streaming
- 500 hours of video storage and streaming
- 2000 hours of video storage and streaming
Pooled Usage Pricing
Pooled usage pricing aggregates usage across a period (usually monthly) before calculating charges. This differs from immediate usage billing by smoothing out usage spikes and making costs more predictable.
For instance, rather than charging for peak usage, you might charge based on average daily usage over a month. This approach is particularly valuable for services with variable usage patterns, like computing resources or API calls.
A content delivery network might track bandwidth usage throughout the month and charge based on the 95th percentile of usage rather than peak usage. This helps customers avoid excessive charges from temporary spikes while still fairly compensating for sustained high usage.
Value-Based Usage Pricing
Value-based usage pricing ties costs directly to the business value customers receive.
Stripe’s payment processing fees (percentage of transaction value) exemplify this approach. The more revenue a customer processes, the more they pay, but it’s always proportional to the value received.
This model works well when you can directly tie your service to customer revenue or cost savings. For example, a fraud prevention service might charge based on the value of fraudulent transactions prevented, directly linking their revenue to the value they provide.
Choosing the Right Model
Selecting the appropriate usage-based pricing model depends on several factors:
- Your cost structure: If you have high fixed costs, a hybrid model with a base fee might make more sense. If your costs are primarily variable, a pure usage model could work better.
- Customer preferences: Enterprise customers often prefer more predictable pricing models like pooled usage or package-based pricing. Smaller customers might appreciate the flexibility of pure usage pricing.
- Technical capabilities: More complex models require sophisticated usage tracking and billing systems. Ensure you can accurately measure and bill for your chosen usage metrics before implementing any model.
The key is to align your pricing model with both your business needs and customer value perception. The best model makes intuitive sense to customers while ensuring sustainable revenue for your business. Remember, you can always evolve your model as your business grows and market conditions change.
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