Usage-based or consumption-based billing is a metric used to bill customers for their services. This business model allows companies to enjoy flexibility when packaging and pricing their products or services depending on their demand.
Both innovation and technology have and will continue to impact business pricing models. Statistics indicate that usage-based billing is the key driving force behind today’s economic model. Let’s take Ubers and AirBnBs as our examples. These two business models have a defined shared economy. Usage-based billing makes it possible for such businesses to offer services and bill their customers based on different variables like time, peak travel time, distance traveled, or nights reserved.
That said, it’s important to understand that there’s a reason for the excitement surrounding usage-based billing. The pricing model allows users to get optimum value from the products or services offered by the business. Any business that has implemented this pricing model, whether a startup or established business, has outperformed its competitors.
With that said, let’s look at why businesses are switching to usage-based billing.
For small and medium-sized businesses (SMBs) as well as startup companies, the basic or lowest tier of a business offering often suffices for their requirements. However, as the business expands and grows, a need for access to more extensive services and products may arise.
Now, this is where usage-based billing comes in. This pricing model makes it easier for businesses to adapt and bill customers for any additional usage beyond their basic plan. Moreover, usage-based pricing empowers businesses to anticipate their users’ future needs.
Companies can send real-time, personalized customer promotions based on individual interests by measuring and analyzing product or service usage data. For instance, a digital newspaper subscription service can keep track of the number of articles a reader clicks on. If readers exceed their monthly allowance, the newspaper can offer them a-la-carte pricing for any additional articles above their subscription limit. This approach allows for a more tailored and flexible billing method.
A study conducted by OpenView on the yearly revenue growth of SaaS companies revealed that the companies using usage-based pricing experienced a 38% growth compared to those without it.
Additionally, SaaS companies offering usage-based pricing were found to have better net dollar retention (NDR), which is a revenue growth and valuation metric that considers changes in customer upgrades, downgrades, and churn. In fact, those with usage-based pricing had a 9% higher NDR than those without it. This is an indication that usage-based billing can help companies grow at a faster rate.
Better Customer Retention
Usage-based pricing brings about a fundamental change in the sales cycle and product development for companies. Rather than relying solely on sales and marketing efforts, companies that have implemented usage-based pricing models grow through customer usage of their products or services.
This product/service-led growth is effective as it allows customers to continually experience the value of the service or product. This ensures that businesses don’t lose their customers. Additionally, if customers require less usage or need to scale down, they do not need to cancel their subscriptions. Also, scaling up becomes easier when required.
Usage-based pricing also provides companies with in-depth insights into customer usage. This allows them to develop new services based on actual usage and offer upsells at the right time.
Better Customer Feedback Collection
Companies can gather feedback on how their customers use their products through the usage-based model. Because of this, it becomes easy to identify the features that are most appealing to customers and those that require improvement. Analyzing revenue data makes it easy to determine which components of the product are in high demand, which simplifies the process.
Better Investment Magnet
According to the 2021 OpenView survey, nearly 42% of SaaS businesses at the seed stage adopt the consumption-based pricing model. Although the revenue may appear more volatile than other billing models, a closer analysis of the data reveals that companies utilizing this pricing model grow faster, trade higher multiple revenues, and retain more revenue. These factors make these companies more attractive to investors.
Minimal Entry Barriers
Usage-based billing and product-led growth are closely linked. That means users can start with a limited usage amount without signing any upfront contract or paying a large sum. As they begin to see the value of this approach, they can then scale up their usage.
Therefore, users will only pay for what they use, and if they find the service valuable, they will likely use it more and pay more. As they scale up, the business gets to benefit from their success. This approach can also expand your target market, making it easier for smaller companies to access your products or services.
Helps Companies to Reduce Revenue Leakage
Usage-based billing can help businesses prevent or reduce revenue leakage. This problem can arise when a company fails to collect payments for services rendered, often due to issues such as inaccurate billing or customer fraud. However, companies can address this issue by charging users only for the services they use.
Companies use usage-based billing software to track usage patterns, which makes it easier to detect any unauthorized usage and take appropriate measures to prevent it. Additionally, this billing model enables companies to identify potential fraud and resource waste while also providing them with a more precise understanding of customer usage patterns. This ultimately helps businesses manage their resources more effectively, making usage-based pricing an indispensable tool for reducing revenue leakage and increasing profitability.
Determining whether a usage-based pricing model is ideal for your business depends on the nature of your industry, product, or service. Usage-based pricing is most effective for companies already utilizing the subscription-based billing model or other services or products. While this model provides numerous advantages for your business and customers, it may not be suitable for every business. Therefore, many industries are exploring different ways to leverage the benefits of usage-based pricing with innovative approaches. However, if you offer a seasonal or scalable product or service, usage-based pricing is worth considering.