Usage-Based Pricing/Billing /

What you need to know

Usage-based pricing and billing. You’ve heard of it. You’ve seen the competition do it. You’ve had customers request it. You’d like to offer it; you just don’t know enough about it—yet. Here’s all you need to know about the fundamentals of usage-based pricing and billing: why it’s popular, how it works, and what you should consider before making the best move of your career.

What does usage billing refer to?

Usage-based billing is a pricing model where customers are charged based on their use of a product or service. It is also known as a metered or pay-for-what-you-use model. Since customers pay for what they use, charges may fluctuate every period based on the actual usage. This model is becoming popular with the rise in cloud computing and is spreading out to almost every sector.

You may also sometimes stumble upon this concept in the form of variable pricing, pay-per-use billing, consumption-based pricing, and volume billing. Usage-based pricing especially in highly competitive markets, is still evolving and becoming more standardized. It has the potential to offer very granular data on the consumption of its services or products by an individual customer.

How do you bill for consumption?

The consumption-based billing model allows businesses to package and sell products based on the customer's consumption or usage. It relies on timely and accurate measurements of both the resource consumption and the time when the consumption occurs. This type of billing is used by all major utilities such as the local electric company, and the water company as well as mobile phone companies like T-Mobile and Verizon. This model provides customers with savings when they use less resources. Additionally, the metering allows the provider to track customer usage patterns which ultimately lends itself to helping create cost-efficient product packages.

Consumption-based models provide a pricing model for software products that enables flexibility in the packages, prices, and billing periods. This model has enabled SaaS, IoT, and other high-tech businesses to sell tailor-made consumption packages, configure new bundles, and offer dynamic pricing.

What are pay as you use pricing models?

Pay-per-use (also known as pay-per-use or pay-per-use) is a business model that allows you to effectively track and bill for usage of your service. Prices are based on the number of resources consumed, measured by a number of API calls, requests, storage used, etc.

There are several pricing approaches available to help you choose the right one for your business and customers:

  1. Per-unit pricing
    The most common pricing model is per unit pricing. That means that customers who consume more will pay more, and vice versa.
  2. Tiered pricing
    Tiered pricing is a smart way to capture more customers based on how much they use your product or service. Instead of paying a set price per unit. With tiered pricing your customers’ price per unit decreases as a certain tier volume is reached.
  3. Volume pricing
    Volume pricing is similar to tiered pricing, where higher tiers offer more discounted pricing compared to the lower ones. However, with volume pricing the discount is applied to all items once the customer hits a higher tier.
How do I make sense of my usage data?

For high-tech organizations, usage data is an important source of information to measure performance. Usage data not only provides clarity into the customer’s actual usage habits, but also helps you answer questions about how product features are being used, and what to develop next.

With the help of today's cloud technologies, it's possible to track usage data from phone calls, data, API, minutes, etc., and charge for it appropriately.

Once you've captured the usage data, you'll need to review them for any possible errors that need to be fixed and reprocess the failed records. This process of data transformation requires a robust usage-based billing software.

Why is usage-based billing better?

Usage-based pricing is an increasingly popular pricing model for software as a service (SaaS) and infrastructure as a service (IaaS) cloud providers, because it enables businesses to ramp up their revenue, enjoy higher customer retention, and build better customer relationships. Pricing based on usage is also favored by small B2B customers as the cost of entry is lower and the price only rises as the usage increases with business growth. Usage-based billing makes your product more affordable, which makes it accessible to a wider market, no matter the type of business you are.

Flexible pricing associated with usage-based pricing is a more consumer-friendly model since it does not require customers to constantly adjust their plans based on their usage. Another benefit of usage-based billing is that companies can view the usage data in real-time, which lets them make better decisions about which packages or upgrades to offer. This appeals to the customers and possibly increases profits.

How do you forecast revenue with usage pricing models?

With usage-based pricing models, customers are charged based on their usage, so the revenue generated is variable and is determined by the number of resources used by the customer. Forecasting usage revenue has become quite common for tech, SaaS, IoT, and professional services industries. In order to correctly forecast recurring revenue generated from usage, historical sales data, annual recurring revenue (ARR) history, and customer usage patterns need to be taken into account.

The most important thing to look at when assessing revenue is the previous year's annual recurring revenue (ARR) and usage. This will help you predict how it may affect the next year’s ARR. The other key metrics to look at when forecasting recurring revenue are monthly recurring revenue (MRR), customer lifetime value (CLV), customer acquisition costs (CAC), and customer churn rate. Forecasting customers’ future usage works best when you have access to accurate data, which can then enrich revenue forecasts. An agile usage-based billing system can provide accurate usage data for recurring revenue forecasts.

Who should consider going usage-based?

You should consider switching to a usage-based billing model if your customers demand convenience, flexibility, and fairness in pricing. Usage-based pricing is best suited for businesses that offer high-volume transactional services, and it has the ability to track customer usage based on the chosen value metric be it API calls, minutes, downloads, etc. which requires you to automate your billing system. The following businesses can get the best benefit from usage-based billing:

  • Cloud apps and infrastructure companies
  • IoT (Internet of Things) companies
  • Software as a service (SaaS) companies
  • Utility companies
  • Telecommunication businesses
  • Financial services companies that process a high volume of transactions
  • OTT service providers, and streaming service companies, etc
  • Telematics industry
How does usage-based billing work?

Usage-based billing allows you to charge customers based on resources they have consumed, rather than overcharging them for resources they have underutilized. It helps businesses develop attractive client-oriented services that ultimately drive revenue growth. Usage-based pricing allows your business to expand your customer base by removing flat-fee pricing which reduces the initial purchase barrier.

The model allows businesses to create various pricing tiers to fit the customer’s needs. These thresholds or tiers determine the amount you can charge per data that's collected, versus just charging a flat fee. By strategically placing thresholds, businesses can increase revenue based on consumption.

What are the top things I should consider for usage pricing?

When transitioning from subscription to usage-based billing, there are many factors that need to be considered like the different types of customers and the variability of their usage. It is advisable to consider both go-to-market and operational challenges in setting the right price and billing frequency. In order to capture value from customers, companies must think through and execute the following steps:

  1. Choose a usage billing metric that your customer associates with your product value
  2. Determine the usage-based pricing model best suited for your business, product offering, and target customer
  3. Choose a configurable usage-based billing provider that can manage complex billing scenarios and integrates with all the software you use
  4. Determine the usage-based rating rules, and ensure you provide real-time access to usage and rating data
  5. Update your marketing material to reflect the changes in the billing and launch the new pricing model
  6. Make sure your sales team can communicate the value proposition of your product and new pricing model to customers
  7. Inform your customers about the new pricing model and the changes they will expect to their invoices. Also, educate them about the transparency in pricing this model will offer

If you offer it,
you can bill for it.

No matter what you sell, LogiSense can help you measure it and bill it.

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