The ultimate guide to usage-based pricing: how to do it right

Looking for an easy-to-follow guide to get your usage-based pricing strategy in motion?

That’s exactly what this guide is about. We’ll show you the value of using a usage-based model so that, by the end of it, you’ll be armed with enough knowledge to get started immediately.

We’ll cover:

• An introduction to usage-based pricing and why it’s so popular
• A quick rundown of its main benefits
• A step-by-step guide for implementation
• Some common implementation challenges and how to solve them

Let’s get started.

A quick introduction to usage-based pricing

Usage-based pricing is a model where customers are charged based on how much they use your product or service.

It's a departure from subscription models, where customers pay a fixed fee regardless of whether they use the product every day or once a month. With usage-based pricing, you essentially say, "Pay for what you use, and nothing more."

Why is usage-based pricing taking over?

UBP isn't a new concept, but it's definitely having a moment in the spotlight. Several key trends are driving its rapid adoption:

• The rise of automation, APIs, and AI: AI is becoming an integral part of SaaS solutions more and more. This makes usage-based billing a natural fit since it directly measures the value these automated and AI-driven systems provide.
• The product-led growth (PLG) movement: PLG puts the power in the hands of the end-user, who can try out a product with minimal friction. Usage-based pricing complements this approach by lowering barriers to entry and allowing customers to scale their usage as their needs grow.
• The economic landscape: The current economic climate has made pricing strategies a top priority for many businesses. Usage-based pricing is seen as a way to improve customer retention, create smoother expansion paths, and boost profit margins.

The benefits of usage-based pricing

• Easier adoption: Customers can start using your product at a lower cost, eliminating the need for complex capacity planning and reducing the fear of overspending.
• Organic growth: UBP allows customers to increase their spending as their needs grow, creating a natural path for expansion without requiring additional sales efforts.
• Happier customers: Research shows that customers feel they get better value when they pay based on consumption. They only pay for what they use, eliminating the frustration of unused features or overpaying for capacity they don't need.
• Better margins: For businesses with usage-dependent costs, UBP can help control margins by aligning revenue with actual usage.
• Reduced churn: Customers can adjust their usage (and spending) during tough times, making them less likely to churn.
• Increased revenue: Thanks to all these benefits, businesses often see a boost in their Net Revenue Retention (NRR), a key indicator of growth and financial health.

How does usage-based pricing work exactly?

At its core, UBP is about measuring and charging for actual consumption. Instead of paying a flat fee every month, customers are billed based on a specific usage metric that aligns with the value they get from the product.

This usage metric can be pretty much anything that makes sense for your business and your customers. Here are a few examples:

• Resource consumption: This is common for infrastructure-as-a-service providers like AWS, where customers pay for the computing power, storage, or bandwidth they use.
• Individual events or actions: For a communication platform like Twilio, customers might be charged per text message sent or minute of voice call.
• Business outcomes: In the fintech space, companies like Stripe might charge a percentage of the transactions processed, aligning their pricing with their customers' revenue.

The key is to choose a metric that accurately reflects the value your product delivers and is easy for customers to understand and predict.

But why is usage-based pricing a win-win both for business and customers?

Usage-based pricing creates a mutually beneficial relationship between businesses and their customers.

For businesses, usage-based pricing enables better cost management by aligning costs with revenue. It also attracts more customers with its lower barrier to entry and unlocks additional revenue as customers grow and use the product more.

Customers benefit from fair and transparent pricing that charges only for what they use. This provides the flexibility to scale their usage as needed and ensures they pay in direct proportion to the value they receive. This alignment of interests fosters higher customer satisfaction and stronger, longer-lasting relationships.

Industries where usage-based pricing shines

Usage-based pricing has been around for a while in industries like telecommunications. But it's increasingly gaining traction in the following sectors:

• Cloud services: Cloud providers like AWS, Azure, and Google Cloud Platform have embraced usage-based pricing, allowing businesses to pay only for the cloud resources they consume.
• SaaS: Many SaaS companies are moving towards usage-based pricing to provide more adaptable and customer-centric pricing models. Examples include Slack, HubSpot, and Zoom.
• Data and analytics: Companies like Snowflake and Datadog offer usage-based pricing models where customers pay based on data storage, processing power, or the number of queries they run.

A step-by-step guide to implementing usage-based pricing

Step 1: Decide if a usage-based pricing model would make sense for your SaaS product

Before diving into the specifics of implementation, take a moment to assess whether usage-based pricing genuinely fits your product or service. Ask yourself:

Does my SaaS provide value in a way that's easily measurable and directly tied to customer use?

For example, a data processing tool could charge per gigabyte processed, or a communication platform might charge per message sent.

Do customers have varying needs and usage patterns that would make a flexible pricing model appealing?

If your customers use your product in dramatically different ways, a one-size-fits-all subscription might not be the most equitable or profitable option.

To answer these questions, analyze your existing customer data. Look for patterns in how, when, and how much they use your service.

Do you see spikes in usage at certain times? Are there significant differences in usage levels between customers? The answers will give you valuable insights into whether a usage-based model could fit your SaaS business well.

Step 2: Define which measurable units you’ll track and bill for

Once you've determined that usage-based pricing is a good fit, the next critical step is deciding what you'll measure and charge for.

Identifying billable metrics

The heart of any usage-based model is the unit of measurement you choose. This should be a metric that directly aligns with the value your product provides.

For example, if your software helps companies send emails, the number of emails sent could be suitable. You might charge per gigabyte of data stored if it's a data storage service.

The goal is to track metrics reflecting the value delivered to customers while covering your own costs. This can involve some experimentation — you might find that specific metrics work better than others or that a combination of metrics provides the most accurate reflection of value.

The importance of transparent and granular units

The units you choose must be easily understood and trackable for both you and your customers. Avoid technical jargon or overly complex calculations.

Transparency is key here; customers should be able to understand how their usage translates into charges easily.

Choosing the right metrics can make or break your usage-based pricing model. It's worth exploring different options before committing to make sure your chosen units make sense for both parties.

Step 3: Develop a pricing structure

The element that will determine how much revenue you’ll generate is your pricing formula. This formula should clearly link the price to the value your product provides. Don't just focus on covering your costs — think about the benefits customers gain from increased usage.

For example, if your product helps them save money or generate revenue, your pricing and communication strategy can (and should) reflect that.

Offering tiered options

Consider offering a tiered structure with different pricing levels based on usage volume. This can cater to a range of customers, from those with modest needs who want a low entry point to those who need the product heavily and are willing to pay for high usage.

Tiers can also be an excellent way to encourage customers to upgrade as their needs grow. Remember, the goal is to balance value for your customers with sustainable revenue for your business.

Step 4: Implement tracking and billing systems

Selecting the right software to track and bill for usage is essential. You'll need a system to monitor usage accurately, calculate charges based on your pricing structure, and automatically generate invoices.

Various vendors offer such solutions, but you can save valuable time by choosing a billing platform that specializes in usage-based billing and invoicing, such as Orb.

The importance of integration

Make sure your chosen billing system integrates seamlessly with your existing tech. You'll encounter unnecessary friction and potential errors if it doesn't play well with your other software, like your customer relationship management (CRM) or enterprise resource planning (ERP) platforms.

Smooth data flow between systems is critical to avoiding manual workarounds, minimizing billing mistakes, and keeping customer data up-to-date.

Step 5: Communicate with customers openly and clearly

Transparency is key when implementing usage-based pricing. Clearly explain how usage-based pricing works and how charges are calculated. This will help customers understand their bills and avoid surprises.

Here are some tips for communicating with customers about usage-based pricing:

• Use clear and concise language: Avoid jargon and technical terms that customers may not understand.
• Provide examples: Show customers how usage-based pricing would work in real-world scenarios.
• Offer educational resources: Create blog posts, articles, or videos that explain usage-based pricing in more detail.
• Be available to answer questions: Provide customers with a way to get help if they have questions about their bills or usage.

Create a delightful onboarding experience

Once you've communicated with customers about usage-based pricing, onboarding them to the new system is important. This means educating them on monitoring their usage and controlling costs.

Here are some tips for onboarding customers to usage-based pricing:

• Provide usage dashboards. Give customers a way to see their usage in real time.
• Set up alerts. Let customers know when they are approaching their usage limits.
• Offer tips for cost optimization. Help customers find ways to reduce their usage and costs.

Step 6: Monitor closely and optimize when necessary

Customer feedback is invaluable when it comes to refining your pricing strategy. Regularly collect and analyze feedback from your customers to understand their perceptions of your pricing and service offerings.

This can be done through surveys, interviews, or simply by monitoring support tickets and online forums. By actively listening to your customers, you can identify areas where your pricing may be causing friction and make necessary adjustments.

Being ready to make changes on the fly

Market changes, new competitors, and fluctuations in your own costs can all impact the effectiveness of your usage-based pricing model. Be prepared to make adjustments to your pricing as needed to stay competitive and profitable.

This might involve tweaking your pricing metrics, adjusting the tiers or thresholds, or even experimenting with different pricing models altogether. By remaining adaptable and responsive, you can guarantee that your pricing remains aligned with the value you deliver and your customers' needs.

Common challenges you’ll encounter and how to solve them

While usage-based pricing offers many benefits, it's not without its challenges. Let's take a look at some common hurdles you might face and how to overcome them:

Customer resistance to change

One of the biggest challenges is getting customers used to a new way of paying. Many people are comfortable with predictable subscription fees and might be hesitant about the variable nature of usage-based pricing. They might worry about unexpected costs or difficulty budgeting.

Solutions

• Transparent communication: Be upfront and clear about how your pricing works. Explain the chosen usage metric, how it's measured, and how it translates into charges. Provide examples and scenarios to help customers understand how their bill will fluctuate with their usage.
• Educational resources: Create resources like FAQs, blog posts, or videos to educate customers about usage-based pricing and its benefits. Offer personalized guidance and support to answer any questions they may have.
• Gradual transition: If you're switching from a subscription model, consider a phased approach. Gradually introduce usage-based pricing elements or offer a hybrid model to ease the transition and give customers time to adjust.

Dealing with billing complexity

Calculating and managing usage-based bills can be more complex than subscription billing. You need to accurately track usage, apply different pricing tiers, handle overages, and ensure timely and accurate invoicing. This can put a strain on your billing systems and processes.

Solutions

• Invest in billing infrastructure: Look into advanced billing systems like Orb that can automate usage tracking, billing calculations, and invoicing. These systems can handle complex pricing structures and scale with your business.
• Regularly audit and reconcile: Conduct regular audits to ensure billing accuracy and identify any discrepancies. Make it easy for customers to review their usage and invoices and address any concerns promptly.
• Clear invoicing: Provide detailed invoices that clearly break down the charges based on usage. Include explanations of any unusual spikes or changes in usage to avoid confusion.

Next steps

Now that you’ve read our guide on how to implement usage-based pricing in your business, you’re probably wondering how to get started.

As stated before, the key to a hassle-free implementation process lies in using a billing solution tailored to usage-based pricing strategies.

That’s Orb.

Orb is a done-for-you billing platform that takes care of every step of billing and invoicing so you can focus on other key areas of your company’s operations.

Here’s a quick look at how Orb solves usage-based billing for you:

• Billing precision that just works: Never again will you have to worry about missing a single billable event. Orb tracks and captures every interaction, guaranteeing your customers are appropriately billed for the value they are getting.
• Adaptable pricing structures: Build and manage various pricing tiers with ease, thanks to Orb’s plan versioning. This way, you can adapt your model as your business scales without having to deal with data migration.
• Unmatched usage tracking: Transform complex usage data into actionable insights. Orb’s tracking capabilities are perfect for services that bill based on granular usage, like API calls and storage space allocation.
• No-hassle integration: Orb integrates easily with data warehouses such as Snowflake and Redshift as well as accounting software like Netsuite and Quickbooks. Enjoy the benefits of no service interruptions and a simplified workflow.
• Billing metrics you can customize: With Orb, you can define exactly how you measure and bill your customer’s usage. With a drag-and-drop interface and a custom SQL editor, you can build fair pricing plans that fit your exact needs.

Learn how Orb can help you set up a hassle-free usage-based billing strategy.