The easy guide to consumption-based billing (Usage-based pricing)

Many people like you are implementing a consumption-based billing model. Though it may seem daunting, it doesn’t need to be arduous. 

The goal of this guide is to give you all the details you need to get started. Here’s a summary of the contents you’ll find in this primer: 

• A definition of consumption-based billing
• Benefits of using consumption-based billing
• How to determine if consumption-based pricing is right for your SaaS business
• A comparison of consumption-based billing with other models
• Management tips and best practices
• Case studies of companies that used consumption-based billing
• A quick step-by-step guide to implementing a consumption-based billing model

What is consumption-based billing?

You've heard the buzz about consumption-based billing in SaaS… but what exactly is it?

Consumption-based billing, also known as usage-based pricing, is a model in which you charge customers based on exactly how much they use your SaaS product. Utility usage—a water bill, for example—might be a helpful point of comparison.

The analogy falls short, however. To explain why, let’s look at the difference: 

• Metered billing: You measure usage as though it wasa tap of running water. This means that you’ll be charged up till the exact moment the faucet is closed. You pay “x” amount based on the water usage. It's a simple multiplication of “water used * price of water.”
• Consumption-based billing: Here, you’re still paying based on your usage. The difference is that you’re charged per event. A phone company tracks each individual event (calls, messages, roaming, etc.) or other complex transactions to create your bill. 

Why use consumption-based billing in SaaS?

If you're a SaaS provider, here are the benefits that you should pay attention to:

• Cost efficiency for both parties: It's an overall fairer model. People who might not need all the bells and whistles of a full-featured subscription appreciate it. For providers, it also means that operational expenses are easier to correlate to customer usage. 
• Better scalability: As your customers grow, so does their bill. It's a natural alignment that benefits both parties. In this case, your billing system might need an upgrade.
• Adaptability: Consumption-based pricing lets you cater to a wide range of customer needs and usage patterns. You can create different pricing tiers, offer pay-as-you-go options, or even get creative with hybrid models.
• Satisfied customers = better business: Customers are more likely to stick around when they feel they're getting a fair deal. Consumption-based billing aligns cost with value, leading to happier customers.

Is consumption-based billing right for your SaaS business?

Consumption-based billing sounds excellent. But is it the right fit for your SaaS product?

Here's the deal: Consumption-based billing shines when your product has variable usage patterns. If your customers use your software in wildly different ways, it can perfectly match their bills to the value they get.

But before you dive in, here are a few things to consider:

• Listen to your customers. Take a good look at how your customers are using your product. Are there some power users who could benefit from a usage-based model? Would others prefer a flat subscription? Their feedback is gold.
• Consider revenue predictability. Consumption-based billing offers great flexibility. However, it can sometimes make your revenue less predictable. Consider how this might impact your cash flow and financial planning. 
• Check out the competition. Take a peek at what your competitors are doing. Are they using consumption-based models? If so, how are they structuring their pricing? This can give you valuable insights and help you position yourself in the market.

Consumption-based billing compared to other models

Consumption-based billing isn't the only option out there. Let's see how it stacks up against some other popular pricing models:

Subscription-based pricing

Customers pay a recurring fee (monthly, annually, etc.) to access your product or service, regardless of how much they use it. In contrast, consumption-based billing charges customers only for what they consume.

Pros

• Predictable revenue: You know exactly how much you're earning each month, making forecasting and planning easy.
• Simple to manage: It doesn't get much easier than charging the same amount each billing cycle.

Cons

• Less flexibility: Customers are locked into a fixed price, whether they use your product a little or a lot. Unlike consumption-based billing, which adapts to how users interact with your SaaS product.
• Potential for overpaying: If a customer doesn't use your product much, they might feel like they're not getting their money's worth. Consumption-based billing aligns cost with usage.

Tiered pricing

You offer different service levels or features at various price points, typically with a higher price for more features or usage. 

Consumption-based billing can be incorporated into tiered pricing. However, it will focus on charging for actual usage rather than predetermined feature sets.

Pros

• Cater to various needs: You can attract a broader range of customers with different budgets and requirements.
• Upselling opportunities: Customers might be tempted to upgrade to a higher tier as their needs grow.

Cons

• It can get complicated: Managing multiple tiers and their features can be a headache.
• Can alienate users: Some customers might feel pressured to choose a higher tier than they need. Consumption-based billing allows for more granular usage and cost adjustments.

Freemium model

You offer a free basic version of your product, with premium features available for a fee. Consumption-based billing can be used in conjunction with a freemium model. You'd charge for using premium features or for exceeding certain usage limits.

Pros

• Attracts a broad user base: The free tier can bring in many potential customers.
• Conversion potential: Some free users will love your product so much that they'll gladly pay for the premium version.

Cons

• Free users might not convert: It's a gamble. You might end up with many free users who never become paying customers. Consumption-based billing ensures revenue from all users who consume the product.
• Resource-intensive: You'll need to invest in supporting those free users, which can be costly.

Management best practices for consumption-based billing

Now, you've decided to take the plunge into consumption-based billing. Here comes the important part of managing it effectively. Keep these best practices in mind before getting started:

Have a clear and readily available pricing page and documentation 

Think of your documentation as a trusty roadmap for your customers. It should clearly explain your billing model, how you measure usage, and how charges are calculated. 

Keep it simple and jargon-free so even non-technical users can understand it. If you serve an international audience, consider offering translations to make it even more accessible. 

Transparent billing, above all

When it comes to billing, surprises are never fun. Your invoices should clearly show exactly what customers are being charged for.

You should also provide a detailed breakdown of their usage and let them easily download invoices for their records. One of the main reasons companies prefer these models is the trust they foster. 

Keep customers educated and in the loop

Don't ever leave your customers in the dark. Offer tutorials, resources, and support channels to help them understand their usage and billing.

Think of it as giving them the tools to take control of their spending. Anything that helps them better understand how they’re being charged. Remember, this is also a means of building trust.

Review regularly

The ebb and flow of the SaaS industry is constantly changing. That's why reviewing your pricing and usage models regularly is crucial. Are they still aligned with market trends? Are your customers' needs changing? 

By thinking on your feet and making adjustments as needed, you can ensure that your billing model remains fair and competitive.

Case studies of companies that used consumption-based billing

Example: Snowflake

Snowflake was founded in 2012. It emerged as an industry disruptor with its cloud-native platform and innovative pricing model. Unlike traditional data warehousing solutions, Snowflake separated computing and storage costs. This allowed businesses to scale their usage independently and only pay for their consumption. 

This cost-efficiency resonated with a wide range of customers, from startups to large enterprises. Snowflake's growth and successful IPO in 2020 show how its strategy attracts and retains users.

Example: AWS (Amazon Web Services)

AWS, launched in 2006, pioneered cloud computing and introduced the pay-as-you-go model. By doing this, it changed the way businesses access and pay for computing resources. 

The consumption-based model eliminated the need for upfront hardware investments, allowing customers to pay only for the services they used. However, as AWS expanded its array of services, the billing structure became more complex, leading to some customer confusion.

AWS has invested in improving its billing tools, documentation, and cost management features to address this. They aim to guarantee transparency and empower customers to control their cloud spending. 

Steps to implementing consumption-based billing

1. Identify key metrics

The first step is determining what aspects of your product or service will be measured to calculate usage. Choose metrics that truly reflect how customers derive value. 

For instance, if you offer a data analytics platform, track the amount of data processed or the number of queries run. Ensure your chosen metrics are relevant to your offering and align with the value you deliver to customers.

2. Determine pricing tiers or rates

Once you've identified your key metrics, it's time to establish clear pricing tiers or rates. You can create a tiered structure with different price points based on usage levels. Alternatively, you can opt for a simpler model with a single rate per consumption unit.

The key is to be transparent about your pricing structure and value propositions. You must ensure customers can easily understand how their usage translates into costs.

3. Choose the right billing platform

Selecting the right billing platform is crucial for the success of your consumption-based model. Look for a platform like Orb that can handle the intricacies of usage-based billing, including tracking and invoicing.

Consider whether you need a platform in the first place. However, if you plan on scaling up, you will need tools. Especially those that integrate with your existing systems to automate these processes.

4. Integrate tracking and monitoring

To guarantee accurate billing, you must implement tools to track customer usage in real-time. This could involve embedding tracking code in your product or service or using APIs provided by your billing platform. 

Regularly monitor and validate your tracking data. This helps you accurately identify any discrepancies. The result? Precise billing and happier customers who trust the process. 

5. Keep in touch with customers

Transparency is key to building trust with your customers. Clearly explain how your consumption-based billing model works. This is also an excellent opportunity to highlight its benefits and clue everyone in.

Provide comprehensive documentation outlining your pricing tiers, rates, and billing process. Be readily available to answer any questions or concerns your customers may have.

6. Monitor and analyze usage

Regularly reviewing your usage data can yield valuable insights. Track customer usage patterns over time. 

This way, you can identify trends and make informed decisions about pricing adjustments. By analyzing this data, you can improve your profitability and customer satisfaction model.

For example, if a particular feature is underutilized, you might consider lowering its price. Alternatively, you can bundle it with features that make sense for other customer demographics. 

Next steps

Now that you've explored our guide on consumption-based billing, you're probably eager to get started. The secret to a smooth transition lies in choosing the right billing solution. Better yet, one explicitly designed for consumption-based pricing.

Consider Orb. 

Orb is a powerful billing platform that handles every aspect of billing and invoicing, freeing you to focus on growing your business.

Here's how Orb can make consumption-based billing a breeze:

• Precision billing: Never miss a billable event again. Orb meticulously tracks and captures every interaction. This helps you make sure your customers are billed accurately for the value they receive.
• Adaptable pricing structures: Create and manage many pricing tiers with Orb's Plan Versioning and Migrations functionality. This allows you to scale your model as your business grows without the hassle of data migration.
• Unmatched usage tracking: Transform intricate usage data into actionable insights. Orb's tracking capabilities are ideal for services based on granular usage, such as API calls and storage allocation.
• Frictionless integration: Orb integrates with popular data warehouses like Snowflake and Redshift. It also plays nicely with accounting software like Netsuite and Quickbooks, ensuring uninterrupted service and a streamlined workflow.
• Customizable billing metrics: Define precisely how you measure and bill your customers' usage. You can craft fair and custom pricing plans with a user-friendly interface and a custom SQL editor. 

Learn how Orb can help you establish a hassle-free consumption-based billing model.