Consumption-based pricing for SaaS: the ultimate guide | 2024

Curious about consumption-based pricing for your SaaS?

This model offers compelling advantages, but it's important to understand how it works before taking the leap.

Aligning your pricing with how your customers actually use your product can pay huge dividends as your company grows. Consumption-based models can attract new customers, boost revenue, and create a fairer experience for everyone.

In this guide, we'll explain the advantages (and challenges) of consumption-based pricing and show you how to make a smooth transition that benefits your business and your customers.

We’ll go over:

• What is consumption-based pricing?
• What are the different types of consumption-based pricing models?
• Advantages and challenges of using this model
• How does a consumption-based pricing model compare to other popular models?
• Best practices for businesses adopting consumption-based pricing
• Next steps to take in your implementation journey 

Let’s kick off with a definition.

What is consumption-based pricing?

Consumption-based pricing is a model in which customers pay for software services based on their actual usage. It's sometimes referred to as pay-as-you-go, usage-based pricing, or pay-as-you-grow (with an emphasis on scalability potential).  

Here’s how it works in SaaS: 

1. The customer uses the software: This could involve making API calls, storing data, or sending a designated number of emails.
2. Metrics matter: The service provider tracks a specific usage metric that directly reflects the value the customer receives from the tool.
3. Usage = Bill: At the end of a billing period, the provider calculates the customer's usage and charges them accordingly.

Think of it like an electricity bill — the customer's charges are based on the number of kilowatt-hours they use. With a consumption-based billing strategy, customers only pay for the software resources they actually consume.

Types of consumption-based pricing models

Let's dive into the different flavors of consumption-based pricing. While the core idea is “paying for what you use,” there are nuances to each model — let's figure out which might be the right fit for your business:

• Pay-as-you-go (PAYG): This is he purest form of consumption pricing. Customers pay based solely on their usage within a billing period, with no commitments or minimums. This is great for unpredictable workloads or businesses just starting out.

• Usage-based pricing: Charges are tied to specific usage metrics. For example, a cloud storage provider might charge per gigabyte stored, or an email marketing platform could charge per email sent.

• Pay-as-you-grow: This is a “subscription-lite” model. Pricing scales up or down based on usage. It offers some predictability while accommodating customers whose needs change over time.

• Pay-as-you-save (PAYS): This model encourages conservation. Customers get discounts or reduced rates for lower usage levels. It's increasingly common for SaaS businesses where resource efficiency is a priority.

When does each model make sense?

• PAYG is ideal if you serve customers with highly unpredictable usage patterns, or if you want to offer a zero-friction, low-commitment entry point to your service.
• Usage-based pricing works best when you can clearly define a metric that shows the value your customers get from your product.
• Pay-as-you-grow is a good middle ground for businesses that need some level of revenue predictability but want to accommodate growth without drastic price jumps for their customers.
• PAYS is perfect for companies in industries where resource conservation is important or when costs are directly tied to conserving those resources. Think cloud infrastructure services like Spot, which charges a percentage of the savings you make. 

Advantages of consumption-based pricing

Consumption-based pricing offers a win-win scenario for both SaaS customers and providers. Let's see why:

• Cost efficiency for consumers: If you're a customer with fluctuating needs, this model can be a budget lifesaver. Instead of paying the same fee month after month, your costs go up or down in sync with your actual use of the software.

• Better resource management for providers: A consumption model lets you align costs directly with how your customers use your software. This means better capacity planning and a clearer picture of where to invest in future growth.

• Boosts customer satisfaction: When customers feel they're only paying for what they truly use, it builds a strong sense of fairness and value. This can lead to increased customer loyalty and positive word-of-mouth.
• Reduced upfront costs: Consumption-based pricing often means customers pay less upfront compared to subscription models. This removes financial hurdles, further expanding your SaaS’s reach.
• Predictable pricing for customers: While revenue forecasting may be trickier for you as the provider (more on this later), customers can actually enjoy more predictable costs. With usage-based pricing, they know their bill will reflect their activity within your product.

Challenges of consumption-based pricing

While the advantages are clear, implementing consumption-based pricing isn't without its hurdles. Here are some key challenges to be aware of:

• Billing complexity: Tracking detailed usage metrics and accurately generating invoices can get complex, especially if you offer different pricing tiers or usage thresholds.
• Predictability of revenue: Without subscriptions bringing in steady revenue, your income will naturally fluctuate based on customer usage. This requires careful forecasting and budgeting.
• Customer usage monitoring: You'll need reliable systems to track the usage metrics that form the basis of your pricing model. Accuracy and transparency are essential here.
• Cash flow issues: Since customers are billed after their usage, you might need to catch up on when you incur costs providing the service and when you receive payment. Managing this cash flow discrepancy is critical.
• Customer perception: Some customers might prefer the predictability of a traditional subscription model and find it harder to budget for usage-based costs.

These challenges shouldn't necessarily deter you from implementing a consumption-based model. The key is to be prepared. Investing in the right billing software, exploring forecasting techniques, and transparent customer communication can help you mitigate these risks.

Comparing consumption-based pricing with other models

Now it’s time to compare some of the most popular pricing models to see which would make sense depending on your business needs and your customer base. Let's break down how these models stack up against each other:

• Consumption-based: Customers pay according to their actual usage, emphasizing fairness and aligning costs closely with realized value. Potential drawbacks include the complexity of billing and revenue predictability.
• Subscription: Customers pay a recurring fixed fee for access, regardless of usage levels. This provides predictable revenue for providers and predictable costs for customers. However, subscriptions can lead to overpaying for low-usage customers and missed revenue opportunities for high-usage customers.

• Flat rate: Customers pay a single, fixed fee for unlimited access, offering simplicity for both the customer and provider. The downside is that low-usage customers might subsidize high-usage ones. This can hinder revenue growth because it doesn’t make extra money from customers who use the service more.

• Hybrid: This model combines elements of consumption-based pricing with either subscriptions or flat-rate pricing. It offers flexibility and can address some of the shortcomings of pure consumption-based pricing. 

For example, a base subscription might cover access to core features, with additional charges based on usage of premium add-ons.

Here’s a handy comparison table:

Which model is best?

• Choose a consumption-based model if your focus is on aligning costs directly with the value your customers get from your SaaS. Choose it if you're also prepared to invest in the systems (like billing software) and strategy to manage potential revenue fluctuations.
• Choose a subscription model if predictable revenue is your top priority, and you're ok with some customers not utilizing the full value of their subscription based on their usage.

• Choose flat-rate if you’re aiming for simplicity and can estimate an average usage level that works for most customers. This model also works if your SaaS product doesn’t have high operational costs and can afford to only charge customers once.

• Choose a hybrid model if you want the flexibility to balance predictable revenue with consumption-based elements, catering to a broader range of customer needs. However, hybrid models are highly dependent on the type of SaaS you’re offering. 

Best practices for businesses adopting consumption-based pricing

It’s one thing to understand consumption-based models, but implementing them is a different story. To make the adoption of this model easier for business, here’s a list of some best practices you should keep in mind:

• Invest in precise tracking: Accurate and reliable systems for tracking usage are the foundation of this model. Make sure you have the right technology to capture the metrics that matter and integrate them easily with your billing processes.

• Transparent communication is key: Explain your pricing structure clearly to customers. Provide tools or calculators to help them understand how their usage translates into costs and proactively offer estimates based on typical usage patterns.

• Start with clear value metrics: Before rolling out the new model, ensure the way you measure usage directly reflects the value customers derive from your SaaS (e.g., API calls made, data stored, emails sent, tasks completed). 

• Consider a hybrid approach: Combining consumption-based pricing with subscription elements can ease the transition, provide some level of revenue stability, and cater to different customer preferences.

• Set usage limits or thresholds: Offer tiered pricing or alerts to prevent unexpected cost spikes for customers, helping to manage their expectations and mitigate the risk of customer churn.
• Continuously analyze and refine: Regularly review your customers’ usage data and their feedback to make sure you’re tracking the right metrics, your pricing structure still works, and communication strategies are effective.

• Consider a slow rollout: Start by piloting the new model with a smaller segment of your customer base. This allows you to gather data, refine processes, and address issues before a wider launch.

• Emphasize customer education: Always guide customers on how they can manage their usage and optimize their costs. This is crucial for building trust with your customer base. While profit is key, you never want to leave customers in the dark about charges.

• Invest in billing software: Specialized billing tools can help you charge customers with pinpoint accuracy, avoiding the risks of overcharging or undercharging them due to imprecise data. 

Next steps

After reading our guide, you should now see how consumption-based pricing offers a win-win for your SaaS business and your customers. 

However, managing usage data, configuring flexible pricing tiers, and generating accurate invoices can add extra challenges. 

Orb is your one-stop billing management platform, specifically created for consumption-based pricing models. Our platform simplifies every step, from capturing detailed usage metrics to generating crystal-clear invoices.

Here's how Orb helps you solve billing with consumption-based models:

• Unmatched billing precision: Never worry about missed billable events. Orb captures every interaction, ensuring your customers are billed accurately for the value they receive.

• Flexible pricing structures: Create and manage different pricing tiers easily with Orb's plan versioning. This lets you adapt your model as your business grows without the hassle of data migration.

• Advanced usage tracking: Turn complex consumption data into actionable insights. Orb's robust tracking capabilities are ideal for services that bill based on granular usage, like API calls or storage space.

• Effortless integration: Orb integrates seamlessly with your existing tools — like data warehouses (Snowflake, Redshift) and accounting software (Netsuite, QuickBooks) — minimizing disruption and simplifying your workflow.

• Granular reporting and insights: Orb's detailed reports help you gain a deeper understanding of customer behavior and usage patterns. Use these insights to forecast revenue, improve pricing tiers, and make data-based decisions. 

• Customizable billing metrics: Orb empowers you to define exactly how you measure and bill usage. You can create fair and transparent pricing plans tailored to your unique needs with a drag-and-drop interface and custom SQL editor.

• Hybrid model support: The future of pricing is flexible. Orb's platform accommodates hybrid models that combine consumption-based pricing with other options like subscription models, giving you the freedom to design the perfect pricing strategy.

Learn how Orb can help you execute a hassle-free consumption-based billing solution.