What is Usage Based Pricing (with Examples)

Usage based pricing is a popular pricing model used by businesses in various industries, particularly in the software-as-a-service (SaaS), cloud computing, telecommunications, and utilities sectors. This pricing model is based on the actual consumption of a service or product, meaning that customers pay according to how much they use the product or service, rather than a flat rate or fixed subscription fee.

In recent years, usage based pricing has become an increasingly popular choice for businesses because it aligns the cost with the value that customers receive from the product. For businesses, this model can help capture more revenue, ensure a more predictable cash flow, and cater to a broad range of customer segments. For customers, it offers flexibility and cost efficiency by only paying for what they use.

In this article, we will take a deep dive into what usage based pricing is, how it works, the pros and cons of this pricing model, and examples of how different industries use it.

What is Usage Based Pricing?

Usage based pricing refers to a model where customers pay based on the actual amount of a product or service they use over a period. The pricing structure varies according to consumption levels, meaning that the more a customer uses, the more they pay. This model contrasts with fixed pricing models, where customers pay a predetermined price regardless of usage.

For example, in the telecommunications industry, a customer might pay for mobile data or voice minutes based on how much they consume. Similarly, in cloud computing, companies like Amazon Web Services (AWS) charge customers based on the amount of storage or computing power they use.

The flexibility of this pricing model allows businesses to scale their offerings according to customer demand. It also provides an opportunity to attract both smaller customers who may only need a limited amount of resources and larger clients who require more intensive usage.

How Does Usage Based Pricing Work?

Usage based pricing typically works by tracking a customer’s consumption of a product or service, then charging them based on predefined rates. These rates may vary depending on the volume of usage, with discounts applied for higher usage levels.

A common feature of usage based pricing is the “pay-as-you-go” model, where customers are billed for their actual usage at regular intervals, such as monthly, quarterly, or annually. Some businesses may implement tiered pricing, where different price points are assigned to various usage thresholds.

For instance, a cloud service provider might offer a pricing model like the following:

• 0-100 GB of storage: $0.10 per GB
• 101-500 GB of storage: $0.08 per GB
• 501+ GB of storage: $0.05 per GB

As the customer consumes more storage, they pay at a lower rate for the additional usage, which encourages them to use more of the service.

Types of Usage Based Pricing Models

There are different ways to implement usage based pricing depending on the business and industry. Some of the most common types of usage based pricing models include:

1. Pay-As-You-Go Pricing
   This model charges customers based on the actual amount of usage without any upfront fees. It’s particularly common in industries like telecommunications, utilities, and cloud computing. For example, mobile phone users pay for the number of calls or the amount of data they consume.
2. Tiered Pricing
   In tiered usage based pricing, customers are charged based on their consumption within defined tiers. Each tier offers a set amount of usage, and once the customer exceeds the threshold of a given tier, they move to the next one. This model is beneficial for businesses that want to provide customers with incentives to increase usage while still controlling costs.
3. Volume-Based Pricing
   This model rewards customers who use larger quantities of a service by offering discounted rates as their usage increases. For instance, cloud providers may offer volume-based pricing for storage services, where the more data you store, the less you pay per unit of storage.
4. Freemium with Usage Limits
   In this model, businesses provide a free version of the product with limited usage, and customers who exceed these limits are charged based on additional usage. For example, many SaaS businesses offer a free plan with a limited number of users, but if customers want to add more users or use additional features, they are billed based on usage.

Pros and Cons of Usage Based Pricing

While usage based pricing offers a number of advantages, it also comes with some challenges. Below, we discuss the key pros and cons of this pricing model.

Pros of Usage Based Pricing

1. Flexibility for Customers
   One of the most attractive features of usage based pricing is the flexibility it offers to customers. With this model, customers only pay for what they use, making it easier for them to scale their usage up or down depending on their needs. This is especially useful for small businesses or startups with limited budgets, as they can avoid paying for unused resources.
2. Better Alignment of Value and Price
   Usage based pricing ensures that customers only pay for the value they receive. This creates a fairer pricing structure, where customers can feel confident they are not overpaying for services they are not using. It also aligns with customer satisfaction, as they are paying based on their consumption rather than a flat fee.
3. Encourages Scalability
   For businesses, usage based pricing helps facilitate growth. Since the pricing adjusts with customer usage, it allows customers to scale up their consumption as their needs grow, leading to increased revenue for the business. As customers grow, they will likely upgrade to higher usage levels or purchase additional services, thus generating more income.
4. Attracts a Wide Range of Customers
   The pay-as-you-go or tiered structure makes usage based pricing an attractive option for businesses with varying customer needs. Small customers with low usage can opt for the basic plan, while larger customers can pay for higher usage tiers. This allows businesses to cater to a broad range of customers, regardless of their size or budget.
5. Predictable Revenue Streams
   While variable, usage based pricing can still offer businesses predictable revenue streams over time. If customer consumption is consistent, businesses can forecast income based on historical usage data. Additionally, usage patterns provide valuable insights into customer behavior, helping businesses optimize their offerings.

Cons of Usage Based Pricing

1. Revenue Uncertainty
   One of the main drawbacks of usage based pricing is the uncertainty it brings to revenue generation. Since customers’ usage can vary significantly month-to-month, businesses may experience fluctuating revenues. For instance, if a customer reduces their usage or temporarily stops using the service, the business may face a drop in income.
2. Complex Pricing Structure
   Usage based pricing can sometimes be difficult to understand for customers, especially when there are many different pricing tiers or complex usage metrics involved. If customers are unsure about how much they will be charged, they may hesitate to use the service. Transparent pricing and clear communication are crucial to prevent confusion and ensure that customers feel confident in their purchasing decisions.
3. Inconsistent Cash Flow
   While usage based pricing allows businesses to capture more revenue from high-usage customers, it can also result in irregular cash flow, especially if the customer base is not consistent in their consumption patterns. Businesses may need to account for periods of low usage or consider incorporating a minimum charge to ensure consistent revenue.
4. Difficult to Predict Customer Costs
   Customers may find it challenging to predict how much they will pay, especially if they are uncertain about how much of the service they will consume in a given period. This uncertainty may make some customers hesitant to commit to a usage based pricing model, particularly for products or services that require heavy usage.
5. Risk of Over-Consumption
   While volume-based discounts are an advantage for high-usage customers, they can also lead to over-consumption, as customers may use more of the service than they need in order to maximize the value they receive. This could strain business resources and lead to unexpected costs for both the business and the customer.

Examples of Usage Based Pricing

1. Cloud Computing
   Providers like Amazon Web Services (AWS) and Microsoft Azure use usage based pricing for their cloud services. Customers pay based on how much computing power, storage, or bandwidth they use. This model is attractive to businesses that only need cloud services on an as-needed basis.
2. Telecommunications
   Telecom companies often use usage based pricing for mobile data, voice calls, and text messages. For instance, a customer may pay a fixed rate for 1GB of data usage, and once they exceed this limit, additional charges apply. Customers can also opt for data packages or unlimited usage plans depending on their needs.
3. Utilities
   In industries such as water, electricity, and gas, usage based pricing is the standard. Customers are billed based on the amount of energy or water they consume. This model encourages energy conservation and ensures that customers only pay for what they actually use.
4. Software-as-a-Service (SaaS)
   Many SaaS companies, such as Slack and Salesforce, use a combination of subscription and usage based pricing models. For example, a customer may pay a base subscription fee, with additional charges for extra features or usage beyond a certain threshold. Read more about how to grow SaaS companies in this article.

Conclusion

Usage based pricing is a flexible and customer-centric pricing model that is becoming increasingly popular in a wide range of industries. It allows businesses to align their pricing with actual customer usage, providing customers with flexibility while encouraging growth. However, the model does come with challenges, including revenue uncertainty and the potential for complex pricing structures. By understanding the benefits and limitations of usage based pricing, businesses can determine whether this model is the right fit for their products or services.