Usage-based pricing is a consumption-based pricing model in which customers are only charged when they use a product or service. Typically, the customer is billed at the end of the billing cycle. In a flat, subscription pricing model, the user is charged a fee regardless of how often they use the service. In contrast, a usage-based charge fluctuates according to what the customer actually consumes. Usage-based pricing may also be referred to as metered services.
Usage-based billing is not a new concept; most people are familiar with the pricing model if they purchase metered services such as electricity or water from public utilities. Today, many software as a service (SaaS) and infrastructure as a service (IaaS) cloud providers are adding usage-based pricing options to their subscription billing models to retain customers. Having this option allows customers to explore how to use the services in a natural manner, without spending money up-front.
Usage-based pricing allows for an activity-based management (ABM) strategy in which business processes are evaluated and adjusted for their cost efficiency by using an activity-based costing strategy. In software development, for example, this might mean moving from a subscription-based cloud service to serverless computing and a very granular function-as-as-service (FaaS) pricing model.
Common usage-based pricing models include:
Per-Unit Pricing - customers are billed a per-unit fee immediately after use.
Pay-As-You-Grow - customers pay to license capacity in increments. As they use all the capacity in their initial license, they buy an additional license to unlock more capacity.
Advantages and disadvantages
One of the biggest advantage to purchasing products or services through a usage-based delivery model is that the pricing model's transparency makes it easy for the business side to directly align costs with consumption. A major disadvantage, however, is that variable use translates into variable OPEX expenditures, which can play havoc with budgets and make forecasting financial expenditures difficult.
On the provider side, usage-based pricing can help reduce customer churn, but it’s critical that businesses balance usage-based pricing balance with sustainable, recurring revenue. Because too much or too little usage-based pricing can compromise a business’ long-term growth, experts recommend that no more than 50% revenue should be usage-based.