Consumption-based pricing, pay-as-you-go, pay-per-transaction, unit-based pricing, or metered billing. However, you may refer to it, ‘usage-based pricing’ is by far the most desired pricing model today (we will get to the why in a bit).
Usage-based pricing is where customers only pay for what is consumed. This model calculates pricing based on volume rather than other metrics such as the number of users. In recent years, usage-based pricing has become increasingly prevalent within the Software-as-a-Service (SaaS) industry. In most cases, this replaces the more traditional subscription- and seat-based pricing models.
Let’s take the case of Zapier. They recently sparked a debate when they announced their ‘pay-per-task billing’ model.
So how does the new plan work?
For starters, Zapier has opened up access to value (# of zaps) by providing more flexibility with a pay-as-you-go model. Each extra task that exceeds your plan limit is charged on a per-task basis.
Prior to Zapier, Intercom made the switch, moving their product ‘Fin’ to pay-per-resolution instead of a monthly subscription.
So, why is there a widespread shift to usage-based pricing?
Current software trends, as seen below, advocate for a migration towards usage-based pricing models:
- AI streamlines operations, replacing human teams — requiring new monetization models
- Usage-based pricing enhances scalability and cost-effectiveness — aligning costs with actual consumption
- Dynamic environments need — fair, adaptable usage-based pricing
- Cloud and SaaS demand — flexible pricing to match resource consumption
With usage-based pricing, your revenue growth is a reflection of the value your customers derive from using your product. Read more on that here.
It’s as simple as this — if your customers get value, they stick around. If they don’t, they take the business elsewhere.
How do you implement usage-based pricing?
The good news is that today's software can effortlessly track metrics such as the number of SMS sent, data bandwidth consumed, or API calls made. That's not all. This data can now be seamlessly ingested in real-time or near-real-time into billing systems.
According to Bessemer Partner Ventures’ State of the Cloud 2021 report, the usage-based pricing model has been on the rise because it goes hand-in-hand with product-led growth. Daniel Sharon, Head of Ops & Finance at Qwak, joined us for a webinar and talked about how usage-based pricing is central to PLG’s success. You can watch it here.
“It minimizes the friction of getting started by allowing the customer to start at a low cost — and only pay more as they receive more value.”
— Daniel Sharon
Having said that, implementing usage-based billing introduces a whole new set of complexities that require careful consideration.
We will get into how you can address each one of them.
Let’s start with understanding the responsibilities of the stakeholders involved in the process.
A breakdown of the stakeholders involved:
1. Sales
First up, let's consider the sales team, which engages with customers directly. Their primary focus isn't billing; rather, they invest their time in negotiating deals that provide optimal value to customers while maximizing revenue for the company. Documenting the terms of the agreement is crucial for them to ensure customers receive more value than they pay for, thereby maximizing customer satisfaction and loyalty.
2. Tech and product
The tech and product teams are responsible for delivering the service or product to customers. Their primary concern is ensuring the quality and delivery of the service, not billing. They track the services provided to different customers to maintain accurate records.
3. Finance
The finance department takes the lead in determining the billing strategy, which significantly influences adoption rates and customer activation. They are responsible for translating the terms of the contract into actionable billing processes. They start by reviewing the contract signed with the customer to determine if it contains sufficient information to generate an invoice. If additional service data is required, they collaborate with the tech or product teams to obtain the necessary details. Subsequently, the finance team creates and sends invoices to customers, ensuring accuracy and promptness in the billing process.
We will now look at the steps that you need to take to deploy a usage-based strategy for your business.
Step 1: Identifying pricing axes
Whether you're entering into usage-based pricing contracts that are valid over a period of time or getting started with a new venture — the initial phase of integrating usage-based pricing is crucial. It all begins with identifying the axes along which your products or services can be priced. These axes essentially serve as the foundational parameters guiding how usage will be measured and billed.
Consider a scenario where your company provides cloud storage services. In this context, potential pricing axes could cover storage capacity, data transfer volume, or the number of active users. Each axis represents a vital dimension that influences how customers interact with and consume your offerings. By outlining these axes clearly, you pave the way for a structured and transparent pricing framework that aligns seamlessly with your business objectives and customer needs.
Examples of pricing axes and metrics
Step 2: Tracking usage
Implementing usage-based pricing requires robust mechanisms for accurately and comprehensively tracking usage data. This involves capturing information about the services rendered to customers, including frequency, duration, and intensity of usage. While manual methods like spreadsheets may suffice for smaller-scale operations, larger enterprises often rely on automated tools for streamlined data collection.
For instance, a cloud storage provider may use automated monitoring tools to track storage capacity, data transfer volumes, and user activity levels in real time.
To effectively track usage, businesses need to monitor the services they provide, including information that is not explicitly outlined in contracts, such as pricing details.
There are several methods to accomplish this.
- Manual spreadsheet tracking
For services requiring intensive human involvement, like drafting legal contracts, manual tracking via spreadsheets can be employed.
Here's a simple example of how such tracking might look:
- Automated tools
Some companies may have automated systems in place to track usage. This could be third-party software or internally developed tools.
Step 3: Integrating usage data with billing systems
The smooth integration of usage data with billing systems is critical for efficient invoicing and revenue management. Integration methods may vary based on infrastructure complexity and scalability. Whether through direct data inputs or API-driven integration, the goal is to establish a cohesive ecosystem where usage data seamlessly flows into the billing system, facilitating accurate invoicing and financial reporting.
Here's a breakdown of the methods to achieve this integration:
Manual spreadsheet tracking
If you're manually tracking data using spreadsheets, you have the option to upload this data directly into your billing system. For instance, let’s say you're keeping track of customer usage metrics in a spreadsheet format. With integration capabilities, your billing system can absorb this data, automating the billing process and reducing manual effort.
Internal software integration
Now, let's consider a scenario where your usage data is already stored within your internal software systems. In such cases, your billing system can be configured to interface directly with your data repositories. For example, if your internal systems maintain records of customer interactions or service usage, your billing system can tap into this data repository, pulling relevant metrics for billing purposes.
This could be done without any involvement from your product development or tech team. Or you can send this data into your billing system via APIs. Engineering efforts may be required to set up this integration, but it provides a reliable and automated way to transmit data.
Integration with third-party software
In cases where usage data is stored in third-party software, your billing system can integrate with these platforms to extract relevant data. This integration can occur in various ways: your billing system might be equipped to directly interface with the third-party software, retrieving usage metrics as needed. Alternatively, your engineering team could develop a solution to facilitate data transfer between the third-party software and your billing system via APIs.
API-driven data flow
If your usage data flows exclusively through your software but isn't stored anywhere yet, APIs provided by your billing system can be utilized to send this data directly to the billing system. This approach ensures that relevant usage metrics are captured and processed by your billing system, even if they're not stored within your internal infrastructure.
It's important to note that each integration method requires specific functionality supported by your billing system. While some systems may offer comprehensive integration capabilities, others may lack certain features, emphasizing the importance of evaluating your billing system's capabilities before implementation.
By selecting the most suitable integration method and leveraging the capabilities of your billing system, you can establish an uninterrupted flow of usage data.
Step 4: Defining billable metrics
In setting up an effective billing system, the subsequent step involves defining billable metrics and usage aggregates that will serve as the basis for customer charges. It's crucial to note that these metrics are derived from raw data, representing quantifiable aspects of the provided services. This step is undertaken independently of pricing considerations, as contracts with customers may not yet have been established at this stage.
Let’s understand this better with a few examples.
- Total number of SMSes
For a bulk SMS provider, one of the fundamental metrics could be the cumulative count of SMS messages, irrespective of individual pricing considerations.
- Total number of characters in SMSes
The aggregation of characters within SMS messages offers an additional metric. This can be relevant for services that involve textual content.
- Total storage usage
For services that involve data storage, quantifying the total storage utilized becomes a key metric. This metric can vary widely based on the nature of the services provided, ranging from cloud storage to database usage.
- Total number of transactions
Transactional services, common in various industries, can be measured by aggregating the total number of transactions. This metric is key for businesses dealing with financial transactions, e-commerce, or other transactional models.
It's imperative to emphasize that, at this stage, these defined metrics are decoupled from specific pricing structures. The objective is to establish a versatile library of potential metrics that sales teams can leverage when structuring deals with customers. This approach ensures flexibility and adaptability in accommodating diverse customer needs and preferences.
Step 5: Contract creation and pricing flexibility
In the final phase, the pivotal task is to create contracts that reflect the agreed-upon prices, which may or may not be contingent on the previously defined usage aggregates. This critical stage relies heavily on the expertise and negotiation skills of your sales team, in conjunction with the agility of your billing software's contracting engine.
A robust contracting engine will enable salespersons to tailor contracts precisely to match the customer's requirements and perceived value.
Depending on the nature of the services and the preferences of the customer, pricing structures may vary significantly. The sales team must navigate through diverse pricing scenarios, considering factors such as volume discounts, usage tiers, and special agreements.
Moreover, it’s important to regularly re-evaluate your pricing methods as your offerings and customer demographics evolve. Consider integrating a mix of seat-based, usage-oriented, tiered, and subscription pricing models to better reflect the unique value propositions of your offerings.
In conclusion
Implementing usage-based pricing represents a strategic imperative for businesses seeking to optimize revenue, enhance customer satisfaction, and drive operational efficiency.
In our conversations with clients and prospects, we've come to understand that usage-based contracts can present significant complexities.
Here’s an example to give you an idea:
A $15,000/year contract entitles the customer to 1500 credits monthly, which remain valid until the contract's end. Furthermore, upon renewal, any unused credits roll over with a 25% discount.
These complex arrangements present challenges for automation within conventional billing systems. Despite their apparent simplicity in verbal description, implementing such contracts poses significant hurdles for automated invoicing processes. Zenskar addresses these challenges with its innovative contract automation engine. By transcending the limitations of traditional billing systems, Zenskar empowers companies to effortlessly configure even the most complex contracts through an intuitive drag-and-drop builder.
Packed with advanced capabilities, Zenskar enables businesses to navigate the complexities of usage-based contracts, overcome the constraints of traditional billing systems, and ensure adaptable, customer-centric billing solutions.
Unlock the power of usage-based pricing with Zenskar's cutting-edge billing technology. Schedule a demo today!
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