usage-based pricing

What is usage-based pricing?

Usage-based pricing is a consumption-based pricing model in which customers are charged only 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. 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. This option allows customers to explore how to use the services in a natural manner, without spending money upfront.

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, this might mean moving from a subscription-based cloud service to serverless computing and a very granular function as as service (FaaS) pricing model.

Usage-based pricing models

Common usage-based pricing models include the following:

Pay as you go. Customers pay for only what they use or consume. For example, they only pay for a VM when it is running, which could be priced per minute or hour. It is best for companies that have fluctuating business needs.

Per-unit pricing. Also known as price per unit and pay per use, customers are charged based on resource usage. This model is increasing in popularity as cloud vendors provide more granular services, such as functions, or API gateways, which charge per API call.

Tiered pricing. Customers can choose which tier fits their needs and each tier is given a certain allowance. If the customer reaches or exceeds that allowance, they move up to the next tier and that tier's pricing. Typically, there is a free tier to start.

Advantages and disadvantages

One of the biggest advantages 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 with sustainable, recurring revenue. Too much or too little usage-based pricing can compromise a business's long-term growth.

This was last updated in November 2022

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