The post-subscription era is in full swing, and SaaS companies have evolved from traditional subscription pricing to consumption-based or usage-based pricing models that better align with modern buying behavior and the value delivered by their products.
While the consumption-based pricing model has gone mainstream, many companies are still in the early stages of evaluation. Whether you’re evaluating or testing, our primer can help determine if this approach is right for your business, highlighting the benefits and challenges it brings to the table.
What is consumption-based pricing?
Consumption-based pricing is a pricing model where customers are charged according to the resources they consume.
Simply put, customers will be paying for what they have used or consumed only—nothing less, nothing more. So the more they use, the more they pay and vice versa. The metrics that are used to track the usage often depend on the value that the product brings to the customer. Now that you’re clear about what usage-based pricing is, let’s look closely at some of the evolution of SaaS pricing models.
- Traditional pay-as-you-go model. This is consumption-based pricing in its purest form. All customers need to get started is their credit card. Basically, they’re paying for what they’re using.
- Usage-based pricing tier. This is the most prevalent pricing type in the SaaS industry. Dubbed as the hybrid model, the usage-based pricing tier charges based on different levels of usage for a fixed time.
- Volume-based pricing. This pricing model scales so that each unit’s pricing will decrease based on a higher volume of usage. This means you’re encouraged to use more since you're rewarded with a lower price per unit of usage.
As you can see, despite starting off as a pay-as-you-go pricing model, consumption-based pricing quickly developed variants to suit more complex SaaS and customer needs. Also, note that the list we provided is not an exhaustive list.
Key components of consumption-based pricing
Why are more SaaS companies adopting consumption-based pricing?
The evolution of the SaaS buying process plays a large role here. Consumption-based pricing is a win-win for businesses and customers alike.
For the businesses, benefits of using consumption-based pricing include the following:
- Grow faster with price points that are attractive to a larger customer base. Consumption-based pricing removes barriers to entry for many businesses who are just starting out or simply testing the waters with their software of choice. By adopting this pricing model, you can always quickly experiment and test various recurring revenue and consumption-based pricing combinations and choose from the one that provides you with a large margin of profit and is well received by your customers.
- Provides the agility and flexibility to quickly respond to changing business and customer needs. Implementing a consumption-based pricing model not only gives you the convenience of charging according to the market situation but also allowing you to adjust pricing for inflation.
- Improve customer retention by providing more upgrade and cross-sell options. The power of the consumption-based pricing model lies in its capability to let the customer see the value in what they are paying for. This, in turn, improves customer retention by allowing customers to upgrade or downgrade based on their needs and budgets.
- Enable you to combine consumption-based pricing models with additional features or options to create differentiated packages and bundles for your customers to choose from. As we all know, there’s a SaaS solution literally for everything. So how do you stand out? Simply by having the flexibility to provide pricing options that sound attractive to your consumer.
Now that you know the advantages of using a consumption-based pricing model for your SaaS business, you might be considering updating your pricing strategy. There are a lot of moving parts that go into determining a pricing model as it can make or break your SaaS business.
The consumption based-pricing model works best if you can offer your services in smaller parts and the metrics of usage are easily quantifiable. However, that’s not the case with complex SaaS, where it’s harder to single out a metric to charge as they are offering multiple features and services.
To implement any pricing model, you must answer the following questions:
- Are Sales and Finance aligned with your revenue goals?
- Do you have an existing framework in place to support growth?
- Are you equipped to deliver on customers’ changing expectations?
- Can your billing system support the pricing model of your choice?
Remember, consumption-based pricing isn’t for everyone. But we’ve provided you with useful tips and advice as you evolve your pricing strategy for your SaaS business. To learn more about leveraging consumption-based pricing to scale your company’s growth, contact us.