The Cacheflow Blog

Complete Guide to Consumption-Based Pricing for SaaS

May 7, 2024 3:15 PM

SaaS companies are adopting consumption-based pricing models to align with modern buying behavior and tie product cost to its value (aka how much you use it).

When done right, consumption-based pricing is a win-win for you and your customers. 80% of customers report better alignment with product value from consumption-based pricing.

This post explores consumption-based pricing and the various types of pricing models. It also helps you understand when you should opt for a consumption-based pricing model, and the benefits and risks of doing so.

What is Consumption-Based Pricing?

Consumption-based pricing is a pricing model that charges customers according to the amount of product they use instead of charging them a fixed monthly fee. Unlike the flat-rate subscription pricing approach, whereby all users pay the same, this model only requires customers to pay for their consumption volume. 

You can choose one or several metrics measured in units (numbers) and set rates under a consumption-based pricing system to optimize your product costs. For example, it can be measured in number of emails, API usage, and more. This kind of pricing usually involves measuring how many service units were used by each customer and then charging them for consumed services accordingly. 

For example, Algolia, an AI-powered search and discovery platform, changed its SaaS pricing structure multiple times in search of a pricing structure friendlier to its customers, i.e., usage-based pricing structures.

Similarly, Twilio offers consumption-based, flexible pricing options to its customers where they pay for what they consume and do not get locked into big contracts. Further, as the usage volume increases, Twilio offers volume-based discounts to customers so that they always get a fair price. 

Consumption-based pricing is also known as “Usage-based pricing” and “Pay-as-you-go billing.”

Common Consumption-Based Pricing Models

There are different types of consumption-based pricing models that you can follow to charge your customers. 

Tiered consumption-based pricing

This pricing model offers different pricing tiers based on the level of consumption. Increasing the usage limits, you may provide a basic tiered plan with limited usage and a few higher tiers. If the customer exhausts the limits of their current tiered plan, they can automatically upgrade their plan to the next tier. 

Per unit consumption-based pricing

This pricing method is more direct. It charges a flat rate per unit based on the number of units consumed by the customer. For example, you may charge a flat fee on every gigabyte of data imported into your product.

Bulk usage/ volume elated usage pricing

This method of pricing is similar to usage-based pricing per unit. But it comes with a twist. Instead of charging your customers per individual unit, you charge them based on the overall volume. For instance, you may charge $50 per unit for 10 units and $45 per unit for 20 units.

Hybrid usage-based billing

Hybrid billing combines pricing models like the ones we mentioned above to offer customers a more customized pricing option. You can provide a basic version of your product for a base subscription fee with the flexibility to use premium features at additional charges.

Why Should You Opt for a Consumption-Based Pricing Model?

Most businesses, especially SaaS businesses, have numerous advantages when using consumption-based pricing models. 

1. Good perceived value from customers

With consumption-based pricing, your customers are not restricted or locked into long-term payment cycles. They only pay for what they use; it could be more or less than they need. This approach allows them to buy software features per their requirements. So let your customers begin using your product as per their needs and scale up payment when necessary under consumption-based pricing systems.

2. High upside for customers that are growing

Instead of fixed contracts that restrict your customers, consumption-based pricing enables growth as your customer's business scales up. This pricing strategy comforts customers who may be uncertain about where their business is headed but want the flexibility to scale up usage on demand. If they can use more of your product without needing to negotiate new contracts each time, your customers are more likely to increase their usage regularly. 

3. Lower churn risk 

You can mitigate churn risks by adopting a consumption-based pricing model because it makes room for adjustments. Based on the circumstances, your customers can temporarily scale down product use without discontinuing its use, reducing the chances of them leaving altogether. You can nurture strong relationships with your clients and support them during difficult business periods.

4. Increased product usage

Consumption-based pricing offers more flexibility regarding pricing, features, and overall product usage. Your customers can add additional features, team members, and more without upgrading their current pricing plan. It allows easy scalability without any limitations being imposed upon your customers. This means your customers can try out new features and utilize your product better depending on their needs at any given time. The increased product usage also facilitates rapid product improvement through customer feedback.

Risks of Using Consumption-Based Pricing

While consumption-based pricing offers many advantages, you may encounter several challenges when using it for your business.

1. Harder to forecast revenue

When you adopt consumption-based pricing, it is extremely difficult to predict revenues. Unlike the traditional pricing models, which charge a monthly fixed subscription fee, you have to figure out what your customers will do. This is difficult to comprehend because customer's behavioral patterns vary considerably. This challenge becomes even more complicated when usage patterns change drastically from one customer to another. Even advanced analytical tools and predictive analytics models may not deliver the right insights. 

2. Difficult to bill and collect payment

It becomes tough to bill and collect payment when your product is priced based on what is consumed. Further, sending out invoices and processing payments is complicated as the fees fluctuate with usage. Hence, you need to maintain accuracy in recording and processing the billing data to generate accurate invoices. As billing periods differ from one customer to another, you might need an automated billing system that understands consumption-based pricing to speed up your payment collection processes.

3. Higher cash flow risk

Due to the variations in customer usage patterns and inconsistent billing cycles, it is difficult to manage cash flow. You might even face challenges in keeping up with the generated revenue because of the unpredictability associated with the consumption volume. You have to thoughtfully manage your funds and make sensible financial decisions to combat the uncertainties this pricing model brings. 

4. More susceptible to changes in market demand

Customer usage patterns fluctuate with market dynamics, seasonal trends, and competition changes. This unpredictable market demand may threaten any business that adopts consumption-based pricing models. Demand volatility requires you to monitor the target markets continuously and understand customer behavior proactively.

Wrapping Up

SaaS businesses need to choose the right pricing model to succeed in today’s rapidly changing product industry. However, its complexity may make implementing an effective pricing strategy difficult. This is where Cacheflow comes into play.

Cacheflow allows companies to easily adjust and refine their pricing strategies in response to new market dynamics. Thanks to its advanced features, you can simply use its usage-based billing software to connect product usage with automatic billing. Its user-friendly interface will help you deliver fair charges based on your customers' consumption. Cacheflow offers incredible features for optimizing charges, automating tedious billing operations, and streamlining quote-to-cash processes

Let Cacheflow become your reliable partner when implementing consumption-based pricing models and uncover more avenues for revenue generation. 

Book a demo to streamline your consumption-based pricing while keeping clients satisfied. 

Consumption-based Pricing FAQs

1. What is consumption-based costing?

Consumption-based pricing is a model that charges customers for what they use. It is different from traditional flat-rate systems, which charge the same amount no matter how much is consumed. Under consumption-based costs, fees are not fixed but vary with the usage level to ensure fairness in relation to customer-perceived value.

2. What is an example of consumption-based licensing?

Amazon Web Services (AWS) is the best example of consumption-based licensing. Customers only pay for what they use in terms of resources which are usually computed per hour or unit. The idea behind this license type is to move away from flat rate charges at the beginning. It allows customers to save money depending on their needs, thus making it scalable and cost-efficient. It is among the best tactics for winning SaaS renewals and expansion deals.

3. What is the advantage of using a consumption-based model?

Charging your customers based on the actual product usage is one of the advantages of a consumption-based model. It helps you become more transparent about pricing and build a flexible product for your customers.