A comprehensive guide to usage-based pricing in SaaS and what you need to know

In recent years, usage-based pricing, also known as consumption-based pricing, pay-per-use pricing, and pay-as-you-go pricing, has gained a lot of traction among SaaS companies—largely driven by consumer requirements and expectations. Today, customers want more flexible, transparent, and value-driven solutions for their specific business needs. They only want to pay for what they use, and don’t want to be “locked” into a service with rigid or long-term contracts.

This article explores the rise and relevance of the usage-based pricing model among SaaS companies, in conjunction with hybrid pricing—as compared with the traditional subscription-based pricing. You’ll learn about the benefits of usage based pricing for both customers and service providers with some examples from leading SaaS companies that have successfully implemented different models. We also cover some of the challenges associated with usage-based pricing and how technology can help you overcome them. 

A brief history of usage-based pricing

Businesses today use a lot of SaaS tools, more than 370 per company on average, by some estimates. With SaaS playing such a large role in so many of our jobs today, it’s easy to forget there was a time not too long ago when the concept of software as a service didn’t even exist. 

Before SaaS, software was sold as on-premises solutions – a business model that came with a high price tag in terms of the total cost of ownership (TCO). As the name suggests, on-premises software usually required expensive hardware to run, complex installations and frequent software updates, as well as ongoing maintenance of servers. As a result, while larger enterprises were able to afford to make such investments, smaller businesses were less able to take advantage of new software tools. That is, until Salesforce unlocked the door for them.   

In the early 2000s, Salesforce—a pioneer in the SaaS industry—created a paradigm shift by making the case for on-demand software and eliminating the need for extensive in-house hardware. However, given the inherent unpredictability of revenue, investors were naturally skeptical of this innovative business model.

Now Salesforce’s objective was to remove all up-front payments from customers and replace them with monthly payments (or the “pay-as-you-go” approach) in return for access to the software solution. This meant that smaller businesses now could easily access and afford the software technologies they needed, e.g., such as emails, CRM, and instant messaging tools. 

On the downside, monthly billing became a huge challenge for accounting teams as they had to generate invoices for each and every customer every month in order to receive payment. So, vendors started shifting from monthly contracts to annual contracts and eventually multi-year contracts, making revenue more predictable while also making it very convenient for customers to stick to one service provider for their business needs. 

Usage-based pricing (as we think of it today) was introduced into the SaaS market about 10 years later when companies like Twilio and Stripe started billing based on the number of requests made to servers through their APIs. As more companies started seeing the benefits of usage-based pricing and started adopting elements of it into their pricing, the model became more widely recognized as a viable and reliable way to generate recurring revenue in SaaS.  

While usage-based pricing for SaaS businesses has been on the rise ever since, in the last couple of years, there has been a marked shift from pure usage-based pricing or pay-as-you-go pricing models to “hybrid” pricing models that combine both traditional subscription and usage components. A majority of usage-based businesses currently prefer a more hybrid model to attract and retain customers.

Understanding the usage-based pricing models

Unlike traditional SaaS subscription models that charge a fixed rate per user or feature, the usage-based pricing model adapts to each customer’s needs, allowing them to pay less when they use less and more as their usage increases. 

While fixed monthly fees can be very cost-effective for many SaaS customers, for those whose data needs fluctuate, with a subscription-based model, the price they’re ultimately paying for the service is higher during low-usage months. In these cases, switching to a usage-based pricing model can help customers cut costs without sacrificing the value they get from the product.

Usage-based pricing models also allow SaaS service providers to take a more customer-centric approach, ensuring their product becomes more accessible to more users—as they can start with a lower entry cost and scale up as their business needs grow. Such engagement often helps service providers discover new use cases, enhance customer satisfaction, and ultimately, increase customer lifetime value.

While the term “subscription” is pretty well understood within the context of the traditional SaaS pricing model, within the highly complex world of usage-based pricing, that term can mean different things to different people. So, for the purposes of this article, we have detailed three different pricing models—subscription-based, usage-based, and hybrid.

Subscription-based pricing

Subscription-based pricing, also known as “flat-rate” pricing, is a plan where customers pay a recurring fee on a monthly or annual basis to access products and services. These payments provide customers with ongoing value since they can use the product over an extended period rather than purchasing it once. Flat-rate pricing works best for products and services that customers use regularly and don’t necessarily need more than what they pay for.

This pricing model has been a mainstay in the SaaS industry since its inception and is still widely used today. This is because for a SaaS business, flat-rate pricing is a lot simpler than almost any other pricing model, which makes business financial processes, such as billing, accounting, and forecasting easier.

Subscription-based pricing also provides businesses with better control over their revenue by enabling them to forecast future income from existing customers. Given the ease of billing and payments, it helps SaaS companies differentiate from competitors and reduce customer churn. 

On the other hand, customers benefit from low-cost access to the necessary services and the convenience of monthly payment plans.

However, for SaaS businesses that use a purely subscription-based model, growth is dependent entirely on winning new customers and/or raising prices—with the latter option being quite unpopular among customers. 

Usage-based pricing

Usage-based pricing seems to be the second most popular pricing model after subscription-based pricing. This pricing model can be found across the entire SaaS stack, from infrastructure through applications. 

In usage-based pricing, customers pay for a product or service based on how much they use it. Therefore, there isn’t any standardized form of pricing structure. And, as a result, revenue derived from this pricing model will almost always vary from month to month. 

The different types of usage-based pricing models include:

• Per-unit usage pricing: As the name suggests, in this case the price varies based on how many “units” of product a customer uses or consumes, rather than charging them for the amount of time they have the service active. This means that customers who consume more will pay more, and vice versa. Companies can define their units of pricing in any number of ways, such as the number of seats or features they use, the amount of cloud storage or compute, etc., per their specific business requirements.

• Tiered pricing: Usage-based tiers constitute a fixed price the customer pays for a fixed allowance of units for the period they have chosen. For any additional units consumed, customers are charged overages. With this model, your customers’ subscriptions are adjusted or converted based on tiers or bands of usage. Tiered pricing can help garner more customers by incentivizing them to use the SaaS product or service in greater amounts.

• Volume pricing: Volume-based pricing is basically a declining price per unit against increasing volume. The more you consume, the less you pay for each unit. Volume pricing is a great strategy for encouraging customers to buy more products at deeper discounts. This creates greater value for their money, and they're more likely to buy your product or service.

Hybrid pricing

Hybrid pricing is a strategy that combines two or more pricing models within a single plan, such as:

• Two or more usage-based pricing components, or
• Subscription fee combined with a usage-based component, or
• Minimum commitment fees—i.e., the customer will be charged a minimum subscription fee regardless of the usage or usage-based components (agreed upon in the contract)—along with the defined usage-based components.

While it may seem like splitting hairs to describe this type of pricing model as “hybrid” when the majority of components are usage-based, these models are far more complex than those with a single usage-based component or any other type of pricing model.

Nonetheless, this mix-and-match approach allows SaaS companies to cater to multiple customer profiles by offering different pricing metrics and options (e.g., basic, premium, enterprise, even freemium, etc.) within a single package. By closely mapping and scaling pricing with customer-perceived value, a hybrid pricing model leads to increased conversions and customer retention. 

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Examples of usage-based and hybrid pricing models 

If you’re considering a usage-based pricing model for your business (or if you just find them interesting), it’s worth exploring some real-world examples to get a fair idea about how to build one.  

Based on our explanation of the different types of usage-based pricing models and hybrid model, here are some examples from leading SaaS companies that have incorporated these pricing strategies:

Usage-based pricing model with only one usage metric

• Twilio provides cloud-based communication tools on a use basis. Their usage-based pricing depends on the number of communications sent or received, such as SMS or voice calls. It caters to the fluctuating communication needs of businesses with the pay-as-you-go model. It also provides volume-based discounts for clients with predictable needs.

• Amazon Web Services (AWS) employs a granular usage-based pricing strategy that includes on-demand flexibility, reserved instances at discounts, and spot instances for flexible workloads. The company offers more than 115 solutions for free trials and 200 fully featured services on a pay-as-you-go model. AWS pricing is based on region, outbound data transfers, storage options, and configurations.

• Mailgun is a comprehensive email service designed for developers and businesses. It comes with a free trial plus three pricing plans that allows users to send bulk emails. Mailgun’s email API uses a per-email model that enables businesses to scale their cost based on email volume.

Usage-based pricing model with two or more usage metrics

• Snowflake is a cloud data warehousing service that uses a credit-driven pay-as-you-go model. Its usage-based model is based on two usage-based components—usage of compute (number of credits used to run queries or perform a service) and consumption of data storage (number of bytes stored per month and the cost of moving data across regions)—along with additional functionality for each pricing tier.

• Microsoft Azure charges for virtual machines (VMs) by the minute. It mainly follows the pay-as-you-go structure wherein users can pay only for the time that a VM instance is running. It also includes two other pricing models, that is, reserved instances where customers pay upfront for a predefined period of VM run time or spot VMs where customers purchase (at a discount) a fixed amount of computing capacity but without any control on the run time.

• Datadog offers a flexible, tiered pricing structure aimed at both small startups and large enterprises. The pricing structure focuses on the volume of data ingested and the features utilized. Factors influencing costs include infrastructure monitoring, application performance monitoring (APM), log management, and synthetic monitoring.

• Mailchimp offers a usage-based pricing model allowing customers to buy email credit blocks or opt for monthly contacts-based plans. The pricing depends upon the number of email subscribers or the volume of emails sent. It lowers the barrier with free plans for customers with limited needs. 

• Zapier allows users to pay based on the number of automated tasks, known as Zaps, that they run each month. Their usage-based model is based on the actual value it generates for users. More flexible and scalable tiered pricing plans with advanced features are also available.

Hybrid model that combines a flat-fee subscription with one or more usage metrics

• Stripe adopts usage-based pricing in the form of flat-rate, transaction-based fees. It aligns costs with the revenue generated by its clients by charging a percentage of the payment amount processed. The model is transparent and predictable with minimal upfront costs.

• Zendesk has an easy-to-understand pricing model with a price-per-agent- per-month combined with add-on usage charges based on customer needs (e.g., additional contacts or interactions), making it adaptable for businesses with variable customer support requirements.

• Userpilot offers flat subscription fees but charges overages for exceeding usage limits for certain features.

These examples highlight how usage-based pricing models vary in complexity and application across SaaS businesses, enabling CXOs and business leaders to align their pricing strategies with customer needs and usage patterns.

Benefits of usage-based pricing for your SaaS business

Usage-based pricing works well for both vendors and customers as it links costs to value received and allows fees to scale as customers grow. 

With consumption-based pricing, 80% of customers have reported better alignment with the value they receive from the SaaS product/service, almost 50% of software companies have witnessed a growth in customers, and nearly two-thirds have seen an increase in revenue from existing customers.

While this pricing model may not be applicable to all businesses, for those SaaS companies that do use it, the benefits can be significant. Let’s take a look!

• Lowers barrier to entry: Usage-based pricing allows customers to start using your services at a minimal cost. They pay only for the features or volume they actually use before committing to larger, fixed-fee plans. This also attracts more customers to get started and allows for a subset of customers to grow their usage rapidly. Easier adoption also means that SaaS vendors are able to evaluate what works well for users as they expand their market reach.

• Improves revenue potential: Usage-based pricing presents an excellent opportunity for companies to deliver greater value to the customer and pursue product-led growth (PLG). As customers grow, their product and service needs expand. Higher usage by customers leads to more revenue for your SaaS business. 

• Increases customer retention: Customers have greater control over their spending in a usage-based model compared to a subscription plan. Many customers report that the consumption-based pricing model has resulted in better alignment with the value received from vendors. This flexibility also reduces the chances of customers churning during slow periods.

• Enhances customer satisfaction: Usage-based pricing is transparent, as customers only pay for what they use, rather than paying for a bundle of features they don’t use. It improves satisfaction and loyalty as they are able to optimize their product usage, without worrying about shelfware or wasteful spending. 

• Increases NRR: Net revenue retention (NRR) measures a company's ability to retain revenue from existing customers over a specific period of time. It is a key metric to gauge the success of the usage-based pricing strategy. Businesses with a usage-based pricing model typically see higher NRR than those that don’t.

• Increases customer lifetime value (LTV): A key differentiator for usage-based pricing is that SaaS businesses that use it typically don’t limit the number of users who have access to their software. This drives customers to discover new use cases, leading to long-term success and a higher customer LTV.

• Improves margin control: The right pricing metric can help SaaS businesses link revenue and costs to usage, improving consistency of unit economics per customer and helping them gain tighter control over margins. Companies that implement usage-based pricing models tend to see higher LTV and lower CAC payback period—this means faster growth and higher valuations from investors.

• Increases investor appeal: Usage-based pricing increases customer LTV as customers spend more on your offering as they grow. It reduces churn rates as customers are more likely to adjust their usage based on their needs than canceling a subscription. These factors appeal to investors as they see potential for steady and sustainable revenue growth in your Saas company.

Common challenges with implementing usage-based pricing

Usage-based pricing is flexible and indicates potential growth, but SaaS businesses face several challenges, too, such as:

• Choosing the right value metric: Choosing the right metric to bill your customers is difficult. You can pick a value-based metric from data usage to active users or a number of transactions, but it must align with customer expectations to prevent dissatisfaction. This also helps you avoid the “taximeter” effect—wherein customers might consume less and less over time by artificially constraining adoption or hoarding usage credits. The right value metric will enable you to provide customers with access to experiencing value and monetize on the basis of how much value they get.

• Effectively handling overages: Customers can become frustrated if they exceed their usage limits and face overage charges. It is important to maintain transparency in pricing structures and set customer-friendly overage policies. It would be helpful for service providers to display usage credits/limits on dashboards and send proactive alerts before the customers reach their usage threshold.

• Predicting revenue: Forecasting monthly revenue consistently becomes complex with usage-based pricing because customer usage can fluctuate. You need to monitor customer behavior changes, as a sudden drop in usage could lead to income instability. To forecast revenue accurately, it is recommended to use a minimum commitment model with fixed and usage-based fees or offer a prepaid model where customers can buy usage credits upfront.

• Educating customers:  It is important to effectively communicate the advantages, flexibility, and fairness of this model to both existing and new customers. They may resist a usage-based pricing model due to the complexities of variable costs, unpredictable bills, and untraceable overage charges. Transparent communications and real-time usage reports can help customers see the value and understand costs.

• Choosing a billing solution: Finding a robust billing system that supports usage-based pricing models is difficult. It must accurately track customer usage, automatically generate invoices, and ensure transparency in managing overages.

Drivetrain makes implementing and tracking the success of your usage-based pricing model easier

Usage-based pricing provides flexibility to SaaS companies and their customers. As a service provider, you can offer flexible pricing based on demand and usage, while customers have the freedom to adjust their usage as their needs change. Unlike flat-fee subscription models, usage-based pricing more closely aligns customers’ costs with the value they receive. 

While consumption-based and hybrid pricing models open up new opportunities for growth, they also introduce a level of unpredictability that makes revenue forecasting and strategic planning challenging. It becomes trickier to track and measure the financial health and performance of SaaS businesses , as well as predict revenue, even with key SaaS metrics like NRR, ARR, gross margin, LTV, etc., given the inherent variability and unpredictability of usage. 

Implementing a strategic FP&A solution or using a cash flow forecasting software for your SaaS business can enable you to overcome these challenges by automating the data integration and validation process and simplifying financial forecasting, modeling, and reporting. 

Drivetrain is a purpose-built, third-generation FP&A software platform, with over 200 integrations, which seamlessly integrates with disparate systems and apps to consolidate and validate all the data you need into a single source of truth (without IT support). You can then slice and dice that data and analyze customer behavior patterns around usage, seasonality, churn, and expansion—all in real time.

A simple yet powerful platform, Drivetrain enables startup founders, SaaS business leaders, and finance teams to easily build financial models using in-built templates, conduct multidimensional analysis across various business aspects (e.g., geographies, market segments, pricing tiers, etc.), and generate data-backed insights for informed decision-making. It also assists finance teams to raise and track invoices and manage their billings processes effortlessly, with custom dashboards that provide immediate visibility into the SaaS business’ billings trends, such as customer utilization patterns and overages.  

Drivetrain comes with a highly intuitive and familiar spreadsheet-like interface and plain English formulas that makes it easy to use, even for non-finance users. The platform’s easy collaboration feature enables multiple users (across departments) to access historical data and actuals regarding usage-based components and customer utilization patterns and adjust their forecast assumptions—on the same “spreadsheet”—to create more accurate revenue and cash flow forecasts as well as share insights with relevant stakeholders.

In this situation, the role-based access feature ensures data privacy by restricting user access to specific data, reports, models, or dashboards. Users are permitted to only access the data they need to perform their tasks effectively. This feature helps maintain regulatory compliance and also reduces data security concerns. 

‍Learn more about how Drivetrain can help you measure and track financial health and business performance with usage-based pricing.