What Is Usage-based Billing? The Complete Guide for 2024

Think about how you pay for your electricity or water usage at home. You only pay for what you use, right?

That's similar to how usage-based pricing works for enterprise software. Instead of a flat fee, businesses pay based on how much they use the software, making it fairer and more flexible for everyone involved.

Usage-based billing has come to the forefront as a popular billing mechanism that charges customers based on their actual consumption of services or products. With usage-based billing, businesses can scale pricing based on increased usage while allowing users to get started for little to no cost and pay later as usage grows.

Companies that can measure how much of their product or service is utilized are actively implementing the usage-based billing model.

In this comprehensive guide, we will look at how usage-based billing is beneficial to customers and businesses. We will also run by real-world examples of usage-based billing and how businesses can overcome the challenges of implementing usage-based billing the right way.

What is usage-based billing? 

Usage-based billing (UBP), also known as consumption billing or metered billing, is a pricing strategy where customers are billed based on the usage of a product or service. Businesses that use UBP will need to measure the exact units of measurement to determine how much to charge a customer.

TL;DR

• Usage-based billing is also known as 'consumption-based billing’ and it allows you to pay for a product or service based on how much you use or consume it in a billing cycle. This type of billing model helps businesses generate revenue based on the value delivered.
• Discover how industry-leading brands like Zoom generate revenue based on the value they deliver.
• From tiered usage-based pricing to hybrid models and pricing linked to impact — take a look at the most common usage-based pricing models.
• Best practices involve defining metrics, efficient metering, transparent rates, and real-time usage insights.
• Challenges include pricing complexity, revenue unpredictability, cost management, and compliance.
• Usage-based billing models foster customer retention by offering fair, value-driven pricing.

Usage-based billing and the value-driven connection

Today, most companies are moving away from fixed cost-based models to value-based ones.

Usage-based billing is a great way for companies to generate revenue based on the actual value delivered. Unlike traditional pricing models, which often impose fixed costs regardless of actual usage, usage-based billing ensures that customers pay in proportion to the value they receive.

According to a report by OpenView, three out of five SaaS companies have started to use some form of usage-based pricing.

For SaaS companies, usage-based billing is not just an ideal approach to provide more value to customers but also to create a more stable revenue stream that is reflective of the value derived by customers.

Moreover, adjusting pricing as the value delivered increases allows companies to capture more revenue without overcharging customers.

Usage-based billing examples

When it comes to usage-based billing, Zoom, Sendgrid, and Datadog are some popular tools that champion this model. Zoom, for instance, offers video conferencing and collaboration software with a range of pricing plans to suit different usage needs. While some plans have fixed monthly fees, others operate on a usage-based model, with charges based on the number of participants or minutes of meetings held.

Nearly 15% of SaaS companies have already introduced a usage-based billing model, while 46% have taken a hybrid approach — either by testing usage-based billing in addition to the traditional subscriptions or by offering a usage-based subscription plan.

With more companies adopting this approach, here are a few popular usage-based billing examples:

• ​​SendGrid: SendGrid offers email delivery and marketing services with usage-based pricing based on the number of emails sent, delivered, and engaged with by recipients.

• Datadog: Datadog provides monitoring and analytics services for cloud-scale applications. Pricing is based on usage metrics such as the number of hosts or containers monitored, with charges varying depending on the level of monitoring and analytics features used.

How to implement usage-based billing?

Here are some best practices to help you maximize your revenue and achieve sustainable growth.

• Set up a system to track usage data accurately: Make sure that you establish a system to monitor and map the usage data correctly. This can be done by integrating usage data with third-party systems using APIs.
• Define your value metric: After determining how customers perceive the value of your product or service and the price they are willing to pay for it, you then need to establish an appropriate usage metric.
• Create a pricing plan: Following usage measurement, you will need to convert it into monetary terms by applying pre-set rates corresponding to the extent of usage. You also need to review your pricing regularly to ensure you are offering customers the value expected for the price paid. 
• Communicate the pricing structure: Customers do not like bill shocks. It’s important to communicate with customers about how usage impacts billing. Furthermore, any pricing revisions or adjustments must be clearly communicated to customers.
• Analyze usage trends: By closely tracking usage patterns, you can analyze how customers are using your products or services.
• Iterate your pricing model: Based on your customer trends and feedback and other factors like market demand, you need to further fine-tune your pricing models. 

Challenges of usage-based billing

There are a few challenges that you may encounter in implementing usage-based billing, such as complexities in pricing, difficulties in forecasting revenue, possible bill shocks for customers, and keeping up with regulatory compliance.

Let’s look at how to overcome these usage-based billing challenges:‍

Complexity in pricing

The usage-based pricing model introduces a new layer of complexity, especially concerning the difficulty in determining the suitable value metric and its associated price for some products and services. The best way to address this is to rely on customer feedback to understand their usage patterns. This will help you ascertain the perceived value of different features and allot the most relevant value metrics to them.‍

Unpredictability of revenue 

Usage-based billing brings with it revenue volatility, making it difficult for businesses to forecast and plan for future income. While diversifying your revenue streams can help stabilize overall revenue, you can also encourage customers to sign long-term contracts or commit to a certain usage level in exchange for discounted pricing or other incentives. These long-term commitments can provide more predictability in revenue.‍

Cost control

Under a usage-based pricing model, customers may struggle with bill shocks, which is why it is important to provide them access to real-time usage metrics. This will help them know what to expect and save them from exceeding budgeted usage levels.‍

Regulatory Compliance

Compliance with regulatory requirements related to usage-based billing, such as data privacy and consumer protection laws, can add another layer of complexity. Some of the ways to address this include conducting regular audits and establishing a comprehensive legal and compliance framework that outlines the regulatory requirements applicable to usage-based billing.

5 Benefits of usage-based billing

Usage-based billing offers a number of business model benefits when compared to traditional subscription models, like — pricing flexibility, billing transparency, value alignment, scalability, and customer retention, among others.

We will take a look at the above 5 benefits of usage-based billing from both the customer and business perspectives:

Flexibility in pricing

Usage-based billing offers customers and businesses a great deal of flexibility. While customers can scale their usage up or down based on their needs and budget constraints, businesses have the choice to tie pricing to different value metrics.

Transparency in billing

Customers appreciate being able to track their usage and costs under usage-based billing. When businesses offer clear and transparent pricing, it helps them build trust and credibility with their customers, allowing them to strengthen customer relationships and differentiate themselves in the market.

Value alignment

Usage-based billing aligns with the value customers derive from the product or service, ensuring they pay for the features and functionalities they find most valuable. From a business perspective, aligning pricing with the value delivered ensures that these businesses capture the full value of their offerings, better monetize their products or services, and, in turn, increase profitability.

Scalability 

For customers, usage-based billing allows them to scale with their usage growth without experiencing any limitations or interruptions. Similarly, businesses can accommodate increasing demand without making any upfront investments in infrastructure or capacity.

Customer retention

Customers are most likely to remain loyal and committed to a business that offers transparent and flexible pricing that is closely aligned with their needs and usage patterns. Usage-based pricing helps businesses reduce churn and increase customer lifetime value by providing options that cater to varying customer needs and preferences.

Try Zenskar’s modern, flexible, and no-code billing infrastructure

Navigating the complexities of usage-based contracts requires a billing system with seamless data ingestion capabilities. Zenskar handles usage data natively — enabling our clients and their customers to enjoy real-time visibility into usage aggregates. We provide the most user-friendly integration for non-contractual data. Whether it's through convenient spreadsheet uploads, APIs, or manual entry — Zenskar effortlessly pulls data from where it already resides. 

That’s not all. Zenskar offers an unparalleled contract automation engine. You can configure complex contracts using a drag-and-drop builder. Whether dealing with nuanced product details or complex usage-based contracts, Zenskar's innovation ensures automated invoicing, defying the limitations of conventional billing systems.

Zenskar automates everything from usage data metering to payment collections and reporting on revenue recognition.

Match the speed and flexibility of pricing iteration with the velocity of product iteration. Schedule a demo with us today!

Frequently Asked Questions (FAQs)

1. What are common billing models for usage-based billing?

Here are some of the most commonly used types of usage-based pricing:

1. Tiered usage-based pricing

In tiered pricing models, the cost is divided into several tiers. Each tier comes with a fixed cost and a specific range of usage — once the customer exceeds the upper limit of a tier, the pricing of the next tier applies. Under this pricing model, the customer may pay a set amount of money for the first initial set of units and less for additional units of use. ‍

2. Per-Unit Pricing

The per-unit pricing is more direct, where customers are billed a fixed amount for each unit of product or service used. This method of pricing is more direct, where customers are charged at a flat rate per unit; the rate does not change regardless of the amount used.

3. Volume-Based Pricing

Among the other variants of usage-based pricing, volume-based pricing is the most straightforward model, where customers are charged based on the volume of service or product that is consumed. For instance, a customer can be asked to pay $75 per unit for 20 units.

4. Hybrid model

As seen earlier, most companies resort to hybrid pricing models, which are a combination of traditional subscriptions and consumption-based pricing. For instance, users can be charged on a per-seat basis in addition to charges on usage limits.

5. Pricing is linked to impact

An emerging usage-based pricing strategy for SaaS companies in the FinTech space is determining pricing based on the business impact or magnitude of customer success.

2. How is usage-based billing tracked for cloud solutions?

Usage-based billing for cloud solutions is tracked based on the resources consumed, such as computing power or storage space. The usage metrics are applied against a pricing structure that scales based on consumption levels.

3. Is usage-based billing used for SaaS?

While it has been primarily used by utility companies and ride-sharing apps — usage-based billing has gained widespread acceptance among Software as a Service (SaaS) companies.

4. What is the difference between usage-based billing and metered billing?

The usage-based billing model charges the customer for the actual consumption of a product or service, whereas, metered billing tracks and charges customers for exact usage metrics, such as — data used or the number of transactions carried out.

5. How does usage-based billing work?

Usage-based billing functions similar to paying for the actual data used on a pay-as-you-go mobile data plan, where you're charged based on your exact usage.