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Usage Pricing 101: A Beginner's Guide to Usage Pricing

Choosing your pricing model is one of the first and most fundamental steps when creating your business model. For founders just starting out, it's natural to think that pricing should look something like "X$ for Y product, during Z time.” It is a simple formula and it works well, both in our heads and inside a spreadsheet.

However, as much as we wish pricing was that simple, recent years have given rise to more complex pricing models that might be a better fit for your business and customer base. And yes, as the title suggests, we are talking about usage-based pricing.

Usage based pricing has several advantages, you can read about them here. The short of it - usage pricing allows for much higher flexibility in representing value, and allows customers to start small, and increase usage and budget as they discover and validate the value in the product. 

A usage-based model enables customers to pay a price that truly reflects their activity – no more, no less. And with over 62% of SaaS companies already adopting or testing it, it’s on the fast track to taking over as a core pricing method for many companies.

If that sounds like something that might unlock value for your company, read on as we dive into the most common usage-based pricing models. Note that these are the 101 basics, watch out for our Usage 201 advanced part coming up.

Fixed Rate Pricing 

In fixed rate usage pricing (AKA “flat rate”) customers pay one fixed rate per unit. This model ideally fits linear pricing models, which can be driven by various reasons. One example is where the marginal value of units sold does not diminish with larger quantities. Also appropriate when the price elasticity of demand is inelastic, for example when a product is in high demand with little competitive pressures. A final example is when the seller resells the units which have a fixed marginal cost.

For example, API Calls - $0.30 per API Call. The customer is billed $30 per SMS, whether they send one or a million. If you sell 10,000 API Calls, you calculate your total like this: 10,000 x $0.30 = $3,000

Pros: Single-rate pricing simplifies the billing process, makes it easier for customers to understand what they are paying for, and significantly reduces invoice disputes. If your customers value simplicity or need a straightforward solution, fixed rate pricing can be a good fit for you.

Cons: Although a one-size-fits-all approach may seem like the perfect customer-satisfier, it can also ensure none of your customers are happy, and even limit your profitability by not taking into account different customer segments’ demand and WTP.

Tiered Pricing

A tiered pricing model offers customers a reduced fee per each consumption tier, as consumption grows. In other words, the more you use, the less you will pay for each unit in each tier. With this model, you set a price per unit within a specified range, or ‘tier’. As soon as a customer fills up one tier, the remaining units will be priced based on the next tier price and range, and so on. 

For example, API Calls

  • Tier 1: 1-3,000 API Calls for $0.30 per API call. 
  • Tier 2: 3,001-7,000 seats for $0.20 per API call. 
  • Tier 3: 7,0001-10,000 seats for $0.10 per API call. 

If you sell 10,000 seats, you calculate your total like this: (3,000 x $0.30) + (4,000 x $0.20) + (3,000x $0.10) =  $2,000 

Pros: By offering a reduced price per unit range, a tiered pricing model gives customers an incentive to buy more and increases upsells. It anchors the first tier price point, and gives a ‘discount effect’. It also gives your customers the option to pick and choose what fits their budget and needs. 

Cons: Tiered pricing can be confusing and difficult for customers to understand. This can lead to invoice disputes, so you need to make sure your invoices are crystal clear. 

*Note: There's no pricing dictionary, and sometimes definitions get mixed up. Often, 'tiered pricing' is confused with 'stair step pricing' (which we explain below). When choosing your pricing model, make sure your team's definitions are aligned.

Volume Pricing 

The volume pricing model is similar to the tiered model, but has a simpler approach to calculating final price per unit. Similar to  the tiered model, the volume model also offers customers a reduced price as consumption grows. The price calculation is simpler though. Volume Pricing mandates that the final tier price per unit is applied on the whole volume of units consumed.

For example, API Calls

  • Tier 1: 1-3,000 API Calls for $0.30 per API call. 
  • Tier 2: 3,001-7,000 seats for $0.20 per API call. 
  • Tier 3: 7,001-10,000 seats for $0.10 per API call. 

If you sell 10,000 seats, you calculate your total like this: 10,000x $0.10 =  $1,000 

Pros: Using a volume pricing model can help you maintain a competitive pricing, with a simple and easy to understand model, and appeal to a larger customer base. In addition, similarly to tiered pricing, volume pricing encourages your customers to buy more to get a better price.

Aggressively reducing unit prices would probably not optimize price, and can cause a price race to the bottom, eroding companies’ and an industry profits in the short and longer term. In addition, once you lower your price on the whole volume, you set a new (and lower) standard for your products' pricing. This can make customers object to future price increases and lower your product's perceived value.

Stair Step Pricing 

Stair step pricing provides customers with a fixed price per usage range, or 'step'. This pricing scheme behaves like a subscription, which is determined by Usage. Consumption within each tier provides greater value to the customer, since the step price happens on the first marginal unit consumption. 

For example, API Calls

  • Tier 1: 1-3,000 API Calls for $900. 
  • Tier 2: 3,001-7,000 seats for $1,700. 
  • Tier 3: 7,001-10,000 seats for $2,000

If you sell 10,000 seats, you calculate your total like this:
Tier 3 price =  $2,000 

This model is different from the rest in two main ways: a) in a stair step pricing model the calculation is a simple single price point for the whole consumption , and not the price-per-unit; b) in stair step, the total price increases with volume, whereas in tiered and volume, the unit price decreases. Although, this can still reflect a reduced per unit price as consumption grows.

Pros: Companies that use Stair Steps enjoy better pricing clarity and less customer disputes. Stair step pricing does not require as much operational resources as more complex usage pricing.

Cons: Stair step is very crude in terms of fine tuning a price point on the demand curve, so you always over price or under price for some customers. 

While adopting a usage-based model, or moving to a hybrid pricing strategy sounds like a nightmare to implement, the truth is that with the Received billing platform, it couldn't be easier.

Our flexible, no-code pricing configuration allows you to easily build any model you want, from subscriptions to usage, while our usage tracking auto-calculates your customers' usage rates based on the logic you set.

Learn more about Received complex billing solution.