Consumption-Based Pricing: A Strategic Advantage or Hidden Risk? 

SaaS pricing is always changing, shaped by events like the pandemic, the growing influence of AI, and evolving customer needs.

In the past, companies relied on predictable pricing models like flat subscription fees or seat-based charges. These methods were straightforward and easy to manage. Then, usage-based pricing started making waves. By charging based on how much customers use specific features or services, companies can let customers pay at their own pace and potentially boost revenue from heavy users. Those who have embraced this approach often see notable benefits.

So, where does that leave us today? Is consumption-based pricing the answer to all pricing challenges that keep founders up at night? Are subscription models and usage-based pricing fundamentally at odds? Can companies thrive on a model that’s purely consumption-based?

Let’s dive into these questions and break down the basics.

What is Consumption-Based Pricing?

Consumption-based pricing, sometimes called usage-based pricing, charges customers based on how much they actually use a product or service, rather than a fixed monthly fee.

The way usage is measured can differ depending on your business. It might be based on things like API calls, AI tasks, cloud storage, translated words, or support tickets handled.

The Growth of Flexible Consumption Models

Several factors are driving the move toward consumption-based pricing:

• Automation & headless apps: As SaaS platforms increasingly automate tasks, the traditional seat-based pricing model struggles to keep up. With automation handling more functions, companies don’t need as many human seats or licenses, making this pricing model less effective. Headless apps, which operate through API calls rather than direct user interactions, face the same challenge. This disconnect can lead to undercharging customers and eroding profit margins.

• The rise of AI: The growing use of AI, including new generative AI applications and advanced language models like GPT-4, is pushing for new pricing approaches. Because the cost of these AI models is based on usage, flat fees or seat-based pricing might not always capture the value these technologies deliver. Companies need to adapt their pricing strategies to better reflect the costs and benefits of AI integration.

Benefits of Consumption-Based Pricing

• Lower barrier to entry: Compared to rigid subscription pricing models that require a revenue commitment devoid of consumption, Pay-as-you-go (PAYG) models significantly reduce the barrier to entry, making them attractive to startups.

• Pricing and value alignment: Customers pay only for what they use, satisfying value-conscious buyers. 

• Customer-centric, data-driven mindset: Usage-based monetization requires companies to meticulously track, measure, and report usage metrics, demanding strong data discipline and operational rigor. As revenue growth directly correlates with product consumption, prioritizing feature adoption and customer retention becomes essential. This makes a customer-centric approach non-negotiable for success.

• Better revenue growth and NDR: OpenView’s benchmark study shows that public usage-based SaaS companies outperform the broader SaaS Index.

Challenges of Consumption-Based Pricing

While consumption-based pricing offers many benefits, it’s important to be aware of potential risks:

• Product utilization & LTV:CAC impact: Low-intent users drawn by a pure PAYG model can result in higher Customer Acquisition Costs (CAC) due to the need for extensive marketing efforts to attract a high volume of users. Simultaneously, their sporadic engagement and higher churn rates often lead to lower Customer Lifetime Value (LTV), as these users may not generate sustained or significant revenue over time. Some customers might limit their usage to control costs, potentially reducing the value they get from the product and increasing the risk of churn. 

• Revenue predictability: Unlike subscription models with fixed recurring revenue, consumption-based pricing can lead to more variable income, making financial forecasting and planning more complex.

• Customer budgeting: Predicting and budgeting for variable costs can be difficult for customers whose usage fluctuates significantly. 

• Infrastructure requirements: Implementing consumption-based pricing requires robust metering and billing systems. 

• Pricing communication: Explaining consumption-based pricing models to customers can be more nuanced than straightforward subscription plans. Clear communication and transparency are key to overcoming this challenge.

• Cash flow management: Particularly for postpaid models (where the customers scale without restrictions and pay for aggregated usage after the fact), there may be a delay between service usage and payment collection. This requires careful cash flow management.

When considering consumption-based pricing, it’s crucial to weigh these challenges against the benefits, such as improved alignment with customer value, potential for higher revenue from power users, and increased flexibility for customers. 

The Myth of Pure Consumption Pricing

It may seem like you need to choose between usage-based and recurring revenue models, but the concept of pure consumption pricing is largely a myth. In reality, many successful brands blend elements from both models.

By integrating recurring revenue streams with usage-based pricing, subscription companies can find a balance that addresses some challenges of solely consumption-based models. This strategy enables stable revenue while maintaining the flexibility and customer value alignment that consumption-based pricing offers.

DeepL: Persona-based pricing

DeepL, a leading global Language AI company and a Chargebee customer, exemplifies a tailored approach to pricing. For its API product, which provides translation services via API, DeepL employs a pay-as-you-go rate (e.g., $25.00 per 1,000,000 characters). This model makes sense because seat-based pricing would undercharge high-volume customers, potentially hurting the company’s bottom line.

In contrast, for its ‘DeepL Translator‘ product, which is used directly by human users, the company opts for per-seat pricing. This approach offers the predictability that individual and business customers often expect from software tools.

DeepL effectively captures value across its diverse product offerings by adapting its pricing strategy to different user segments.

Zapier: Pricing based on core value metric and usage complexity

Zapier, renowned for automating business processes, employs a sophisticated pricing strategy beyond simple seat-based or task-based models. While the number of automated tasks is a core value metric, Zapier doesn’t rely solely on this measure. Instead, it blends task-based pricing with subscription tiers, where higher task volumes lead to a reduced cost per task.

Additionally, Zapier charges a standard subscription fee for each pricing tier, accounting for the complexity of usage. This includes multi-step workflows, enterprise support, and other advanced features.

This hybrid model allows Zapier to capture the value delivered through task automation and the broader platform capabilities, ensuring fair monetization across different user needs and usage patterns.

Comparing AI pricing models: OpenAI, Intercom, and Loom

Since AI companies must pass on costs incurred to provide AI services, consumption-based pricing may seem the default choice for all AI platforms and AI-enabled software companies. But again, there’s no one-size-fits-all approach here.

• Since OpenAI’s value is directly tied to the consumption of tokens (pieces of words used for natural language processing), it follows a unit price for a specific volume of tokens. For example, GPT-4o is priced at $5.00 per 1M input token. 
• Intercom charges for its ‘Fin AI’ chatbot based on the number of tickets resolved ($0.99 per resolution)—a classic consumption-based model. However, it retains seat-based pricing for human agents to accurately capture the value delivered across its product ecosystem.
• Loom AI takes an entirely different approach. Rather than charging per AI-generated action, it offers its AI services as a $4/creator/month add-on. This pricing model encourages usage without users worrying about increasing their bills, avoiding the risk of customers switching to alternative AI tools due to cost concerns.

Choosing the right way to price based on usage is crucial for success. A pure usage-based pricing model may not always be the best choice and can even be counterproductive if not used correctly.

However, if there are some aspects of your product that you can monetize based on usage, you can make that part of your overall pricing strategy, which brings us to hybrid pricing.

Hybrid Pricing: Combining the Best of Both Worlds

Hybrid pricing combines usage-based and subscription pricing. This means you get the predictability of a subscription along with the flexibility of paying based on how much you use. By using both approaches, you can improve your pricing strategy and benefit from the strengths of each model.

How to Make the Most of Your Consumption Pricing

As you adjust your pricing strategies to include usage-based billing, choosing the right billing vendor is crucial for your financial operations. Here are some important factors to consider:

• Product catalog flexibility:  Your pricing and packaging will change over time, so you need a billing system that can adapt. This means it should handle various pricing models—whether you’re using fixed or usage-based charges, one-time or recurring fees, or trial and freemium options. 

• Accurate billing: Your metered billing system should accurately track usage and turn it into precise billing information. It should also automate tasks like syncing financial data with your accounting and revenue systems, no matter what strategy or revenue streams you use.

• Speed to market: It is uncommon to get pricing and packaging perfect on the first try. Your success depends on how quickly you can make and test price changes compared to your competitors.

• Integrations: Your billing system, being the source of truth for revenue data, needs to work smoothly with your CRM, payment processors, tax tools, and accounting systems to avoid data silos and ensure consistency.

Key Takeaways

• Consumption pricing has seen rapid and widespread adoption as it aligns pricing with the value delivered to customers, lowers the barrier to entry, and offers flexibility to customers.

• Embracing consumption-based pricing doesn’t have to be an all-or-nothing decision. While pure consumption models work well for infrastructure companies like AWS or Snowflake, they may not suit every subscription business. 

• With a hybrid pricing approach, you can mix usage-based and subscription pricing. This allows you to maintain predictable revenue while offering customers the flexibility to pay based on their usage as their needs grow.    

• Choosing the right billing provider is crucial to the success of your consumption pricing model. 

Chargebee is the leading Revenue Growth Management (RGM) platform for subscription businesses. Our mission is to help businesses of all sizes grow their revenue by providing a comprehensive suite of solutions, including subscription management and recurring billing, pricing and payment optimization, revenue recognition, collections, and customer retention.

Chargebee is trusted by businesses of all sizes, including Freshworks, Brevo, and Study.com. We are proud to have been consistently recognized by our customers as a Leader in Subscription Management on G2.