Consumption-Based Billing

What is Consumption-Based Billing?

Consumption-based billing is a billing model where a business charges customers based on usage amounts, rather than a flat rate. Cloud services and certain types of SaaS companies favor it because it offers flexibility for customers, who can scale their usage up or down based on their current needs.

Consumption-based billing works by tracking and measuring a customer’s product or service usage. This can be done through various methods:

• Metering (tracking usage in real-time)
• Monitoring (monitoring and reporting on usage)
• Resource pooling (allocating a certain amount of resources for usage)
• Tiered pricing (charging customers based on different levels of feature access)

In consumption-based pricing models, there’s a set price per “unit” of usage. For example, Uber charges per mile or minute, and AWS charges per GB of data storage or per hour of server usage. Customers only pay for what they use, rather than a predetermined rate.

Synonyms

• Pay-as-you-go billing
• Usage-based billing
• Metered billing

Importance of Consumption-Based Billing

Benefits for Businesses

When businesses implement a consumption-based model, they have less difficulty relating the costs and benefits of using a product to its users. This helps to create a sense of value, as customers are only paying for what they actually use instead of a flat rate that may not align with their usage needs.

The ability to uniquely adapt to customer usage patterns at the individual level has plenty of other perks for businesses:

• Higher rates of customer satisfaction and loyalty
• Greater revenue potential over time as customers increase usage or scale up their services
• Enhanced agility when setting, testing, and improving pricing strategies
• Increased transparency through clear usage metrics and billing data
• Ability to analyze and understand customer usage trends for improved personalization and product development

Benefits for Customers

In industries where fluctuating consumption patterns are commonplace, a consumption-based model is the fairest option for customers. Since costs go up only when they use more, there’s a clear correlation between value delivered and payment made.

There are several advantages to this:

• Understandable costs that translate directly to usage volume
• Low barriers to entry as customers can start out with low usage
• Greater control over budgeting and spending
• No hidden or surprise fees
• Increased flexibility and scalability
• A more personalized product experience

Considerations for Consumption-Based Billing

Implementing a consumption-based model is quite difficult without the right tools. Accurate billing according to usage metrics requires sophisticated software that can monitor, track, and measure usage levels for thousands of customers. 

One-time purchases or fixed subscriptions might make more sense depending on the type of business you’re running. If your customers frequently have high or consistent usage, a standardized approach will probably align with their needs and your value prop more effectively. For instance, people might pay per X,000 marketing contacts, but they’d never do the same for CRM storage.

Even if usage-based billing is the ideal model for your company, you’ll probably need to establish a “baseline” for services. For example, HubSpot’s Marketing Hub starts at $800 for its Professional tier, which includes 2,000 marketing contacts. As you purchase more contacts, you’ll pay an added fee.

When you’re constantly collecting customer data, there are also privacy concerns. Be sure to review laws and regulations around collecting, storing, and managing personal data. Since consumption-based models are designed to track individual usage over time, make sure you’re transparent about what data you collect and why, as well as how you protect it.

Types of Consumption Billing Models

The billing methods you’ll potentially use are practically the same as consumption-based pricing models.

Let’s dive into some common types of consumption billing models:

Simple Pay-As-You-Go

Pay-as-you-go pricing is the most straightforward model — you’ll bill customers based on the exact amount of resources or services they use. It’s commonly seen in utilities like water or electricity but is increasingly applied in cloud services and SaaS products.

Example: Snowflake uses a PAYG model, where you only pay for the storage and compute power your data consumes. It’s a flat rate per terabyte, based on average usage for the month.

Tiered Usage Model

Fundamentally, tiered usage works just like tiered pricing. In this model, usage is bracketed into a few different levels. The price per unit changes depending on the tier. For instance, the first 1,000 units could cost $1 each, the next 1,000 $0.90, and so on. This model can encourage higher usage as the unit cost decreases with volume.

Example: Mailchimp uses a tiered usage model for its marketing contacts. When you purchase 5,000 credits, each one costs $0.03. If you were to purchase 100,000, they’d cost $0.015 each.

Volume-Based Pricing

This is similar to tiered pricing, but instead of distinct tiers, prices are set based on usage volume brackets. Customers pay according to the bracket their usage falls into, encouraging larger purchases for better rates.

Example: AWS uses volume-based pricing for its S3 storage service. Customers pay $0.023 per GB for the first 50TB of usage, but prices decrease as usage volume increases.

Hybrid Billing Model

If your billing platform supports hybrid billing (it should), it’s possible to combine different models as you see fit for your business. For instance, customers may pay a flat monthly fee for a baseline level of service, with additional charges based on usage over that amount.

Example: Marketing automation software vendors use a combination between flat-rate and usage-based billing by charging a baseline monthly fee, plus usage-based access to features and marketing contacts.

Overage Charges

Customers sign up for a base usage amount, and if they exceed this amount, they are charged additional overage fees. It works when your standard plan is a flat-rate subscription, but you don’t want customers to have to upgrade their plan for occasional or short-term overages. 

Example: AT&T sells multiple different data plans for its mobile service. If you exceed your monthly data allotment, you pay $10 per extra 50GB up to $100.

Freemium to Premium Upsell

The freemium model offers a basic service level for free, with the option for users to pay for additional features or increased usage limits. It’s a popular strategy software companies use to attract new users and convert them into paying customers over time.

Example: Dropbox offers a free version that limits storage and features. Users can then upgrade to one of its premium plans for more space, sharing features, and security options. 

Credit/Packaged Units

Customers purchase a pack of credits or units in advance and then consume services against this balance. This can streamline billing and provide predictability for both provider and customer, though it requires customers to estimate their future usage accurately.

Example: When you purchase iCloud storage, you can either pay $0.99 per month for up to 50GB or up to $64.99 for 12TB.

Dynamic Pricing

Prices may fluctuate based on demand, time of day, or other factors. While not purely a consumption-based model, it often complements metered billing in sectors like energy rideshare services, where resource availability and demand vary over time.

Example: Your utility company charges a higher rate for electricity used during peak hours and raises rates in the summer months when you’re more likely to use A/C.

Industries Using Consumption-Based Billing

Different versions of the consumption-based billing model have been around for decades in sectors where resources are limited or highly variable:

• Energy and utilities (water, electricity, gas)
• Telecom (mobile and landline services)
• Transportation (taxi services)
• Entertainment (movie rentals, pay-per-view TV)

Since the emergence of the subscription economy and the Fourth Industrial Revolution, there’s been a massive wave of new services and business models that have to leverage consumption-based pricing as well:

• SaaS, PaaS, and IaaS (product/feature access, usage activity)
• E-commerce and retail (shipping, storage, and inventory management)
• Digital media (streaming services, gaming)
• IoT (device usage, data consumption)
• Cloud services (storage, compute power)
• Ride-sharing apps (Uber, Lyft)

Software Used in Consumption-Based Billing

To efficiently implement consumption-based billing, you need software tools that can accurately track and bill usage. This may include:

• Subscription management — to manage recurring subscription billing, upgrades, discounts, proration, billing period changes, etc.
• Metering and monitoring software — to track usage data and activity.
• Cloud monetization platforms — to manage variable pricing models and usage calculations for 5G, IoT, and cloud services.
• CRM — for customer records and service delivery tracking.
• Business intelligence and analytics — to track usage patterns, analyze pricing strategies, and optimize pricing.
• Payment gateways and processing — to automate payment collection from customers.
• Accounting software — to manage financial records and reporting.

Future Potential of Consumption-Based Billing

Just as it has been in the past, flexibility, scalability, and alignment with customer value perception will ultimately drive the success (or failure) of consumption-based billing models. Of course, technology also plays a massive role in making these models more viable.

Let’s dive into what the future holds for consumption-based billing.

• Incorporation in diverse technology sectors. Initially popular in cloud services and SaaS, consumption-based billing is expanding across different sectors, including AI and advanced technologies, where it offers a cost-effective means to access cutting-edge tools and services.
• Sophisticated billing platforms. Companies like DealHub are continuously innovating in the billing platform space to support increasingly intricate consumption-based models. Implementing complex billing structures efficiently and accurately is only getting easier for businesses.
• Enhanced data utilization. Detailed tracking and analytics within your billing software offer invaluable insights into customer behavior. You can use them in product development, pricing strategy adjustments, and customer retention efforts.
• Economic resilience and agility. Consumption-based models provide businesses with the agility to adapt to market changes, offering resilience against fluctuating demand and economic volatility. Businesses using them will find themselves able to adjust during economic downturns much more quickly.
• Greater market penetration. As more companies adopt these models, they create competitive advantages, enabling deeper market penetration and the capture of a broader customer base, potentially disrupting traditional pricing structures and business models.

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