Launching a consumption-based pricing model: What, why, and how?
Whether you’re adding a new product or implementing usage pricing, you know you need to take action quickly—before your competitors catch up. But the data can be hard to wrangle, pricing experimentation takes too long, and you aren’t sure how to mix and match multiple pricing models.
The fact of the matter is, you know consumption or usage-based pricing is a win-win for you and your customers—if it’s done right. But how do you do it and do it fast?
Let’s start with the basics.
What is consumption-based pricing?
Consumption or usage-based pricing is a model where customers pay based on the amount they consume of a service. Examples include gigabytes of data storage, kilowatt hours of energy, or outputs from a chatbot.
This model is increasingly popular for its flexibility, allowing businesses to monetize scalable offers that grow with customer usage.
The keys to achieving growth with consumption are:
- The right tools to capture, mediate, track, and bill for usage
- Flexibility to offer a mix of usage and subscription pricing models
- Agility to quickly test and change pricing and packaging
Learn more: Guide to consumption based pricing
Why consumption-based pricing?
Consumption is fast emerging as the pricing model of choice for companies across industries, especially those developing and launching new GenAI offers. This is because the model provides good alignment with and demonstration of value to the customer.
Subscribed Institute research has shown that many of the fastest growing SaaS companies leverage a consumption-based model. In fact, the number of companies employing some form of usage-based pricing increased 9% to 26% between 2020 and 2022.
Why are these models increasing in popularity? Consumption-based pricing can be a competitive differentiator and may enable a lower cost of sale and lower barriers to entry. And when used as part of a hybrid model, consumption has been shown to contribute to higher year-over-year (YoY) annual recurring revenue (ARR) growth across all company sizes.
Benefits of consumption-based models
The following are some of the top reasons consumption or usage-based pricing models could be a good option for your business:
- Customer-centric approach: Provides transparency and aligns costs with value, enhancing customer satisfaction and loyalty.
- Differentiated value proposition: Helps your offer stand out in the crowd by using value metrics tied to actual usage or outcomes.
- Flexible and scalable growth: Lowers barriers to entry, letting customers start small and scale as needed, which can lead to higher consumption over time.
- Recurring revenue growth: Adds predictability and helps grow recurring revenue when used as part of a hybrid model.
- Transparency and control: Offers customers real-time insights into their usage, helping them manage costs and avoid overages.
- Visibility and tracking: Empowers your sales, customer success, and finance teams with accurate, auditable usage insights.
How do you know if a consumption model is the right choice?
When deploying consumption, there are three key factors that must be considered in order to achieve recurring growth: the company and product, use cases, and pricing model.
Company and product
Consumption-based pricing models can be a powerful lever for growth, but some companies hesitate to implement them because of the perceived risks and investments involved. Building the capabilities and deploying in the appropriate situation is critical. Consider the following variables:
The tech stack
How does the entire technology stack align with respect to flexible use? For infrastructure as a service (IaaS) and platform as a service (PaaS) companies that sit on an AWS stack, usage flexibility is critical, and consumption models tend to fit well.
AWS EC2, Snowflake, and Fivetran are examples of three different technology offerings that are complementary and aligned in flexible use.
Product-led vs. sales-led growth
Pure usage-based models often work well with product-led growth because they scale naturally without the need for selling a new contract. Sales-led paradigms can work with consumption-based as well, but often are best suited for committed spend or hybrid contracts.
Fixed vs. variable economics
For products with more predictable cost of goods sold (COGS) and stable usage patterns, a recurring user-based subscription model could serve well. For products with spikes in consumption and variable costs (e.g., in some Generative AI use-cases), consumption or outcome-based models could be a better choice.
Use cases
A key insight from our data analysis reveals that most deployments of consumption-based pricing models involve some mix of usage and recurring models. Companies that succeed in their deployment often target use cases more aligned with the benefits and value they bring.
A few example use cases where consumption-based models often make more sense include:
- Spiky demand profiles (e.g., certain analytics workloads, Snowflake) where flexibility is more important than predictability.
- Seasonal businesses and industry sectors (e.g., retail technology around the holidays, accountants at tax season).
- Generative AI tools that have a variable consumption of tokens.
Pricing models
As you plan your consumption model, it’s good to know what your pricing options are. Here are just a few that you can mix and match as you fine tune your strategy:
- Pure usage: A pay-as-you-go usage model offers the most flexibility for the customer and can go to zero in a month where they don’t use the product.
- Overages: This model gives customers a certain quantity of units per billing period. Anything over this limit is charged per-unit based on the overage price.
- Minimum commitment: With this model, customers are charged at their commitment level on each invoice, even if they don’t consume the committed usage amount.
- Hybrid consumption: This approach employs a mix of both subscription and usage-based charge models for a single offering.
How to implement consumption-based pricing?
Now you know the benefits of consumption and how to choose the right model or mix of models for your business, but how do you implement usage pricing quickly and what features should you look for?
Here are the top 4 capabilities you’ll need to make your consumption model a success:
1. Price without developer intervention
- No-code pricing tools: Change pricing models or adjust price points without needing extensive developer resources.
- Automated pricing updates: Ensure that changes in pricing are reflected across all systems, including in-app purchases, eCommerce platforms, and CPQ systems.
- Data-based value metrics: Quickly track and define meters you can monetize across all of your products.
2. Offer diverse pricing models
- Usage models: Include volume, tiered, multi-attribute, or pay-as-you-go options to cater to different customer needs.
- Prepaid credits and top-ups: Allow customers to manage their budgets better by prepaying and using credits as needed.
- Discounts and trials: Introduce promotional pricing or trials to attract new users and encourage consumption.
- Hybrid models: Combine traditional subscription fees with usage-based charges to create hybrid models that offer stability and flexibility.
3. Capture, measure, and track usage data
- Automated mediation: Effectively manage the aggregation and processing of usage data, ensuring that data from various sources is normalized and accurately represented for billing.
- Scalability and integration: Seamlessly integrate usage data into billing systems and support scalability by handling large volumes of data without compromising on performance.
- Dynamic data integration: Stream usage from various sources then automatically enrich, aggregate, and deduplicate the data.
4. Analyze and optimize for growth
- Real-time analytics: Continuously monitor and analyze usage patterns to understand customer behavior and adjust offerings accordingly.
- Cost and revenue tracking: Compare costs against revenue for each pricing plan to identify the most profitable strategies.
- Experimentation: Apply different pricing plans to the same usage data to discover which maximizes revenue and customer satisfaction.
- Cross-functional implementation: Successfully roll out new pricing company-wide by consulting and planning with multiple stakeholders, such as sales and revenue accounting teams.
Take the next steps with consumption pricing
Quickly launching and scaling a consumption-based pricing model requires a strategic approach that combines flexible pricing tools, comprehensive data integration, and continuous analytics.
By leveraging advanced platforms like Zuora, companies can not only implement these models effectively but also stay ahead in competitive markets by adapting to customer needs and consumption patterns rapidly.
Learn why leading companies use Zuora to move fast and quickly add usage to their pricing mix.