4 minute read / Mar 17, 2022 / pricing /

Usage Based Pricing: 3 Questions to Ask Before Leaping

Is charging by consumption (usage-based pricing) a superior model for a business? When we say UBP, we mean charging customers by how much they use, rather than a constant amount of seats per month or API calls per month.

On on hand, UBP lubricates the customer conversion funnel. Prospects sign up and grow their accounts seamlessly. Usage data feeds the PLG lead score, and AEs outbound to the most promising users. Customers expand as their needs dictate and customer segments fall out from usage data

On the other hand, customers may be frustrated to estimate how much of a product they’ll use and the surprise of overage charges. Separately, the startup may have to reinvent its GTM: new AE quotas, sales materials, margin calculations.

These three questions may help guide a startup to the best answer:

  1. Is my startup selling an application or infrastructure?

Application software companies sell seats. Infrastructure companies sell API calls, licenses per core or host, SMSs, bandwidth, storage by the GB. Salesforce largely set the standard for selling application seats.

Most of the time, application software companies don’t sell seats via UBP. Slack is a notable exception. Selling constant seat counts stems from the perception that the number of people using software shouldn’t change that much from one month to the next for most software. The predictability of fixed costs outweighs the benefits of flexibility.

Infrastructure usage can vary widely depending on seasonality (retail traffic spikes in Q4), developer activity (migration from one architecture to the next), new product launches, amongst other factors.

Selling UBP to a buyer accustomed to buying a flat seat count introduces more friction into the sales process. Often, the effort probably isn’t worth it, unless the company’s stated strategy is to differentiate on price structure.

  1. What should my unit of pricing be?

The goal of UBP is to align the cost of software with the value. The unit of pricing is the crux to unlocking that puzzle.

The unit must be easy for a customer to understand, simple to predict, and crystal-clear so there aren’t arguments on what a unit is or isn’t in the future.

Company Product Unit Pricing
AppDynamics APM CPU Core $6 / core / month
ScoutAPM APM API Call $1 / API call / month
Lightstep APM Service $85 / service / month
Instana APM Host $75 / host / month
Splunk APM Host $55 / host / month
DataDog APM Host $31 / host / month

Aligning on a particular unit isn’t easy. Within the same space, companies have different takes. Here’s a table of the usage-based pricing schemes of Application Performance Monitoring (APM) companies’ that I put together from scanning each business’s pricing page. There are four different units across these six companies.

Having varying units might be an advantage: it’s harder for customers to price discriminate. How many API calls per host or services per host is the same as $31 per host per month?

But it might confuse the customer who’s accustomed /ato buying the service in a different way.

Is your startup differentiating on pricing to compete with an incumbent? Or are selling a superior product at a premium in which case using the same pricing model with higher fees reinforces the brand?

  1. Can this pricing model achieve certain boundary pricing conditions?

How much should a Fortune 500 bank pay for your startup? How about a 50 person SaaS company?

The UBP pricing scheme needs to satisfy these boundary conditions: a certain customer ought to pay a certain amount in order for the business to succeed.

Often, a straight UBP pricing model doesn’t scale into the enterprise. A F500 may not consume enough units to justify a $250k or $2m deal. Introducing pricing layers on the unit of pricing can remedy this challenge. Basic units cost $1. Units that are HIPAA compliant cost 3x as much and FINRA compliant is one dollar more per unit.

Sometimes, companies add a second part to the UBP model: the platform fee, which makes the UBP a 2-part tariff. The platform fee instant boosts the ACV ad can be tailored per customer segment

One other thought on UBP. Some customers fear the sticker shock of dramatic usage in the first billing period. To offset this risk, many sales teams cap the charge in the first billing period to ensure customers who sign up and use substantially more of a service don’t suffer sticker shock when the first bill arrives.

Thanks to Barry McCardel for the inspiration on this post.


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Guess the Startup Answers