Usage-Based Pricing Guide

For SaaS and Cloud Computing

Why Usage-Based Pricing?

Superior Economics

Usage-based pricing has become a popular theme in the venture capital community over the past few years.  Investors love business models powered by usage-based pricing because of the strong financials posted by publicly traded cloud computing vendors that have adopted this approach. Providers such as Snowflake, Twilio, Datadog, and Digital Ocean have demonstrated above average performance on financial KPIs such as Net Dollar Retention and annualized revenue growth.

Usage-based pricing is used by all of the major cloud computing providers including Amazon Web Services, Microsoft Azure, Google Cloud Platform, and Oracle Cloud for their infrastructure-as-a-service offerings.  Usage is the de facto model for cloud-based services such as compute, storage, database, AI/ML, observability, search, networking, messaging, and the Internet of Things.  

cloud computing illustration

Pricing and Discounting

For Usage-Based Pricing

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The four most popular contract models for usage-based pricing are:

  • Single rate – Same flat rate applies regardless of the volume consumed in the period.  $3 per unit whether 1 unit is consumed or 1 trillion.
  • Tiered – Price X for the first n units, then lower price Y for the next n units, etc.  $3 per unit for the first 100 units plus $2 per unit for the next 100.
  • Volume – Discounted price is determined by the total volume used in the period.  $3 per unit if consuming less than 100.  $2 per unit if between 101-200.
  • Stair Step – Price increases in steps as usage grows from one bracketed range to the next.  $150 per month for 0-100 units.  $300 per month for 101-200 units.
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Contract Structures

For Usage-Based Pricing

One of the most attractive dimensions of usage-based pricing (as compared to other pricing models) is that you pay only for what you use. If you use the product only for one hour you are only billed for a single hour. If you don’t use the product at all in a month, you do not have to pay any fees. The direct correlation between actual usage and the price paid is attractive to customers, particularly as compared to a subscription pricing model in which you are billed for a full month regardless of whether you use the product each day of the month or not at all.

Many SaaS and cloud providers with usage-based pricing enable customers to sign up online for the product. There is no need to speak with a sales representative or sign a long term contract. Customers can simply create a user account, enter credit card details, and begin using the product immediately. The no contract model is commonly referred to as the “pay-as-you-go” (PAYGO) model or alternatively as a “month-to-month” account. The customer is billed for the amount they consume at the end of the month. They can cancel at any time without any advance notification or penalty.

The pay-as-you-go model is an effective strategy for new customer acquisition, but it does not scale well. Without a contract in place the customer typically does not benefit from a volume discount and is paying list price. With usage-based pricing models, consumption tends to vary month-to-month, leading to unpredictable changes in expenses and challenges with budgeting. As consumption grows, the benefits of not having a long-term contract commitment are outweighed by the disadvantages of not having discounts or predictability in expenses. As a result, most customers with a meaningful amount of usage will prefer to switch to an annual contract model.

The four most popular contract models for usage-based pricing are:

  • Prepaid Usage – Fixed number of units purchased in exchange for discount. Drawdown against balance monthly.
  • Monthly Minimums – Pay the higher of 1) minimum monthly spend commit or 2) actual usage fees.
  • Spend Commitments – Commit to dollar value of spend of usage-based services in exchange for discount.
  • Tiered Subscriptions – Fixed fee paid per month which includes a fixed number of units.  Bundled with other entitlements.
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collage of screenshots of Ordway's billing software

Ordway’s Usage-Based Billing

Optimize for revenue growth and customer experience

  • Long term contracts – Prepaid, monthly minimums, spend commits
  • Pricing  models – Flat rate, volume, tiered, stairstep
  • Billing automation – Data mediation, usage rating, invoice generation
  • Customer comms – Billing portal, real time alerts, usage data exports
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