Usage-Based Pricing Guide | Part 1

Pricing & Discounting Models

The Four Most Popular Models of Usage-Based Pricing and Discounting

A growing number of SaaS and cloud providers are adopting usage-based pricing strategies to power their business models.

In these usage models, the customer pays a variable amount each month based upon the quantity of service consumed. There are four popular usage-based pricing models that vary in how discounts are offered and how the monthly billing calculation is performed. These pricing models can be paired with quantity models (block aggregation, high water mark, 90% percentile) and contract structures (pay-as-you-go, prepaid, monthly minimums) to design commercial arrangements that best meet the needs of their customers.

infographic of man with magnifying glass inspecting invoice line items

ruby red square

Single rate

Apply flat rates to usage for linear pricing models

Example: The customer is billed $0.50 per transaction whether they performed 1 transaction or 1 million transactions.

Tiered

Compute charges at multiple rates for multiple tiers.

Example: The customer is billed $1 for the first 1000 units consumed, $0.50 for the next 1000 units, and $0.25 for any additional units.

Volume

Apply dynamic volume discounts based upon usage.

Example: The customer is billed if $1/unit if volume is below 1000. Above 1000, all units from 1 to n are billed at a discounted rate ($0.50).

orange stair step icon

Stair step

Tiered packages – each with a max allowance.

Example: Package A includes 500 units for $100/month. Customers of package A are billed $100/month whether they use 0, 250, or 500 units.

Single Rate Pricing

The single rate model for usage-based pricing is the simplest and most popular approach.

The single rate model goes by many alternative names such as “flat rate,” “quantity,” and “per unit.”

In this single rate model the customer pays one fixed rate per unit independent of how much they consume. The formula to compute the amount owed is simply:

Price x Quantity = Usage-Based Charge

A better description for the single rate model would be to call it a single rate tier – to differentiate it from the other usage-based pricing models which have multiple “tiers” of pricing as described below.

single rate usage based pricing chart

Example of Single Rate Pricing

For example, if the single rate was $4 per unit, the customer would pay:

  • If 100 units are consumed then the customer is charged $400 (100 units x $4 per unit)
  • If 300 units are consumed then the customer is charged $1,200 (300 units x $4 per unit)
  • If 500 units are consumed then the customer is charged $2,000 (500 units x $4 per unit)

Tiered Pricing

The tiered model for usage-based pricing offers customers an incentive to consume more by offering a discount that increases with increased consumption.

The tiered model is also referred to as graduated pricing. The calculations for tiered pricing are more complex than in other models as the price x quantity calculation must be performed for each different tier.

  • Tier 1: A “list” price X per unit is charged for the first n units.
  • Tier 2: A lower price Y per unit is charged for the next n units.
  • Tier 3: Another lower price of Z per unit is charged for the next n units. And so on.

It is rare to see a tiered model displayed on a vendor’s website. Tiered pricing is typically implemented as part of discounting strategy for a longer term contract. Discounts might be applied based upon the number of units consumed or alternatively, based upon the dollar value of the spend.

Tiered usage-based pricing

Example of Tiered Pricing

For example, assume that the vendor offers a three-tiered usage based pricing model with the rate of $6 per unit for the first 200 consumed, $4 for units 201-400, and $6 for units 401+. If the customer consumes 500 units during the billing cycle then the amount owed would be calculated like this:

  • Tier 1: The first 200 units are charged at a rate of $6/unit. The subtotal for tier 1 is 200 x $6 = $1,200.
  • Tier 2: The next 200 units are charged at a rate of $4/unit. The subtotal for tier 2 is 200 x $4 = $800.
  • Tier 3: The last 100 units are charged at a rate of $2/unit. The subtotal for tier 3 is 100 x $2 = $200.

The total price is $2,200, which is the sum of the three subtotals ($1,200 + $800 + $200).

Volume Pricing

In the volume model for usage-based pricing is similar to the tiered model, but with a different approach to calculating the amounts owed.

Like the tiered model, the volume model also offers customers an incentive to consume more by offering a discount that increases with consumption.

  • Tier 1: A list price of X per unit is charged to customers with volume under a threshold of n.
  • Tier 2: Once the customer consumes n+1 units, the price drops to Y per unit for all units.
  • Tier 3: Another lower price of Z per unit is charged once the customer reaches the next threshold. And so on.
Volume usage-based pricing charts at three different rates

Example of Volume Pricing

For example, suppose that the vendor offers three discount tiers:

  • Tier 1: If 100 units are consumed, then the customer is charged the $6 per unit rate. The price is 100 x $6 = $600.
  • Tier 2: If 300 units are consumed, then the customer is charged the $4 per unit rate. The price is 300 x $4 = $1,200.
  • Tier 3: If 500 units are consumed, then the customer is charged the $2 per unit rate. The price is 500 x $2 = $1,000.

Stair Step Pricing

The stair step model for usage-based pricing offers more predictability to customers by guaranteeing a fixed price for usage as long as it is within a certain bracketed range.

  • Tier 1: If the customer consumes between a range of minimum A (e.g. 0) and a maximum B (e.g. 200), they pay a fixed price of $X for the billing period.
  • Tier 2: The next range of between minimum B (e.g. 200) and maximum C (e.g. 400), they pay a fixed price of $Y for the billing period.
  • Tier 3: Additional tiers define additional ranges for increasing prices per month.

The stair step model operates more like a traditional subscription pricing approach, in that, the pricing is more predictable. The customer typically selects a subscription tier with a usage range that best matches their forecasted consumption during the period.

stair step usage based pricing chart with three tiers

Example of Stair Step Pricing

For example, assume that the vendor offers a three-tiered stair step model as outlined in the rate table below.
Tier 1

If the customer is in the lowest tier and

  • 0 units are consumed, the customer pays $1,000.
  • 100 units are consumed, the customer pays $1,000.
  • 199 units are consumed, the customer pays $1,000.
Tier 2

If the customer is in the middle tier and

  • 201 units are consumed, the customer pays $1,500.
  • 399 units are consumed, the customer pays $1.500.