Many very smart people have been writing and talking about usage-based pricing lately. Quite honestly, I was confused. I’ve done a lot of reading on this topic and it seems that usage-based pricing is a subset of your range of possible pricing metrics.
First, usage-based pricing means to charge for the use of your product. Instead of an all you can use subscription model, charge based how much someone uses. By the way, this is what you do when you go to McDonald’s. They charge you for a hamburger, which you eat. That’s usage-based pricing. In the more recent tech world, Uber and Lyft have usage-based pricing. But taxis have always had usage based pricing.
So why the big push? I think it’s a response to the push into subscriptions. If you define subscription as paying the same amount each period for access to a product, then by that definition it doesn’t matter how much you use it. If you subscribe to a magazine, it doesn’t matter if you read it cover to cover or never open it. Your usage was irrelevant.
But it makes sense that someone who reads a magazine cover to cover probably gets more value than someone who rarely reads it. That heavy user would probably pay more. What if the magazine could charge based on the number of articles you read? It makes sense.
But what about long distance phone calls. Do you remember when phone companies used to charge by the minute? That was usage-based pricing. Now they bundle unlimited long distance with their rates. According to this push for usage-based pricing, they went backwards.
In my book, Win Keep Grow: How to Price and Package to Accelerate Your Subscription Business, I talk about three value levers, one of which is your pricing metric. A pricing metric is what you charge for. A great pricing metric should be closely tied to how your buyers receive value. That is exactly what usage-based pricing should do. The more a customer uses, the value they get, the more they pay.
But there are more pricing metrics than usage-based. In the above definition of subscriptions, the pricing metric is simply the number of users. In usage-based pricing, the pricing metric is some measure of how much the customer uses your product. Which is better?
The subscribed Institute recently did a study that showed that companies that derive 25% of their revenue from usage and the rest from subscription grow the fastest. To do this, a company needs more than one pricing metric.
My advice, read about usage-based pricing. It’s an important subset of the pricing metrics you may choose to use. Then, when it’s time to create your pricing model, think about the range of possible pricing metrics. A usage-based pricing metric may be ideal for your situation … but it may not.