Billing models explained

Choosing between usage-based billing and tiered pricing can significantly impact your product’s success and customer satisfaction.

Deciding on the right pricing strategy is one of the most critical decisions for any software product. It directly influences revenue, customer acquisition, and long-term growth. Two of the most common models you’ll encounter are usage-based billing and tiered pricing. While both are popular, they serve different types of products and customers. Understanding the nuances of each will help you choose the model that best aligns with your business goals and your customers’ needs.

This guide will break down how each model works, explore their pros and cons, and help you determine which approach is the right fit for your product.

Usage-based billing and tiered pricing are two distinct models for charging customers. With usage-based billing, customers pay for what they use, while tiered pricing offers packaged features at set price points.

Usage-based billing, often called pay-as-you-go, links the cost directly to the consumption of a service. If you use more, you pay more; if you use less, you pay less. This model is common for services like cloud computing (e.g., AWS), data storage, and API calls, where the value is directly tied to the amount consumed.

Tiered pricing, on the other hand, bundles features and services into distinct packages or “tiers” with set prices. Customers choose a tier that best fits their needs and pay a predictable, recurring fee. This is the most common model for SaaS products, as it offers simplicity and predictability for both the customer and the business.

Let’s take a closer look at the mechanics of each pricing model.

This model requires a robust system to track consumption accurately. Here’s a typical flow:

1. Define the metric: First, you need to decide what you’re measuring. This could be anything from API calls and data stored to minutes of video processed or number of active users. The metric should be a clear proxy for the value a customer receives.
2. Track usage: Your system must monitor and record each customer’s consumption of the defined metric in real-time. This requires reliable and scalable metering infrastructure.
3. Calculate the bill: At the end of each billing cycle, you calculate the total usage for each customer and multiply it by the price per unit.
4. Invoice the customer: The final step is to generate and send an invoice. Since the amount can vary each month, invoices need to be clear and detailed, so customers understand what they’re paying for.

Tiered pricing is simpler to manage but requires careful consideration of how to package your features.

1. Define your tiers: You start by creating distinct packages. Tiers are often designed around customer personas, such as “Basic,” “Pro,” and “Enterprise,” and are differentiated by the features, limits, and support levels included.
2. Set price points: Each tier has a fixed recurring price, typically charged monthly or annually. This provides predictable revenue for the business and predictable costs for the customer.
3. Manage upgrades and downgrades: As a customer’s needs change, they can move between tiers. Your billing system needs to handle these transitions smoothly, including prorating charges when necessary.

Usage-based billing is a great fit for products where value is directly proportional to consumption. It’s particularly well-suited for:

• Infrastructure and platform services: Think cloud hosting, data storage, or API-first products. Customers pay for the resources they consume, which feels fair and transparent.
• Products with variable usage: If your customers’ needs fluctuate significantly, a usage-based model allows them to scale their costs up or down without being locked into a high-priced tier.
• Early-stage startups: This model can be an excellent way to attract new users, as it lowers the barrier to entry. Customers can start small and only pay more as they get more value from your product.

Tiered pricing is the go-to model for many SaaS products because of its predictability and simplicity. It works best when:

• Value is tied to features and capabilities: If your product’s value is best communicated through the features it offers, tiers are a natural way to segment your audience and guide them toward the right plan.
• Predictable revenue is a priority: For businesses that need stable cash flow and predictable forecasting, tiered pricing is ideal.
• Your target customers prefer fixed costs: Many businesses, especially larger enterprises, prefer predictable expenses for budgeting.

No pricing model is perfect. Here are some common pitfalls to be aware of.

With usage-based billing, the biggest challenge is bill shock. Customers may accidentally use more of your service than they intended and be surprised by a large bill. To mitigate this, it’s crucial to provide clear dashboards, usage alerts, and spending caps.

For tiered pricing, the main difficulty is designing the right tiers. If your tiers don’t align with customer needs, you might find users stuck on a plan that’s too small or paying for features they don’t need. It’s important to regularly review your tiers and get feedback from customers to ensure they make sense.

Whether you choose usage-based or tiered pricing, here are a few tips to help you succeed:

• Align with value: Your pricing should always be aligned with the value your customers receive. If you’re not sure what that is, talk to them.
• Keep it simple: Don’t overcomplicate your pricing. Customers should be able to understand what they’re paying for and why.
• Be transparent: Provide clear and accessible information about how your pricing works. No one likes surprises when it comes to billing.
• Be prepared to iterate: Your pricing strategy isn’t set in stone. As your product and market evolve, you may need to adjust your model.

For businesses looking to implement flexible and scalable billing, Kinde offers a powerful solution that supports both tiered and usage-based models.

With Kinde, you can easily set up and manage your pricing plans, whether you’re building a straightforward tiered SaaS or a more complex usage-based platform. Kinde’s billing tools are designed to work seamlessly with its authentication and feature flagging capabilities, allowing you to create a cohesive and powerful monetization strategy.

• Kinde Billing
• Kinde docs