What is consumption billing? All SaaS companies need to know

It’s impossible to miss — if you’ve been in the business of building or purchasing SaaS products long enough, you’ll notice a major trend has started to catch on:

Both big-league and scale-up SaaS companies are switching to consumption billing. 

Now, you might be thinking, “What about monthly subscriptions?” 

The truth is that while monthly subscriptions are fine for companies just starting out if you really want customers to grasp the full extent of your SaaS product’s value — and boost your company’s revenue — it’s time to start charging based on consumption. 

With that in mind, here’s what we’ll cover in this article:

• What is consumption billing?
• Types of consumption billing models
• Consumption vs usage billing models: differences and similarities 
• Why do SaaS companies switch to consumption billing?
• Consumption billing: pros and cons
• Recommended next steps 

What is consumption billing?

Consumption billing is a dynamic pricing model that charges your customers based on their actual usage of your SaaS product. Unlike traditional flat-rate models, it offers flexibility and fairness by aligning costs directly with consumption levels. 

The next logical question would be, "If it's so good, why aren't all SaaS companies implementing it?" 

The answer lies in the challenges of accurately tracking usage and managing complex billing systems. Moreover, some customers favor predictable billing, making this model a better fit for specific markets and product types outside the realm of SaaS

Types of consumption billing models

Unit-based pricing

With unit-based pricing, customers are charged a fixed price for each unit of consumption.

• Example: a cloud-based API service might charge $0.01 for every API call made, allowing customers to correlate their costs with their usage directly.

Pay-as-you-go pricing

Pay-as-you-go billing charges customers based on usage but with the added flexibility of variable pricing that can adjust for factors like demand or time of use. 

• Example: a project management tool could charge based on the number of active projects, allowing businesses to scale their costs with their current needs.

Tiered pricing

Tiered pricing groups together certain usage amounts into packages at different price points.

• Example: a SaaS company might choose a three-tier approach: 0-100 API calls could be $50, 101-500 calls $100, and 501+ calls $200. 

Volume-based pricing

Volume-based pricing charges customers based on the total amount of service or product used, often with rates that decrease as usage increases.

• Example: a data storage provider may charge $0.10 per gigabyte for the first terabyte of storage, but reduce the rate to $0.08 per GB for any storage beyond that.

Minimum pricing with overage 

Some companies implement a minimum monthly charge along with overage fees for usage beyond a certain threshold. 

• Example: 500 API calls may be included for $200/month, with an overage charge of $0.30 per additional call. 

Flat-rate pricing

A flat-rate pricing model offers unlimited usage of a service or product for a fixed monthly or annual fee. Flat rates often work best when usage and costs are predictable.

• Example: an online graphic design tool might offer unlimited access to its features and resources for a flat rate of $99 per month.

Threshold-based pricing

Threshold-based pricing sets specific usage levels or thresholds, with the price adjusting based on crossing these predefined limits.

Key distinction: Unlike minimum pricing with overage, which combines a base fee with charges for additional usage, threshold-based pricing shifts to a new pricing tier once a usage limit is exceeded.

• Example: a mobile app hosting service charges $50/month for up to 10,000 sessions. Exceeding this, the plan automatically upgrades to $75/month for up to 20,000 sessions.

Rollover pricing

Rollover pricing allows customers to carry over unused portions of their service allocation into the next billing period, preventing waste and maximizing value. 

• Example: a SaaS tool for social media management might include 100 scheduled posts per month. If a customer only uses 80 posts in one month, the remaining 20 can roll over, giving them 120 available posts for the next month.

Time-based pricing

Time-based pricing involves charging customers based on how long they access a service, with options like monthly or weekly billing.

• Example: a VPN provider offers subscriptions at $9.99 for one month of unlimited data usage, suitable for travelers needing short-term, secure internet access.

Consumption vs usage billing: Are they the same?

Consumption billing and usage-based billing are often used interchangeably, but some subtle differences set them apart.

How are they similar?

• Both models charge customers based on their consumption or use of services and products.

• They offer flexibility, allowing customers to adjust their usage and expenses according to their needs.
  ‍
• Each requires precise tracking systems to measure customer usage accurately.

How are they different?

• Consumption billing is typically linked to the measurable amount of resources consumed, such as gigabytes of storage or hours of server time.

• Usage-based billing, being broader, considers various metrics like volume, time, transactions, and access to features for billing.
  ‍
• Consumption-based billing is often preferred for resource-intensive services like cloud computing, whereas usage-based billing finds application across a wider array of industries, catering to a broader range of billing metrics.
  ‍
• The scope of usage-based billing extends beyond mere consumption, accommodating different aspects of service usage, including the number of users and the level of service access, in its pricing strategy.

Why do SaaS companies switch to consumption billing?

SaaS companies that have been around the block for some time are making the switch. The reason behind such an uptick in this billing model’s popularity rests on three key pillars. 

Improving high-demand customer monetization

Picture this: Your most active customers are using your SaaS product day in and day out, pushing the boundaries of what's considered "high usage."

This is bad news, as costs might plateau due to bulk discounts or capped pricing, leaving potential revenue on the table.

Switching to a consumption billing model flips the script by ensuring that high-demand customers contribute more to your bottom line while being fair to those who use your SaaS product less intensively. 

Offsetting increasing costs

Imagine a situation where every new customer, every additional query, every extra API call means dipping deeper into your resource pool. 

For businesses that offer an AI-based product — where each API call done by your customers means using up more credits from your LLM provider (which costs you money) — the traditional flat-rate pricing model won’t cut it. 

By aligning costs directly with usage, consumption billing ensures that as your customers' demands grow, so does their contribution to covering incremental operational costs. 

Reflecting actual value 

Consumption billing allows you to tie pricing more closely to the value your customers are gaining from the product. 

More and more customers are choosing to only pay for what they need and use. The reason behind this is simple: Scalability.

By going the consumption billing route, companies can offer customers the option to seamlessly adjust their usage (and spending) in alignment with their needs and the actual value they derive from the service.

Consumption billing: pros and cons

Though it might sound tempting to make the switch right away, consumption-based billing has advantages and drawbacks you’ll want to weigh carefully. 

Pros

• Flexibility for customers: Allows scaling of services and costs directly with needs, giving customer satisfaction a huge boost.
  ‍
• Better value communication: Directly ties cost to usage, making the value of services transparent and building trust.
  ‍
• Higher revenue potential: Choosing this model helps businesses generate more revenue from high-usage customers, capturing a SaaS product’s full value and monetizing it. 

Cons

• Higher operational costs: Requires sophisticated systems for tracking and billing, which can be costly to implement and maintain.
  ‍
• Revenue unpredictability: The model can lead to variable monthly revenues, something that might hinder financial planning and operational management.
  ‍
• Potential for customer dissatisfaction: Customers with lower usage might feel they're getting less value, especially if minimum charges apply.

In sum

So, upon learning all about consumption billing for SaaS companies, you’ve decided this is the right model for your business. 

Now what?

Next steps 

The next step is finding the right technology to actually implement it. 

This is where Orb comes in. 

Orb is a billing platform built specifically for businesses looking to implement usage-based pricing models.

It handles the entire billing process so you don’t have to.

For consumption billing, Orb makes it easy to define metrics, set prices for those metrics, and charge customers based on their actual usage of your service.

Some of the key features that make Orb ideal for consumption billing include:

• Usage metering: Orb enables defining chargeable metrics (API calls, storage, user count) and tracks customer usage in real time for accurate billing.
• Pricing flexibility: Offers control over metric pricing, including tiered rates, customer segment differentiation, promotions, and on-the-fly changes with automatic prorating.
• Billing automation: Automates billing cycles, handling overages, prorated changes, and price adjustments without manual calculations or invoice generation.
• Revenue recognition: Ensures compliance with ASC 606 and IFRS 15 for consumption billing, providing detailed usage and invoicing data for accurate revenue reporting.
• Scalable solution: Orb supports high-volume and complex pricing models, offering technology and support for a smooth transition to consumption billing.

Learn how Orb can help you execute a successful, hassle-free consumption billing solution.