The Ultimate Guide to Understanding the SaaS Consumption Model
As a SaaS founder, you know that understanding your consumption model is the foundation of scaling and optimizing your business. Without an in-depth knowledge of how customers use and pay for your product or service, it’s difficult to make informed decisions about growth strategies.
With this ultimate guide to the SaaS consumption model, we aim to provide entrepreneurs with key insight into its advantages and disadvantages.
We’ll start by outlining the core components of a SaaS consumption model, then compare it with the SaaS subscription model, and finally, help you decide which approach is right for your business.
What is a SaaS Consumption Model?
The SaaS consumption model (also known as usage-based pricing) is a pricing model used by SaaS businesses to charge customers based on their usage of the service.
It’s an alternative to subscription-based pricing, where customers pay a set fee each month or year regardless of their usage.
3 Main Components of a Consumption Model
The metered billing of a SaaS consumption model involves the customer being billed for the usage of resources on a periodic basis, such as a monthly or quarterly basis.
In this system, customers are billed for the exact amount of resources they use, which can help them manage their budget and usage more effectively.
In a consumption-based pricing model, mediation is the process of monitoring resource usage and ensuring that customers are billed correctly for their usage. This helps ensure that customers pay only for the resources they consume.
In addition, mediation can also help identify areas where customers may be over- or under consuming resources and adjust their pricing accordingly.
The billing component of a consumption-based pricing model involves collecting payments from customers based on their usage. This includes setting up payment gateways, processing payments, and issuing invoices to customers.
A great example of a company using a consumption-based pricing model is Amazon Web Services (AWS).
You can try out the AWS tools without any cost until you start processing and storing data, at which point AWS will send a metered bill at the end of the month for all resources consumed.
This is a user-friendly approach that allows customers to only pay for what they need and not be locked into long-term commitments or fixed fees for services they may not frequently use.
Common items billed through consumption model
- Compute or CPU: The amount of compute or CPU usage utilized by the customer
- Memory: The amount of memory used to store and process data
- Storage: The amount of storage space used to store files and data
- Network: The amount of network bandwidth used to transfer data
- API Calls: The number of application programming interface (API) calls made to the service
- Users: The number of users utilizing the service
- Transactions: The number of transactions made within the service
- Additional Services: Any additional services provided by the SaaS vendor
- Data transfer: The amount of data transferred from the service
- Credits: Credits for the usage of any features or services provided by the SaaS vendor
Pros of a SaaS Consumption Model
1. Increased Customer Lifetime Value
The consumption pricing model can help to increase your customer lifetime value (CLV).
CLV is a measure of the total value that a customer will bring to a company over the course of their relationship with the company.
Since the model allows you to bill customers based on their actual usage, it can help to increase CLV as customers are only paying for the value that they are receiving. As a result, customers will have an incentive to continue using the product and are less likely to churn.
2. Reduced Churn Rate
Churn is the percentage of customers who cancel their subscription or do not renew their contract within a given period of time.
The consumption pricing model can help to reduce churn by aligning the interests of the customer and the SaaS provider, as customers are only paying for the service when they are using it.
3. Improved Cash Flow
Cash flow is the amount of money that is flowing into and out of a business.
The consumption pricing model allows you to bill customers in advance for their usage, which can help to ensure that there is always money coming into your SaaS business to cover costs.
1. Can Be Difficult to Predict
One of the primary disadvantages of this model is that it can be difficult to predict the extent to which customers will use your SaaS product. This can make it difficult to set pricing that is both fair and profitable.
This also makes it challenging to budget and forecast revenue accurately.
2. Requires More Active Management
This model also requires more active management than other pricing models.
For example, you will need to closely monitor usage levels and make sure that customers are not being overcharged or undercharged.
Additionally, you will need to have a system in place for handling overages and billing disputes.
3. Can Be Expensive for Customers
It can be expensive for customers, especially if they unexpectedly increase their usage.
This pricing model can also be confusing for customers, as they may not understand how their usage will impact their bill.
As a result, it is important to make sure that your customers are fully aware of how your pricing works before they sign up for your service.
4. May Not Scale Well
The consumption-based pricing model may also not scale well as your business grows.
For example, if you have a large number of customers with high usage levels, you may need to hire additional staff to manage billing and customer service issues.
Additionally, if you experience rapid growth, it may be difficult to keep up with demand and maintain accurate usage data.
5. Requires Upfront Investment
Lastly, the consumption-based pricing model requires an upfront investment in infrastructure and staff in order to manage billing and customer service issues effectively.
This upfront investment can be costly and may not be feasible for all businesses.
The Consumption Model Vs The Subscription Model
The consumption model vs. the subscription model is a debate that’s been rumbling on for some time.
On the one hand, you have the consumption model which allows customers to buy needed services or products on an ad hoc basis as and when the need arises, this is ideally suited to those who want short-term access to services.
On the other hand, there’s the subscription model. This allows customers to pay for an ongoing service or product that is in continuous use, often with discounts and additional benefits. This model is suited to those who require long-term access to SaaS tools.
So which SaaS pricing model should you choose? Ultimately it comes down to the needs of your customer base, as each pricing model offers its own set of advantages and disadvantages.
Here are some factors to consider:
- Do my customers need to use the services for a long period of time?
- Is the SaaS product and the services that come with it likely to change?
- Does usage vary significantly from customer to customer?
- How much upfront investment can you make in setting up the pricing model and managing billing issues?
- Are customers expecting a certain pricing model?
- What does my SaaS product offer that makes it different from competitors’?
Ultimately, the decision comes down to your individual business needs. It’s important to understand the pros and cons of each pricing model before you make a decision. Take the time to consider customer preferences, usage patterns, and financial investments before settling on a particular SaaS pricing model. This will ensure that you can maximize the revenue potential of your SaaS product and offer customers a pricing model that works best for them.
When Should You Shift to Consumption Pricing Model?
Moving away from traditional subscription-based pricing models for SaaS businesses to consumption-based pricing can provide more accurate cost structures and help save customers money.
This shift should occur when customers demonstrate a high level of usage and the infrastructure is mature enough to handle that capacity, as well as when there are multiple customer segments needing different levels of usage at different prices.
Making this switch requires careful consideration to not only think about a customer’s specific needs and their use cases but to also identify solutions that accurately reflect upgrades or downgrades in demand.
Without an advanced billing system in place, offering consumption-based pricing models may be challenging – but it’s important to evaluate where this model makes sense if companies want to maximize value for customers without sacrificing profitability.
Who Benefits The Most From a Consumption Model?
Consumption-based pricing models can work particularly well for companies that offer digital tools and services with fluctuating levels of usage, such as medical imaging firms that need to scale up or down their usage depending on demand in the market.
SaaS companies that provide content management tools and services can also benefit from this type of pricing model because users only need to pay for the specific services they need during certain periods of time.
On the consumer side of things, it is perfect for any individual or organization that wants to pay based on their actual needs at any given moment in time, rather than settling for a one-size-fits-all subscription fee.
Ultimately, the consumption pricing model enables SaaS companies to build a more cost-effective SaaS business that has scalability for changing capacity requirements.
SaaS consumption models are a great way to not only boost ROI but also increase LTV and customer satisfaction.
In order to get the most out of this model, make sure you understand how customers will use your SaaS product and what their needs are.
Use this information to segment your user base and create different plans that cater to each type of customer. And finally, don’t forget to regularly review your consumption model so that it can continue to evolve with your business.
Note though that this model is not for everyone. Each SaaS business is different and understanding what pricing model is right for your SaaS company should be based on a careful evaluation of factors such as customer needs, cost of goods, and economic factors.
If you’re considering shifting to a consumption-based pricing model for SaaS businesses, make sure that you understand all the implications and that you have a plan in place to manage customer expectations.
For more tips on growing your SaaS company, be sure to visit our blog.