Mon Nov 21 2022

The benefits of usage-based billing for API first products

Pay-as-you-go or similarly known as usage-based billing is a method of billing customers based on their consumption. This is inherently different from subscription services which charge a set fee to access their services (i.e. Netflix) and can bring significant value to your organization. Let’s break down some of the key benefits of introducing pay-as-you-go pricing to your users and why this pricing strategy works best for certain businesses and is not ideal for others.

Less Friction

A classic roadblock for many businesses is getting someone to pay you for your product. Once the value has been seen by the end user, they can make the justification to pay or not to pay for your service. Developers are extra keen on using a product before buying, such as using a sandbox environment. Free trial periods are great for allowing developers/users to test your product before they buy.

Free trials however have two key downsides. (1) they expire and (2) you cannot collect revenues during this period. Free trial periods eventually become a paid commitment and default to your standard pricing plans. Offering a customer a more flexible pricing model via usage-based billing options can be more beneficial.  Additionally, usage-based pricing allows you to set up a credit system with your customers. This means you bill your customers ahead of their usage and allow them to draw from this pool. This clears you of credit risk (defaults) and improves cash flows.

Metered billing boosts revenues and customer experience

To offer less friction to your customers during the sale process, offering usage-based pricing allows the end user to only pay for the services they use. If their usage is a lot, they pay for it, and during periods of less usage, they pay less. This should significantly boost the customer experience for your customers. This also allows a business to collect payment instead of offering a product for free. On the flip side, usage-based pricing should enable a business to better monetize its power users.  

Freemium

Freemium tiers are a subset of trial periods. Here you can restrict the usage of your product based on features or usage. Certain freemium tiers will only allow certain parts of the product for free and require someone to pay to use higher-value features. Freemium can also be structured around usage amounts, such as your full suite of features are free until a certain usage threshold is met.

Freemium is also great for growing your total user base and in addition to potentially growing revenues, you gain insights into what features people are willing to pay for. This can help businesses find bottlenecks or conversion problems in their product and correct course.  

Sales Engagement

Salespeople are expensive for businesses. Many products in the B2B space encourage salesperson engagement to negotiate contracts, upsell their product offerings and persuade a prospect to become a customer. Contracts are friction-heavy (commitment, back and forth process) whereas pay-as-you-go pricing is less commitment for a prospect. If they don’t use your product, they pay nothing. We spoke to a Series A company that believed the next step for growth was to offer more flexible pricing models based on pay-as-you-go pricing. Their sales team agreed this would help convert prospects into customers due to a lower barrier to entry, and thus drive more people to their product.

These new users are also acquired cheaply. Without the need for salesperson engagement and signed contracts, a business can reduce its sales and operations expenses to onboard these new users.  

Pay-as-you-go for self-serve

Another business we spoke with has been operated under a sales-led approach for over a decade. Their CFO is now planning to launch a self-serve tool that would allow new developers to test and try the product under a  pay-as-you-go model. This would allow their product to reach more hands, and ideally, developers or smaller teams would be attracted to using the platform if their commitment up front is only tied to their usage. This is low risk for the customer and should thus equal more customers willing to become users.

Another benefit of onboarding new users via pay-as-you-go pricing for a self-serve offering is the ability to grow small users into bigger users. Their sales team engages with these new users, upsell them by offering a more robust set of tools, and locks them into longer-term contracts or continues to operate via usage-based pricing, but encourages the business to grow on their tools/platform. This drives revenues.  

Variations within pay-as-you-go

Pricing can be locked at a set rate or volume, and tiered discounts can be built automatically. If we assume you are charging $1 per API call, you can create custom tiers for users that offer discounts as their usage grows. If you want to learn more about the variations of pay-as-you-go pricing, please refer to our blog post here.

Downsides

You must evaluate if pay-as-you-go pricing would drive revenues for the business. Just as gym memberships love to lock in users for a set price (as many subscribers don’t use the gym much), they can guarantee a set revenue from each customer and collect a steady stream of money. I would argue this is an unpleasant customer experience for someone who is paying for the service and not getting at least the value they are paying. Be careful about this!

Another downside is many enterprise organizations will NOT want to pay based on consumption, but may instead negotiate a set price to help with their budgeting practices. We have chatted with some API-first orgs that sell exclusively to enterprises and ALL are hyper-focused on integrating with services at set annual pricing to help budget cash flows. SMB and individual consumers are more welcoming to paying based on their consumption. One conversation we had with a later-stage API-first company that had surpassed the 100mmARR mark shared their resistance to using outside vendors under a take-rate model. A solution such as an Archetype to take even 1% of their total revenues would be far too expensive and financially unpredictable for the business. They explicitly asked to be quoted on a fixed, annual contract. We have seen that other later stages co’s are similar.    

Overview

Usage-based billing is attractive for many reasons. If you are offering a product that people love and continue to use, you will collect revenue from Day 1. Usage-based billing (pay-as-you-go) has the benefit of being highly flexible, sticky, and correlated to your customer's revenues. As they grow, you grow.

If you would like to see how easy and quickly you can launch PAYG for your API product, DM us on Twitter @getarchetype or email our Head of Growth, Ben at ben@archetype.dev for a demo.

We would love to chat!

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