Ash Rust Highlights 3 Major Risks of Usage-Based Pricing for Startups

Ash Rust, a prominent serial entrepreneur and General Partner at Initialized Capital, recently took to social media to outline three significant risks associated with usage-based pricing (UBP) models for startups. While UBP is gaining traction, particularly within the SaaS sector, Rust's insights underscore critical challenges for both businesses and their customers.

"Lots of startups begin with usage based pricing because it seems the simplest on paper. Here are the problems: 1. Unknown price. Usage based pricing actually creates a good deal of uncertainty as customers can only estimate how much your service will cost over a year. 2. Revenue Volatility. If a customer turns off your service for a week, that means a 25% drop in their monthly payment. 3. Missed Revenue. Usage based pricing also costs you revenue, as tier based pricing allows you to charge for certain features," Rust stated.

The first risk, "Unknown price," points to customer dissatisfaction and potential churn due to "sticker shock." Customers struggle to accurately forecast their annual expenditure, leading to budgeting difficulties. Experts suggest mitigating this by offering transparent cost previews, real-time usage dashboards, and spend caps, as seen with Amazon Web Services (AWS) implementing limits after initial customer outrage over unexpected bills.

Revenue volatility presents a substantial challenge for providers, impacting financial forecasting and stability. Unlike predictable subscription models, UBP revenue can fluctuate significantly based on customer usage patterns. This necessitates robust data science and forecasting capabilities to account for seasonal changes and other unpredictable factors.

Finally, Rust highlighted "Missed Revenue," arguing that UBP can limit a company's ability to monetize features effectively compared to tiered pricing. Hybrid pricing models, which combine a base subscription fee with usage-based charges for premium features or overages, are emerging as a popular solution. This approach provides a predictable baseline for vendors while offering customers flexibility and aligning costs with value.

The shift towards UBP is driven by factors like the rise of AI-native applications and customer demand for flexibility, with 63% of SaaS companies exploring such models. However, successful implementation requires careful consideration of these risks and a strategic approach to pricing communication and infrastructure.