While we’ve historically used the term SaaS (Software as a Service), I think we’d actually be better off calling it SaaSS (Software as a Subscription Service). The recurring nature of SaaS products is fundamental, not only to their structure but to the way we anticipate paying for those services.
Structurally, recurring payments and subscription-style service mirror the way we used to buy software. We would walk into CompUSA, find the product we wanted, and walk out with the software to install and use as we saw fit. The subscription SaaS model revives this way of software interaction – once we get something, we have it forever.
That expectation – that consumers will have access to a SaaS product in the future – creates a wide range of expectations and problems for SaaS businesses. How you bill, when you bill, and what you bill can all affect the retention of customers, putting pressure on your bottom line.
While the market has fallen in love with the recurring revenue model, that hasn’t made managing its implementation any easier.
Because of the second issue – that there are many ways in which consumers anticipate paying for SaaS –, companies must walk a fine line between recouping customer acquisitions costs and keeping customers happy.
Today, we’ll cover the potential SaaS billing models you could put in place, the way those will affect your business and customers, and some best practices for SaaS billing.
A guide to SaaS billing models
There are three basic ways to bill SaaS customers.
Monthly only
Yearly only
Customer chooses monthly or yearly
Any other billing cycle is essentially going to be a slight variation on this theme. For instance, billing every three months instead of every month or – for some reason – every two years instead of every year.
I think those deviations are a) not helpful to your bottom line and b) confusing for customers. My gas company bills me every three months and it makes me want to switch to a 100% coal-based system.
Let’s talk benefits first.
With a monthly billing cycle, customers pay a small amount on a regular basis. That means that they don’t have to overextend their budget to pay you and it means that your bill is unlikely to be the one that breaks their back.
Additionally, monthly billing gives customers a small sense of connection with your product, even if they don’t use it very often. Once a month, there you are in their bank statement.
For the SaaS provider, it creates a steady stream of revenue throughout the year, with fewer of the seasonal ups and downs that come with traditional cash flow scenarios. Young businesses can quickly establish growth and retention rates without too much worrying about prorating customers, allowing them to forecast revenue easily.
Yearly billing gives customers a sense of ‘set it and forget it.’ They pay the one fee and go on with their lives, using your platform whenever they feel like it. If they go three months without touch it and then have two months of daily usage, it’s easy for them to look at the cost of the whole year to justify that downtime.
In that sense, yearly billing is much more like a traditional purchase, with one large outlay followed by use. Many consumers and businesses like the fact that they’re only going to cut one check to get a year’s worth of value.
For the provider, yearly billing – cancellations aside – immediately offsets acquisition costs. You spend your money on sales and marketing and suddenly it’s back in the system.
Both monthly and yearly billing have their benefits, but both also have drawbacks.
The problems with ‘only’ billing cycles
I want you to think real hard about the last time someone told you there was only one way for you to interact with them. Was that great for you? Did it make you want to be a repeat customer?
You can only return this item in a store or only buy it online or only use this coupon by the end of the month. ‘Only’ doesn’t have a great reputation.
While monthly and yearly billing have their benefits, there are also plenty of drawbacks. If you only bill monthly, people who have large periods of downtime are going to start seeing your service as a cash suck. Billing by the year means squeezing out smaller potential customers who work on tight cash flows.
Monthly billing also makes it easier for customers to take one bad experience as a reason to walk away, while yearly payers may see the relationship in longer terms. Yearly billing, though, can mean that when someone does quit, they throw off huge revenue projections – more on this later.
Making your SaaS customers interact with your business solely on your terms is not a great idea. I mean, these are people who are buying your offering because they want the flexibility of SaaS – why would they want a rigid billing structure?
I much prefer the blended, either-or billing option. Yearly subscribers get a discount, monthly subscribers get the flexibility they need. As a business, you start out with happy customers who have already engaged with you. They’ve made a choice for themselves right out of the gates.
This is not without risk.
Giving customers more choice means your business will have more revenue scenarios to work through. People can leave at any time, and you’ll prorate different plans in very different ways. Yearly customers might not get back that discount if they leave before the year is up. Monthly customers might get the whole month back if they cancel within five days of their renewal date.
Financial forecast with recurring revenue
Recurring revenue models – whether monthly, yearly, or a blend of the two – are as plentiful as SaaS businesses. Because subscription-based businesses face both growth and meaningful churn, there are a lot of different blends you can use to try and figure out how much you’re going to make.
The “Rule of 78” is one of the more prevalent options, which has you multiply your first month’s revenue by 78 to get a full year’s forecast. Channel Dynamics has a good explanation of the rule and why it’s not perfect.
You can also just multiply your July revenue by 12 or use a more detailed approach to calculate the cost of churn and the impact of hiring new salespeople.
You might even use a mix of forecasting models for different reasons. Maybe you’ll use the rule of 78 when you’re talking to the press and the detailed model when you’re budgeting. You might increase your churn expectations for public forecasting and align them with reality for investor meetings.
Whatever billing model you use, you’ll have to have a forecasting model that works with it.
Final thoughts on SaaS billing models
SaaS businesses rely on relationships to keep working. If you want to grow, you have to have a product that people are willing to pay for on a recurring basis. To so that, you have to keep them happy.
While we usually focus in on the product or service as the most important part of customer satisfaction, billing plays a large role in that metric. By choosing the right model and finding the right system, you can keep customers focused on your offering, instead of on their bank account.
If you’ve implemented a recurring billing or subscription service for your business, I’d love to hear about it. Please shoot me an email if you’d like to talk. For more tips on growing your small business, check out Capterra’s Knocking Down Doors blog.
Good luck.