For software CFOs, the selection of SaaS billing models is critical to driving product-market fit, competitive differentiation, and predictable cash-flow.
A well-chosen billing model based on careful research and forecasting can help scale a SaaS company more quickly than many other factors. But by the same token, a poorly selected SaaS billing process can put companies in a free fall.
In this article, we will review 8 SaaS billing models you can use to scale your company more effectively. Before we do, however, we’ll explain what makes SaaS billing different and why it presents CFOs with unique opportunities.
What is a SaaS billing model?
A SaaS billing model refers to the way in which a SaaS business charges its customers for using its software. Instead of paying a one-time fee for purchasing the software outright, customers pay a subscription fee to use the software on a recurring basis. The SaaS billing model is typically based on the number of users or the amount of usage, and can vary in frequency from monthly to yearly.
Why SaaS billing models are unique and important for scaling your SaaS business
Understanding what makes SaaS billing different will enable you and your team to maximize its unique strengths while avoiding some of the pitfalls SaaS companies are prone to.
The importance of the SaaS billing model for SaaS businesses cannot be overstated. It provides a predictable and stable revenue stream for the business, which can help with financial planning and investment decisions. Additionally, it allows the business to focus on continuously improving the software and providing value to its customers, rather than worrying about one-time sales.
How SaaS billing models are different than other models
The SaaS billing model has evolved over time as the SaaS industry has grown and matured. In the early days of SaaS, many businesses charged a flat fee for their software, regardless of the number of users or usage. However, as competition increased and customer expectations changed, businesses began to shift towards a subscription-based model. This allowed for more flexibility and scalability, as customers could choose the level of service that best suited their needs.
Today, SaaS billing models are highly sophisticated and can include various pricing tiers and add-ons. Several important factors put SaaS billing in its own category compared to other business models. These factors include:
- SaaS billing models usually involve recurring charges. These days, most types of SaaS billing involve customers signing up for an ongoing subscription to your product. This allows companies to forecast more accurately and scale more sustainably.
- SaaS billing models require specific metrics. Software organizations need to track their prioritized SaaS metrics and leverage predictive KPIs.
- SaaS billing models have unique revenue reporting requirements. Under ASC 606, SaaS companies are required to recognize contract revenue at the same time that the underlying contract obligation for that revenue is met. This calls for a tech stack with ASC 606 support.
Let’s look at some of the most popular and profitable SaaS billing models adopted by industry executives who want to scale quickly.
8 SaaS billing models to scale your SaaS business
The SaaS industry has revolutionized the way businesses and individuals access and utilize software. The success of a SaaS business depends on its ability to offer a scalable, flexible, and sustainable pricing model that meets the needs of customers while ensuring profitability.
Below are eight types of SaaS billing you can adopt to quickly scale revenue, along with some of their pros and cons.
1: Usage-based or pay as you go
Usage-based billing is a SaaS billing process that involves charging customers based on the amount of use they log on your product for a given billing period. The more they use, the more they pay. This model is suitable for SaaS businesses that offer services with fluctuating usage levels, such as storage or bandwidth. Examples of SaaS companies that use this model are Amazon and Twilio.
- Transparent and straightforward for customers
- Tends to have lower churn because users can come and go
- Revenue depends on customer usage trends
- Can be tricky to forecast
Per-user pricing is a type of SaaS billing that charges based on how many users (or “seats”) are associated with each account. It’s very popular among corporate SaaS users and in other highly collaborative environments. Examples of SaaS companies that use this model are Trello, Asana, and Hubspot.
- Facilitates a higher user volume
- Can entice customers with discounted seating bundles
- Limited to multi-user subscription products
- When one account churns, you’ll lose multiple users
The tiered billing model charges customers based on the level of service they require. This model is suitable for SaaS businesses that offer multiple service tiers with varying levels of features or capabilities.
Tiered pricing splits your product’s features into various groups. Each ascending tier contains a few more features and costs more than the previous one. Just make sure your pricing accurately reflects the value of your different tiers.
Pricing tiers examples can be found everywhere in SaaS, from industry giants like Dropbox, Salesforce, and Shopify, to much smaller names as well.
- Users know they can upgrade or downgrade as needed
- Helps users feel like their personal needs are met at a fair price
- You might lose customers on price objections
- Customers might need certain top-tier features but not all
One of the more popular SaaS models is flat-rate pricing. Not everything needs to be complex to be effective.
The flat-rate billing model charges customers a fixed fee for a specific service or set of services. This model works well for SaaS businesses that offer a fixed set of services with no variations in features or capabilities. Examples of SaaS companies that use this model are Grammarly, Hootsuite, and Zoom.
- Appeals to customers who value simplicity
- Can help reduce forecast variance
- Inevitably prices out some potential buyers
- No room for strategic revenue creation in the SaaS billing process
5: Feature-based or Per feature
This type of SaaS billing is similar to tiered pricing in that different subscription options offer varying benefits. But with this SaaS billing process, the subscription options are often grouped around the needs of specific customer segments.
For example, a project management SaaS might have three feature-based options: Self-Employed, Small Team, and Enterprise. Each option would be grouped around features relevant to that particular buyer segment.
- More effective customer segmentation
- Easier sales and marketing messaging around pricing
- Might feel restrictive to certain customers
- Hard to do well without a deep understanding of your customers
6: Bundling or roll your own
This SaaS billing process allows users to bundle as many features as they want, and allows them to pay for that specific range of functionality. Essentially customers can create their own service package by selecting the features they need. This model is beneficial for SaaS businesses that offer a wide range of features with varying levels of complexity. Examples of SaaS companies that use this model are Microsoft Office 365, Google Workspace, and Salesforce.
- Some users will buy more expensive subscriptions
- Gives customers the freedom to create their own experience
- Might make reliable forecasting harder
- Leads to lost revenue from users who don’t buy many features
7: Freemium or ad-supported
This variety of SaaS billing involves offering users a free trial or free version of your product before charging their card; additional features are unlocked with a paid subscription. (Alternatively, you could offer a permanently free version but sell ad space on it as an incentive to upgrade.) This model is a great way to attract new customers, who can use the product for free and decide if they want to upgrade to a paid subscription. Ad-supported models fall under the freemium model, where revenue is generated from advertisements shown within the product. For example, Spotify offers a free version of their music streaming service with limited features, and a premium version with additional features and no ads. In another example, Dropbox offers a free version with limited space and a paid version with more storage and additional features.
- A free trial makes your brand seem generous
- Brings in ad revenue while drawing more prospects
- Delayed compensation on recouping overhead and development costs
- Gives users a chance to churn without paying anything
Hybrid billing involves combining two or more different billing options to form a hybrid, customized pricing plan for each customer. One example is overage billing, where customers pay a flat rate for a fixed usage amount and then pay overage fees if they exceed it (a hybrid of flat rate and pay-as-you-go). Amazon (AWS) offers a hybrid pricing model, for example, which combines different billing models for their cloud computing services. Another example is Hubspot, which offers a hybrid pricing model that combines pricing tiers with usage-based billing for some features.
- Unlocks strategic revenue opportunities
- Provides more flexibility for your customers
- Can quickly get complex
- Might alienate users who prefer a simpler approach
Building and forecasting a subscription billing business
Now that you’re better acquainted with some potential SaaS billing models for your organization, we’ll get into the nuts and bolts of using automation to build and forecast a subscription billing business. Below are some strategies for improving SaaS billing performance and forecasting variability in SaaS billing.
Capture and increase CMRR
Building and forecasting a subscription billing business is an essential part of running a successful SaaS company. One key aspect of this is optimizing recurring charges to capture and increase contracted monthly recurring revenue (CMRR).
For any subscription business model, CMRR is one of the all-important metrics. It measures the recurring revenue customers have committed to spending with you until their next renewal period arrives.
There are two vital processes to follow for your CMRR:
1. Capture revenue: This involves making sure that your ASC 606 contract obligations are meticulously matched against billing events as they take place. Otherwise, revenue leakage can occur, and revenue that you would have captured will be lost.
2. Increase CMRR: SaaS companies increase their CMRR by expanding their customer base or through subscription upgrades and expansions from current customers.
SaaS companies can use tiered pricing, usage-based billing, annual billing options, and focus on customer retention to increase CMRR and improve overall performance. Additionally, forecasting variability in SaaS billing is essential to avoid revenue shortfalls and other financial issues.
With that said, let’s dive into the importance of forecasting in optimizing the SaaS billing process, regardless of the specific billing strategy you choose.
How to build the dataset to reduce forecast variability
In SaaS accounting, forecast variability is the distance between the financial predictions made in forecasts and the realities that materialize. As a SaaS CFO, you’ll always want this distance to be as small as possible.
The way to do that is to build your forecast dataset by focusing on the most critical factors. These should include (but not be limited to) your:
- Monthly recurring revenue: Your monthly recurring revenue (MRR) tells you how much subscriber revenue you’ve successfully maintained from previous billing periods.
- Churn rate: Churn measures how many customers unsubscribe during a billing period. It’s expressed as a percentage.
- Customer acquisition cost: Your customer acquisition cost (CAC) tells you how much you spent on average to acquire each new user. Ideally, your forecasting around this metric should show it steadily decreasing as your organization acquires users more effectively. A rising CAC spells trouble.
- Customer lifetime value: Your company’s customer lifetime value (CLTV) measures how much each user spends with you before they churn. When forecasting to predict trends in your CLTV, you should always want to see this number increase.
Ultimately, SaaS businesses should choose the billing model that best suits their business model and customer base. You should also leverage data and analytics to forecast and manage revenue and optimize your pricing strategies.
Stay ahead of the competition and achieve long-term success with Sage Intacct
No matter which SaaS billing models you’re considering, Sage Intacct can help you make the most profitable choice for your company.
With fully automated multi-factor forecasting, cloud-based reporting, revenue recognition assistance for any SaaS billing process, and much more, Sage Intacct is the #1 accounting software solution in customer satisfaction.
To learn more about how cloud accounting can streamline your subscription billing process with the most widely used SaaS billing models, watch our educational video for SaaS finance executives: Building and Forecasting a Usage-Billing Business.