In recent years, subscription businesses have grown in popularity. The recurring nature of subscription billing models ensures that businesses generate regular revenue. A subscription model is a dynamic growth tool for businesses, especially startups, that can easily introduce their products to new customers. When you accept recurring payments you are also providing greater flexibility to your customers.
Determining the right billing schedule is an important decision for any subscription business. This means deciding whether to charge customers monthly or to take a one-time annual payment. Often customers prefer the flexibility of small monthly payments over a lump sum payment. If you are a startup, a monthly billing option may be the right choice as the low-cost provides limited barriers to entry for your customers. On the other hand, some enterprise businesses prefer an annual subscription as it means more revenue stability.
There are several factors to consider before you decide which billing frequency to choose for your business. Billing has a great impact on your revenue streams, customer acquisition, and retention, so this is not a task that you should take lightly. It may be tempting to follow what your competitors are doing, but choosing a model that doesn't fit your business may cause revenue disruptions.
We have come up with this guide that will help you get a better understanding of both subscription billing models and help you choose the one that is best suited to grow your business.
Monthly Subscription Billing
With a monthly subscription billing cycle, the customer pays their bills every month. Customers can cancel their subscriptions during their billing cycle as they are not typically bound by a yearly contract.
This billing method is preferred by startups or smaller companies that want to acquire more customers with relatively smaller monthly payments.
Advantages of monthly billing cycle
- Lower barrier to entry: A lower upfront fee encourages more customers to sign up and makes it more convenient for customers that are not ready to make a long-term commitment.
- Shorter Sales cycles: It's easier for your sales team to pitch a monthly billing cycle, reducing the time and effort spent in acquiring a customer. This ends up reducing customer acquisition costs.
- Stronger customer relationships: As you consistently engage with your customers to ensure that they are using your services, you form stronger relationships and build customer loyalty.
- Lower risk of chargeback: There is a lower risk of customers claiming a chargeback, as they are more willing to let a one-month payment slide by when compared to an annual bill. Also, it’s easier to offer refunds to unhappy customers without affecting your overall revenue.
- Higher revenues: A monthly billing model allows you to charge more as there is no need to provide additional discounts to entice customers to make a large upfront payment, unlike annual models. This means you earn more revenue over time.
- Easier to implement price hikes: It is easier to implement price hikes as it usually amounts to a few extra dollars per month, something that your customers can ignore if they receive a greater value from your service.
Disadvantages of monthly billing cycle
- Higher churn rate: As customers are not bound by an annual contract, it’s easier for them to cancel the service after a few months. Sometimes, customers cancel before they even realize the value derived from using your service.
- Reduced Customer Lifetime Value: You miss the chance to recover the customer acquisition cost when customers cancel their monthly subscriptions too soon, which means a lower customer lifetime value.
- Difficult to forecast revenue: It becomes difficult to accurately predict revenue projections because of the high customer churn rate.
- Higher merchant fees: Monthly subscription costs more to implement if your merchant charges extra fees based on the transaction frequency.
- Increased complexity: There is an increased hassle of keeping track of any missed payments, expired, or declined credit card transactions.
Annual Subscription Billing
In the annual subscription billing method, customers are billed for their subscriptions through a one-time annual payment. Annual payments are often preferred by enterprise-level SaaS companies as they can retain customers for at least a year allowing them to recover the customer acquisition cost.
Advantages of annual billing cycle
- Higher Customer Lifetime Value (CLV): Customers pay for yearly subscription services upfront which means you can recover your customer acquisition costs. Since your customers remain with you for at least a year you have the opportunity to showcase the benefits derived from your services to encourage renewals. This ultimately translates into a higher CLV
- Greater customer retention: With this plan, you are guaranteed a full year’s revenue upfront with no risk of churn during the annual subscription period. Even if your customers do not renew their services after the year is up, you are guaranteed revenue for the year.
- Lower costs and higher cash flow: Accounting costs and merchant fees are reduced as the transactions are not made every month. Since there is no need to send monthly invoices and dunning management, this saves your business resources and costs related to it. Annual subscriptions ensure a higher cash flow as the payment is made in one lump sum upfront payment.
- Predictable revenue forecasting: Annual payments from customers makes it easier to forecast expenses and revenue.
- Convenient for customers and business: It's convenient for the customers as signing up for a yearly contract becomes more affordable with the discounts for an annual subscription. It's more convenient for the business as internal resources and cost are saved by sending only one annual invoice instead of monthly invoices and dunning management.
Disadvantages of annual billing cycle
- Reduced revenue: When you offer an annual subscription plan you entice customers into paying a lump sum by offering a discount for an annual subscription, sometimes as high as 20%. This reduces your revenue when compared with monthly billing plans.
- Increased Customer Acquisition Cost (CAC): When you are trying to sign up a customer for a yearly plan it requires higher marketing costs as you need to convince a potential customer before they sign up for a deal worth thousands of dollars. You also have to assign resources for customer education and onboarding which increases the CAC.
- Revenue Risk: There’s a greater risk to revenue when an annual subscription customer cancels their subscription compared to monthly subscriptions as the customers pay their dues upfront.
- High barriers to entry: Since annual billing entails paying the dues upfront it means more monetary commitment upfront, which can sometimes dissuade potential customers from signing up. The high upfront fees can act as a barrier to small business owners who cannot afford the lump sum payment.
- Weaker Customer relationships and customer churn: Since your customers transact with you only once over a year, there is a greater chance of customers forgetting that they ever signed up for your services. This may result in them disputing renewal notices. There also may be instances where customers drop your service midway through the year resulting in invisible churn. It is essential to regularly interact with the customer to ensure they are using your services and to ensure that they are getting value out of your services so that there is a greater chance of contract renewal.
Monthly vs. Annual Subscription Billing - Which one should you choose?
As you can see both annual and monthly billing have their own advantages and disadvantages. Regardless of which model you choose, the benefits of subscription billing far outweigh the drawbacks. So it comes down to which billing frequency fits the most with your service offering and target customer.
Often B2B companies whose target customers are corporations choose the annual billing cycle. They prefer this billing frequency as they can lock in customers with yearly plans providing them secure revenues. Conversely, B2C companies or B2B companies that target small businesses, prefer the monthly recurring payments as it's easier to get customers to sign up for their business.
However, a hybrid approach works best for most SaaS companies, as it offers customers the flexibility to choose their billing frequency. The benefits of each billing cycle appeal to different customers, therefore by offering more choices you can onboard more customers.
At the end of the day whatever billing frequency you select make sure that your pricing structure aligns with the value you provide your customers. In case you serve a diverse customer base it may be a great idea to provide both annual and monthly payment options to ensure both types of customers are served. Regardless of which route you select, be sure to be transparent about your billing practices. Make sure you provide correct information about how often and how much they will be billed so there are no surprises when they receive the bill. You alleviate your customer’s experience by providing clear invoices detailing the usage and recurring billing charges. These practices earn you greater customer loyalty.
Learn more about how you can optimize your subscription billing for a better customer experience.
Choosing the right billing cycle is only the beginning. The next step will be selecting the right pricing model that’s suitable for your business and creating a pricing page that clearly states the features and benefits, and pricing for each pricing package. Read our guide to SaaS pricing models to help you choose the right fit for your business.
Whatever billing practices you choose, you need to select a billing service provider that can help you seamlessly integrate both approaches. LogiSense billing platform can handle all your billing and payment needs, and make accepting recurring payments a hassle-free task. LogiSense subscription billing platform helps you boost revenue with the ability to roll out new products quickly. Contact one of our billing experts today to talk about your unique billing needs.