Usage-Based Billing: What It Is and Why SaaS Companies Are Switching Software Usage-based billing is gaining attention as a solution. Rather than a flat fee, usage-based billing allows customers to be charged based on actual consumption. Consumption for this billing model could include the number of users, API calls
Because of an increase in flexibility from SaaS products and evolving expectations of customers, many companies are shifting to a pricing model that feels more equitable and allows for greater scalability. Usage-based billing is not simply a new trend in pricing; businesses are making usage-based billing strategic to help improve customer retention, support their growth, and create better alignment between value delivered to customers and revenue generated from the customer.
What Is Usage-Based Billing? With usage-based billing, customers pay according to how much they use a service during a given time frame.
Instead of paying a flat fee to access the service (for example, you would pay $100 to use the service for 10 hours), you actually pay an amount based on how much you use the service (for example, you may have used the service for two hours). Many industries utilise a usage-based billing model, including utility, telecom, and cloud.
Usage-based billing is now becoming more widely accepted in SaaS applications. How the customer is billed will depend upon the product that the customer is using (a software communication platform would bill based on messages sent; cloud platform charges; finance tools would bill based on the number of invoices processed or financial transactions).
The main concept of usage-based billing is straightforward; the customer pays according to the value they received from using the service.
How Usage-Based Billing Works A usage-based billing model is one where the software measures the defined metrics used in the billing cycle, and at the end of the billing cycle (or sometimes in real-time), the customer is billed based on the consumption tracked during that cycle.
A SaaS company could charge customers either a per-transaction, per-active-user, per-gigabyte of storage, or per 1000 API usage. Some companies solely utilise a usage-based pricing structure, while others have a hybrid model. With a hybrid model, the customer typically pays a monthly base fee and can incur additional usage charges if they exceed their usage limit.
To be successful at this type of pricing model, it is essential to have accurate metering, clear and accurate invoicing, as well as clear communication so that your customers fully understand how much they will be charged for their usage. If you can do this correctly, you will create a stronger connection between product usage and revenue.
Why SaaS Companies Are Switching to Usage-Based Billing This approach to pricing is increasingly being adopted by SaaS providers due to the many issues associated with traditional pricing solutions being resolved through this option. Consequently, both parties will have a better overall user experience when utilising this pricing structure.
Better Alignment Between Price and Value Value alignment is perhaps the largest reason for moving to the usage-based billing structure. With the fixed-priced models, a customer may feel they are overpaying for their product. At the same time, customers that usage is much higher than the plan pricing would provide more value than what is reflected in their monthly fee.
Through usage-based billing, each customer has the ability to view their monthly bill based on the amount of service they actually received from the product. Because of this, they are less likely to dispute the charges on their bill due to an inability to validate whether or not they were charged in accordance with the actual use of the product.
Lower Barrier to Entry Flat subscription pricing may scare some potential customers, especially smaller businesses or first-time buyers. Due to the reduced entry barrier associated with usage-based billing, customers can start off utilising the product with a very small monthly payment based on their current usage of the product, instead of making a large upfront commitment.
Given the number of different potential customers ranging from start-ups and businesses of all sizes that an SaaS provider can target, usage-based billing is a very attractive solution for an SaaS provider to use as a means for providing an opportunity to many different customer types and/or back-end users, as they would be able to adopt the product.
Supports Product-Led Growth With the majority of SaaS companies operating with a product-led growth methodology where the user experiences value through trialling the product and then expanding their use of it over time, usage-based billing complements this model. As the product is being used more frequently, the user will find that the cost of that product increases as their level of use increases.
This provides a more gradual upgrade path. Since the user is not being put on a new, larger plan prior to using the product significantly, the growth of the user's usage aligns with the mapping of new pricing plans as opposed to being driven solely by the sales team.
More Revenue Expansion Opportunities For SaaS companies that have implemented usage-based billing, a built-in revenue expansion mechanism can be created by growing customers who are using their product more and subsequently generating additional revenue without needing to completely change their plan.
As businesses convert customers into repeat buyers, they will ultimately capture additional revenue from the successful customer without hindering the customer experience. Additionally, this will save companies from the time-consuming activities of constantly renegotiating pricing structures or performing manual updates on customer accounts.
Greater Pricing Flexibility Today's software products are increasingly becoming more complex, and not every customer will interact with these software products in the same way. The use of usage-based billing provides greater flexibility than the traditional fixed tier structure often provides in the current complex marketplace. This flexibility in pricing allows businesses to build their pricing around actual customer behaviour, rather than confining customers to a broad category of plan type.
This flexibility can create feelings of fairness in the pricing of the products sold to customers, especially for customers who experience seasonal usage, variable usage, or unpredictable usage patterns.
Common Examples of Usage Metrics in SaaS The way SaaS businesses assess their usage depends greatly on what kind of service their product provides. Taken together, the most common billing metrics a SaaS business will bill by include anything from the number of API calls, transactions processed, emails sent, documents created, GB of storage, active users, projects created, or support tickets closed.
When selecting a billing metric that works for both the customer and the SaaS business, it should be based on what the customer values most, as well as what provides the best representation of how the product is being consumed by the customer. A good billing metric is easy to determine, easy to understand by the customer and has an accurate relationship to customer outcomes.
Benefits of Usage-Based Billing for SaaS Companies The potential benefits of effective usage-based billing are numerous.
It provides an opportunity for increased customer satisfaction due to fair payment for use. It creates access to smaller businesses by reducing upfront costs. It allows for improved efficiency in revenue collection, as customers' spending will grow with their usage. It gives SaaS companies greater visibility into how users engage with their product, which can provide insight to enhance pricing and product strategy
In addition, an important benefit of usage-based billing is the improved transparency it provides. When users clearly understand the cost allocation for billing, they are generally more trusting of the billing process - especially when accompanied by dashboards, alerts for usage, and detailed invoice breakdowns.
Challenges of Usage-Based Billing While some SaaS business models have many benefits, they also come with their own set of challenges. For example, a SaaS company cannot arbitrarily change pricing and expect success immediately. The billing experience needs to be well thought out.
One of the most significant challenges SaaS companies face surrounding usage-based pricing is predictability. Most customers prefer to know exactly how much they will be charged each month. If the monthly charges fluctuate significantly, the customer may not feel comfortable or confident in their bill. SaaS businesses need to solve this challenge by providing customers the ability to clearly track usage, control usage and spending, and forecast costs.
Another challenge is that billing for usage-based pricing is often complex. Billing for usage requires accurate metering systems, accurate invoicing, tax handling, and integration with finance workflows. If a SaaS company does not have the right systems in place, they risk damaging customer trust by making errors in billing.
Finally, choosing the correct metric for billing can be a challenge as well. If the billing unit does not clearly reflect the value received by the customer, billing may confuse or frustrate customers. It is essential to confirm that the pricing model you offer will work for your customers before rolling it out at scale.
Usage-Based Billing vs Subscription Billing Customer subscription billing with traditional implementations is typically straightforward for customers. These customers pay a set price every month and know what services they can expect when they make their payment (based on the service usage or access).
In contrast, usage-based billing is based on how the customer actually consumes the services, allowing for a more flexible and scalable product; however, it requires much more robust infrastructure and communication.
For many companies in the SaaS space, it would be best to hybridise both types of billing approaches into a billing model. For example, combining a monthly fixed price with variable usage fees may create customer cost predictability while allowing the company to price additional service usage in an equitable manner.
When Usage-Based Billing Makes Sense Usage-based billing works best when the amount of use by a customer is very different from that of other customers, when the product delivers measurable value to its users, and when the user desires flexibility rather than a rigid pricing scheme based on set tiers.
This pricing structure is particularly applicable to products that will experience greater levels of usage with growth. The billing structure can grow with the customer and avoid forced plan changes, making the customer journey more seamless and possibly more sustainable than under any other structure.
However, usage-based billing will not work for every SaaS company. If the product does not have an easily defined and/or measurable value for each user, a subscription or hybrid model may be more appropriate for the business model.
What SaaS Companies Need Before Switching To switch to usage-based charging models, SaaS providers must look at more than simply pricing; they also need accurate billing solutions with proven track records of reliability, effective usage tracking solutions to ensure that customers are billed correctly, a clear invoice structure to avoid confusion for the customer and effective communication with the customer.
As with all changes, your organisation's internal processes for operations (finance, sales, support and product teams) must also support the change. Therefore, customers need access to information about how their usage is calculated, so they can keep track of their usage and will not be surprised by unexpected charges.
Thus, if your customers fully understand how your new usage-based billing model works and believe they have sufficient control over their usage, it will be much easier for them to adopt this new billing model.
Conclusion Pricing has been influenced by a new approach, usage-based billing, which allows Software as a Service (SaaS) companies to price based on what the customer actually consumes within the service (usage). This represents a shift in revenue models for many SaaS companies and offers them an alternative to charging customers the same way for the value they collect ("consumed") from using the software.
More SaaS Companies are adopting the usage-based model because of its inherent flexibility, ability to foster and accommodate growth, ability to eliminate common entry barriers associated with traditional pricing models, and because they usually believe their customers will perceive the usage-based pricing experience to be more logical and fair than traditional models. However, effective usage-based pricing requires strong systems, sufficient communication/transparency, and an effective pricing strategy.
For SaaS companies interested in modernising their pricing, developing better alignment with customers, and supporting ongoing scalability of growth, the usage-based model will no longer represent an experiment but rather will represent the next evolution of software monetisation.
Where Swipe Fits In SaaS companies wishing to improve their billing operations should consider using a service like Swipe to make the process much simpler. And when a business has decided on flexible/scalable billing models, creating proper invoicing and a complete billing flow is going to be essential for that business. A solution such as Swipe offers billing and invoicing services that improve how those growing businesses' billing operations are run, organised and easily managed.
FAQs What is usage-based billing in SaaS? Usage-based billing means that you pay for how much of the software service you actually use.
Why are SaaS companies moving to usage-based billing? Many SaaS companies have transitioned to this model of billing due to the advantages it provides for pricing flexibility, value alignment, and supporting the customer's growth over time.
How is usage measured in usage-based billing? Examples of how to measure usage are through APIs
Is usage-based billing better than subscription billing? The measure used to determine what type of pricing structure best fits will depend on the business model. A usage-based pricing model will work well for services that are variable in their consumption, whereas a subscription-based pricing model could be used for services that are predictable in their consumption.
What are the benefits of usage-based billing? Usage-based billing lowers the barriers of entry, fosters pricing equity, promotes revenue growth for the provider, and matches the cost of the product to the usage of the product.
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