For any business, setting a price for what they sell is a key piece of the revenue and profit puzzle. Subscription businesses have the added task of determining not just price points but the billing model they will use. For example, many subscription businesses have a fixed recurring model (same price every time). SaaS companies have a slightly more complex model which requires that they charge for each user accessing the service, often at a prorated rate. And some businesses—usually high-volume transactional services—will find that a usage-based model is the most appropriate and beneficial.
So what is a usage-based billing model? And how do you know if it might be right for your business and your customers?
A usage-based billing model essentially charges customers based on how many units of a product or service they use, calculated at the end of the billing cycle. For example, pay-as-you-go cell phone plans frequently charge on usage, such as minutes of phone time used or number of texts sent. International calls where you’re charged per-minute are another example.
A usage-based model can be well suited for certain kinds of services where customers only want to pay for what they use and where the business wants to match revenue to usage.
Some signs that might indicate that a usage-based model might be appropriate are when:
Customers complain that they are paying too much, showing that price may not be aligned with value
Customers use a lot of your service, but pay a flat rate. This suggests an opportunity for a business to collect more money from better monetization of a service that’s in demand
For businesses considering a usage model (or for businesses who would benefit from a usage model but don’t realize it), here are some of the key features of a usage-based billing model.
Pros and cons of a usage-based model
Merchant can cover the costs of heavy users and also gain more revenue from high usage
Low-to-average-usage customers can pay only for what they use, which feels more fair
Merchant cannot easily predict their recurring revenue
High or variable users may be upset with unexpectedly high bills
For what type of business is a usage-based model most suited?
High-volume transactional services. For example:
(billing on number of emails sent, number of contacts tracked)
(billing on number of GB stored, number of GB streamed, number of video plays)
(billing on number of API calls, number of GB data stored)
(billing on number of phone calls, number of text messages)
Why is the model suited to these types of businesses?
Aligns price with value in a business where customers’ usage may vary widely.
More fair compared to paying for a pre-set number of units where customers will likely never use all of their allotted units.
When usage volume is high, a usage-based model precludes the customer having to accurately predict ahead of time what their usage will be.
For what type of business is a usage-based model NOT so well suited, and why?
A usage-based model is not well suited for time-based businesses (for example, that bill per seat or per user) or physical goods subscription businesses.
Often businesses think of per-seat models as variable because the number of seats can vary in a given billing cycle. The difference is that variability is controlled by the customer and paid at the time of change, where traditional usage based models are variable based on the customer’s usage and paid in arrears. If the value of your service is time-based access, you will want to prorate any mid-cycle changes based on time. This requires a fixed recurring and per-seat model.
Like the per-seat model, physical goods are generally paid up-front and do not involve incremental usage.
Another option: a combination model
In fact, a mix of both fixed recurring and usage-based fees in a subscription plan is a common model that combines the best of both worlds. This blended approach (fixed plus usage) would include a prepaid amount (upfront commitment to usage) plus usage-based charges for usage beyond the prepaid amount. For example, many consumers today have a cell phone plan which includes a certain number of gigabytes of data per month. If they exceed this pre-set allotment, they’re charged a set fee for each gigabyte used beyond what their plan includes
Why is this model useful?
A combination model provides the value of a usage model and the predictability of a fixed model.
Everyone benefits from predictable invoices. Customers pay for usage, and the business has some portion of their revenue that’s predictable.
To implement a mixed model:
Consider having customers pre-pay for a number of included usage units. This provides a customer commitment with a recurring fee agreed upon up-front. If the customer uses more, the usage fee kicks in.
Is your service comprised of multiple values? For example, there is value in time-based access to your service, but you also provide high-volume transactions that are the ultimate goal for your users. Couple a fixed recurring fee for the service access with a usage-based fee for the transactional component.
For seasonal businesses, the included units might need to be reset periodically (at a period length that makes sense for that business’ seasonality). This will allow customers to stick around year round.
The key benefit of a usage-based model for transactional services is that it most-accurately aligns price with value.
Ask yourself, how do your customers value your business? Is it transactional? Is there seasonal use? Is there a high cost for additional usage that the business needs to recoup? Or is there an opportunity for more revenue from a usage model? The answers to these questions will help inform your decision to transition to a usage-based model.
To learn more about Recurly and the different billing models we support, visit this page. You can also talk to a Recurly expert at (844) 732-8759 or sign up for a demo below.