Learn all about the benefits of proration and prorated billing for SaaS, as well as how to implement usage-based billing the right way.
In the last seven years, the number of SaaS enterprises charging based on usage has increased by 16%, reaching 39% in 2021. Customers expect to pay "in proportion" to how they use your product and the utility they obtain from it. Therefore, perfecting your proration model should be a top priority. When a customer changes their subscription plan in the middle of a billing cycle, you should apply the appropriate proration logic depending on whether it is an upgrade or a downgrade.
What is proration?
In subscription billing, proration is a framework that allows consumers to make adjustments to their subscription plans, such as upgrading, downgrading, or cancellation. It also allows subscribers to change the quantity of subscribed items or their frequency in a subscription cycle without distorting their billing.
What is prorated (usage-based) billing?
Prorated billing is a billing model that only charges your consumer for the time they utilize your product or service. This billing method is ideal for SaaS or subscription-based enterprises. But what distinguishes it from other typical billing methods? In a subscription business model, the revenue stream and purchases are recurring. A consumer who signs up for a subscription agrees to pay a specific amount at a specified interval in exchange for a product or service.
The customer's subscription plan and the length of use determine the billing amount. In most cases, the consumer stays on the same plan and regularly pays the same amount. When a customer opts to switch plans or make adjustments before the next billing date, billing becomes a bit more complicated. In such circumstances, the billing amount must be computed proportionally based on the number of days covered by a particular plan. This is what is referred to as prorated billing.
Why is usage-based billing important for SaaS businesses?
Because most SaaS products allow alterations to subscription plans in the middle of a billing cycle, it's critical to sync usage charges with consumption. To make this work, you'll need a clear and explicit method of prorating charges that is fair to both you and your customers.
Charge users fairly
Prorated billing simplifies the billing and adjustment process while maintaining transparent and fair dealings. Whether they upgrade or downgrade, customers are charged solely for what they've used in a billing period.
Offer flexible billing options.
With prorating, customers can easily switch between tiers and add/remove subscription elements based on their needs. Businesses, on the other hand, can easily adjust customer bills.
Increase customer satisfaction
A prorated pricing option gives your clients total control over how much they spend when testing your SaaS product. Your clients know their spending limits and can cease using the product once they've reached their limit. This offers them a better user experience at a lower cost. Businesses can inexpensively install your SaaS solution early on and exploit it for growth thanks to usage-based billing. Your SaaS product scales with them as they expand and gain success, and their usage grows; those scaling consumers can become significant revenue generators for you.
Reduce customer churn
When subscribers are overcharged, they are more likely to switch to other providers. Since subscription-based businesses are founded on the principles of ease, convenience, and cost-effectiveness, proration billing allows SaaS businesses to incorporate these values into their billing and keep their clients.
How to fit prorated billing into your subscription business
As much as usage-billing is a highly beneficial model, businesses can only reap off it if they implement it correctly. Here is our comprehensive guide to acing on prorated billing:
To be fair to your business and your clients, you must be explicit and unambiguous about how you prorate your prices. You want to ensure your invoices are always accurate and that your consumers know precisely what they're being charged for.
Regularly collect recurring payments.
Prorated bill collections can be difficult and stressful. You have more invoices and numerous payment options to choose from. Ensure you regularly collect your payments to avoid a backlog. With modern payment technologies, you can efficiently automate your prorated bill collections.
Adjust offer to meet customer demand
Watch out for customer trends and vary your offers as necessary. You have to stay ahead of customer demand to ensure that you meet them halfway whenever their usage changes.
Set up a smart refund policy
When subscribers cancel or downgrade their subscription in the middle of a monthly billing cycle, most of them expect to access your product until the end of the cycle rather than receive a refund. This means you'll have more money in the bank, and almost all your users will be satisfied. You can always opt to overlook your policy and provide a refund to the few who complain. Also, quarterly or annual billing typically requires a refund policy that ensures consumers are treated fairly.
Focus on accurate revenue recognition
Once you have collected all your bills, ensure that the revenue is accurately recognized. When creating a subscription, be mindful of the dates you enter so you can appropriately capture how proration affects income. Effectively recognizing your bills ensures your business does not miss out on payments or run into erroneous billing.
When to prorate your customer's bill?
You should prorate your customer's bill whenever they switch their subscription plan. You can do this whenever they upgrade or downgrade their subscription.
What are some of the examples of prorated billing?
If your bill date is December 10th and you purchase a $20 per month subscription on November 23rd, you'll be billed for the period between November 23rd and December 10th. The prorated cost, in this case, is $11.33 ($20/30 days x 17 days). Instead of a full month, you only pay for 17 days of subscription.
How to refund a subscription downgrade in the middle of the billing cycle?
Efficient billing systems employ credit notes. A credit note is an invoice-like record that allocates refundable rebates for the amount owed to the subscriber or modifies the invoice amount to reflect the downgrading.
How to bill customers who upgrade accounts before the end of the billing cycle?
Like downgrading, you can assign the adjusted bill to your customer's subscription using software such as a credit note. The software will assign any additional charges to reflect the upgrading.