There are numerous billing frequencies available (bi-monthly, monthly, quarterly, etc.), subscription-based companies typically offer an annual subscription or monthly payment plan. Many will give customers a choice between the two, but have you given much thought as to which payment model is better for your business? While there’s not a definitive answer to this question, there are some basic tactics that will put you on track to long-term growth and profitability, while providing wide customer appeal.
Before walking through the pros and cons of annual vs. monthly billing cycles, let’s look at the meaning of each of them. With an annual subscription billing plan, the customer makes a 12-month purchase for a product or service and provides payment in advance. Annual payment plans lock customers in for the duration of the subscription, which typically renews automatically unless the customer cancels the subscription. To incentivize annual subscription purchases, many companies offer discounts between 10% and 25%.
A monthly subscription billing model requires customers to make monthly payments for the products or services they are using. The payment is charged on the same date every month as long as the subscription remains active. Since this payment plan doesn’t include a long-term contract, customers can generally cancel at any time and cancellation takes effect on the next payment date.
When subscription companies offer both monthly and annual payment plans, customers can toggle between the two. For instance, a customer on an annual plan can move to a monthly plan, which will commence at the end of the annual subscription term. This blog covers annual vs. monthly subscription billing, their pros and cons, which may be best for your business, and how billing frequency affects revenue recognition.
Annual and Monthly Subscription Models: The Pros and Cons
Annual Subscription
Pros:
- Provides a predictable revenue stream for the 12-month subscription period.
- Allows for a longer duration to build strong customer relationships and loyalty.
- Improves customer retention and in doing so lowers churn rate.
- Given the length of the subscription, customers have ample time to understand the value of the product or service.
- Reduces accounting effort since invoices are sent once a year as opposed to monthly.
- Increases cash flow since a year’s worth of revenue is received in advance.
- Improves visibility into the financial status, making the company more appealing from an investor perspective.
Cons:
- The initial cost makes it more difficult to attract subscribers.
- Reduces revenue if discounts, especially substantial discounts, are given to entice customers.
- Increases customer acquisition cost as the sales cycle is longer and it requires more marketing and sales efforts.
- Customers may forget they subscribed, resulting in a dispute of charges.
- When refunds are needed, larger sums of money are involved.
- Staff needs to keep a close eye on metrics to proactively spot and rectify waning interest.
- Increases revenue recognition and deferred revenue complexity.
Monthly Subscriptions
Pros:
- Lowers the barriers to entry, making it easier to attract new customers and grow the business more rapidly.
- Provides more flexibility to increase prices as the increase will appear to be much less than those associated with an annual plan.
- Decreases chargeback time threshold, as well as chargeback amounts.
- Increases frequency of customer communications/interactions through the invoice.
- Shortens the sales cycle which can reduce customer acquisition costs.
- Provides for higher per-month revenue, however churn can negatively affect income.
- Increases customer feedback frequency since recurring payments serve as a reminder.
- Improves administration of refunds and doesn’t heavily impact revenue.
Cons:
- Lowers customer retention rates since canceling a subscription has low-cost implications.
- Increases frequency of creating and sending invoices, which translates to higher transaction costs and more effort.
- Lends itself to increased difficulty in predicting churn rates, which can result in revenue and cash flow forecasting unpredictability.
- Customers may cancel their subscription before they realize the value of the products/services.
- Increases the complexity of tracking payments and following up on delinquent payments.
- Cash flow may be less since smaller payments are received incrementally.
While both payment frequencies provide advantages and disadvantages, no two customers are alike. Plus, each has different perspectives on what represents value. To meet the needs of a larger customer base, many organizations offer both – monthly and annual subscriptions. In fact, it’s been estimated that approximately 70% of software-as-a-service (SaaS) companies offer both payment options.
Choosing the Right Subscription Payment Model
There’s no simple answer and what may be right for one company may not be the best for another. To help the decision-making process, we’ve highlighted some key questions to ask yourself.
1) Who’s your target market?
Are you a B2C or B2B company? If you sell strictly to consumers, monthly billing is typically preferred as it provides a lower upfront cost. If you’re a B2B organization, the next question to ask – is your target market SMBs or large enterprises? Like consumers, SMBs may find the large upfront payment difficult, creating a barrier in purchasing your products and services.
However, if you sell to larger companies, they typically have the available funds to purchase an annual subscription, and this payment frequency is many times preferred as it reduces purchasing department and accounting effort.
2) What subscription pricing frequencies do your competitors offer?
Analyze the subscription pricing frequencies of your closest competitors – those offering similar products and services as yours. Be sure to look at how they communicate their offerings value, problems the product or services solve, and their pricing structures.
Additionally, take note of the benefits offered for annual subscriptions, if they offer discounts for annual subscriptions, if annual subscriptions require payment in advance, and if they offer both annual and monthly subscription payment plans.
3) What is your annual recurring revenue (ARR)?
As a rule of thumb, the lower your ARR the more important it is to bill on a more frequent basis. More frequent billing will help keep cash flowing.
4) Do you offer a variety of products, services, and pricing tiers?
Businesses that offer multiple products and services, as well as different pricing tiers typically encounter the need to modify offerings and pricing. For this reason, these subscription-based companies gravitate to monthly payment models.
5) How do you handle the billing process?
This question comes down to do you process invoices manually or have a system that automates the billing function? Companies that manually handle the billing process can find more frequent billing time consuming and error-prone. However, businesses that have incorporated a billing platform can efficiently handle any billing frequency with ease.
As you can see, there’s not a single billing frequency tactic that appeals to all customers while delivering sought after business benefits. However, there’s one last component in the annual vs. monthly subscription payment model debate – revenue recognition
The Impact Billing Frequency has on Revenue Recognition
Critical to any business and any billing frequency, recognizing revenue needs to be done accurately and in compliance with accounting standards like ASC 606 and IFRS 15. Subscription-based companies face additional complexities such as subscription cancellations, subscription upgrades and downgrades, cancellations, refunds, etc.
Depending on the payment model, subscription-based businesses may encounter deferred revenue complexities. Additionally, companies need to know how much revenue has been collected and can be recognized. Properly tracking revenue provides the ability to stay in compliance with accounting standards, enables accurate tax calculations, and provides the transparency investors require.
Taking it a step further, your company may have more complex transactions where advanced revenue recognition is required. This can include milestone recognition, event-driven, point-in-time, recognition over time, and contracts that contain bundled arrangements. Dig a bit deeper into the differences between annual recurring revenue (ARR) vs. monthly recurring revenue (MRR) and ARR vs. total revenue, recurring revenue processes, and revenue recognition calculations and interpretation mistakes.
Monthly vs. Annual Subscription Billing: Is One Better Than the Other?
Back to the question at hand – which subscription payment model is best for your business? Let’s revisit the section entitled Choosing the Right Subscription Payment Model – question 5 (How do you handle the billing process?) and use a few examples to illustrate.
Let’s assume that your company’s target market is SMBs, you sell multiple products and services at different pricing tiers, and the billing process is handled manually. Given that your target market is SMBs, you may be inclined to sell subscriptions on a monthly basis to ensure affordability and wide market appeal. However, the multiple products and pricing tiers, as well using spreadsheets and performing billing processes manually will more than likely result in additional effort and errors.
Our next example is that of an enterprise that targets large corporations. This company sells multiple software products and services on a tiered basis and billing is handled via an automated system. Given the need for pricing flexibility and the ease of creating and generating invoices, monthly subscriptions may seem the logical choice. However, when we add in the company’s high ARR and their target market’s ability to pay in advance for an annual subscription, the decision as to billing frequency isn’t as clear.
As you can see from the examples, there are several elements to consider when choosing subscription pricing frequency, making both equal depending on a variety of variables.
Keep Revenue Flowing Regardless of the Billing Frequency
Choosing the right subscription billing frequency is just one component of this complex business model. And regardless of the subscription billing frequency, the goal of all companies is to keep revenue flowing. Doing this requires an automated billing system that provides payment frequency flexibility.
BillingPlatform, the industry’s leading multi-tenant cloud-based solution enables organizations to automate their revenue management processes. Our revenue management platform supports any business model with any combination of one-time chargers, subscription, consumption/usage, or hybrid-based billing – all on a single platform. The flexibility of the solution gives companies, like yours, the power to enable any kind of billing model and support even the most complex recurring revenue relationships.
In fact, we’ve been recognized as a leader in billing and revenue management, receiving accolades from analysts and research firms such as Ventana Research – Overall Leader and an “Exemplary Vendor” in 2023 Subscription Management Value Index and Forrester – Leader in The Forrester Wave™ SaaS Recurring Billing Solutions, Q1 2023 – “Extensibility is the strength of the platform.” Forrester
Would you like to learn more about what sets BillingPlatform apart and see a demo of our solution? Contact our team today and we can help!
