Deferred revenue is an essential accounting practice for any scenario where a customer prepays for goods or services. Any team operating a subscription-based business needs to understand its nuances. Whether you’re an established SaaS enterprise or migrating your business to a subscription-billing model, you must understand how to navigate complex revenue recognition while maintaining compliance with accounting standards. Deferred revenue is a critical piece of that puzzle, and this blog clarifies what it is and why it’s reported as a liability.
Deferred revenue refers to advance payments made by a customer for goods and services the company will provide in the future. It’s also known as unearned revenue; since the obligation has yet to be delivered, the payment hasn’t been ‘earned. Deferring revenue appropriately is a key component of revenue recognition for subscription billing.
Following US GAAP guidelines for accounting conservatism, companies must defer revenue anytime there is a delay between when the customer pays and when the obligation is fulfilled. If the good or service is then undelivered or cancelled, the company may owe the money back to the customer.
It’s best practice to recognize revenue as it’s earned and track customer behaviour with a customer aging report. When customers pay in advance, it’s particularly important to keep accurate reports of unearned revenue, so that your company does not invest or use more of its resources than are strictly available.
Deferred revenue and accrued expenses both appear under liabilities on a company’s balance sheet. While deferred revenue refers to money that the business has received in advance of providing goods and services, accrued expenses are money the business owes for goods and services it has already received. One way to think of it is that the two are inverses of each other.
Deferred revenue is commonly held by any business where customers pay in advance for goods and services. Popular examples of businesses with deferred revenue include:
Further reading: The complete guide to 8 SaaS pricing models to grow subscriptions
According to the US GAAP standards regarding revenue recognition, when customers pay for products or services in advance, companies must record the income as a liability on their balance sheet rather than revenue on their income statement. This accounting treatment demonstrates that the company still owes the customer and protects the company from overstating its value.
In the event that the order is cancelled or cannot be delivered according to the original plan (ex. natural disaster, supply chain shortages, bankruptcy), the company must repay the customer their prepayment. Revenue is also taxed in the same period that it’s recognized, so if there’s even a slight chance you’ll have to repay the customer, it’s best to defer the revenue until the goods/services are delivered.
Deferred revenue is a liability until the products or services are delivered, so you will make an initial credit entry under current or long-term liability, depending on whether the sale is under twelve months. You will debit the sales account and credit the deferred revenue account as you earn the revenue.
This process may seem simple, but it can become complex when applied to recurring revenue. If you’re looking for more information, our blog also covers best practices for recognizing revenue under ASC 606 and IFRS 15 and has a special primer for SaaS companies on ASC 606.
Assigning a specific adjustment account to track deferred revenue enables you to record unearned income as a liability and accurately recognize revenue as you fulfil the performance obligation(s) in your contract.
For this example, let’s assume that you’ve secured an annual subscription with a client at a flat rate of $18000. The client pays the full amount upfront; however, you cannot recognize the full $18000 until the service has been provided. You must evenly divide the total across one year, which is the duration of the contract, and recognize the revenue in increments.
For the first month, you recognize $1500 and defer the remaining $16500 to an adjustment account. For each month after that, you’ll credit the deferred revenue account and debit the sales account $1500.
Complex revenue recognition is unavoidable in any business model that employs subscription billing, but it doesn’t have to be complicated. A robust subscription management solution like Subscription Billing Suite can simplify the process by automating deferred revenue and enabling you to remain compliant with accounting guidelines such as ASC 606 and IFRS 15. Your accounting team can focus less on repetitive, mundane tasks and redirect their attention to what matters.
Premium pricing strategies pair well with many of the common subscription billing models and are most often used to establish a perception of higher quality in the marketplace. Traditionally, luxury brands tend to opt for this pricing strategy; however, these days, it’s used in every industry to denote better quality services and products. SaaS companies that have built a solid brand reputation often use this pricing approach in the advanced tiers that offer access to the most features.
Those hoping to implement premium pricing will want to evaluate their market position and make an informed decision by weighing the pros and cons. This blog breaks down the advantages and disadvantages, offering examples of the strategy in action, so you can make an informed decision about whether it will work for you.
Premium pricing is best used where there is brand recognition, and a company has garnered a reputation for high quality in a specific market. Newer brands might start with lower pricing, implementing higher price points as reputation grows, and there’s a strong foundation of social clout, reviews, recommendations, and recognition. It may be premature to implement higher price points without first developing a demand for your products and services.
Premium pricing strategies can also be used effectively in tiered offerings to help increase the perceived value of more affordable tiers. It’s well-known in pricing psychology that many customers will gravitate towards mid-tiers, and higher price points on the final tier can make mid-level options more attractive. At the end of the day, choosing whether premium pricing is the way to go will require comprehensive market research, a close analysis of subscriber churn metrics, and a solid understanding of your costs. You can learn more about choosing the right strategy for your company here.
The SaaS industry is a notoriously competitive market, but one in which Microsoft has built an incredible reputation. There’s no question that most of us can quickly recognize the brand. They offer numerous affordable options, and the level of service and quality associated with Microsoft means they can implement premium pricing on select services and products. For instance, Xbox Series X builds on Microsoft’s reputation, giving gamers access to the console they know and the games they’ve come to love at a premium monthly rate. Alternatively, users can buy the console outright, but they will not have access to the Xbox Game Pass.
The retail industry is a place where premium pricing is associated with high-quality brands. Canada Goose prices its coats above the average cost, confident in the reputation and recognition it’s built over the years. It’s an interesting example as many of the premium-priced retail brands are designer options, but the pricing here is based on the known warmth and durability of the products. These coats are everywhere in colder North American cities, with consumers happy to pay more for the perceived value.
Nowhere does premium pricing come with higher expectations than in the hospitality industry. Brands like Fairmont invest in exceeding standards at every level of their offering. The entire experience caters to premium tastes, from luxury suites to fine dining. Customers expect to be whisked away from the real world into the lap of luxury.
Successfully implementing premium pricing strategies will require flexibility in your accounting department. Teams may need to run multiple pricing experiments and require a subscription billing solution that can effectively handle the complexity of pricing models, billing frequencies, and deferral schedules. Get the basics right by investing in a solution that automates even the most complex billing schedules and empowers you to conduct as many pricing experiments as you like without causing unnecessary work for the accounting team.
With the advent of SaaS migration taking the world by storm, it’s no surprise that many companies are asking questions about handling recurring payments better. Many accounting teams are struggling to keep up with the increased usage of subscription billing models, failing to put in place the software and best practices they need to handle the sheer volume of invoices generated by offering a variety of billing cycles.
The management of recurring payments requires a firm grounding in compliance standards, the automation of time-sensitive and repetitive tasks, and a solid understanding of revenue recognition and deferral schedules. It’s a lot to master. The complexity of introducing a new payment strategy is simply part of keeping up with evolving customer expectations.
The growth of SaaS migration and billing options across industries means that few companies can afford not to put the right tools and best practices in place. Below you’ll learn nine best practices to help you manage recurring payments.
Modern billing models can introduce different revenue streams at varying frequencies. Some customers may pay for a year upfront, requiring you to defer the recognition of that revenue until you earn it. In contrast, others may spread the cost of their subscription over time so that you earn and recognize revenue in synch.
Flexibility is the key to success. Chances are that the more options you offer, the more users you will be able to sign up. However, it’s worth noting that introducing various options can strain the accounting department. Brief the entire team on revenue recognition for subscription billing to optimize their efforts and reduce manual labour.
With the rise of cyber-attacks, companies cannot underestimate the importance of protecting customers’ information (particularly regarding payments and billing) from any threat. Nobody is immune, so it would be remiss not to invest in security measures enabling you to collect and store billing information for recurring payments while maintaining your data integrity.
Many savvy customers will check the ratings of the payment portals and systems you implement, so be sure to consider the reputation of your partners. Partnering with established brands that customers recognize makes it easier for them to entrust their payment information to your system. Users will differ in their prioritization of this measure, but many will never sign up if the early stages of the payment cycle do not feel secure.
Have you ever signed up for a subscription service, only to find yourself wondering about a few things later? Maybe you aren’t sure about the service and want to double-check the cancellation terms, or you’re not entirely sure how refunds work, or perhaps you need to update your credit card information. Chances are the payment policies you ticked when you signed up covered all this, but you didn’t have time to read through them thoroughly.
It’s best practice to make payment terms and processes transparent on your website. The reality of today’s world is that there aren’t always enough customer agents on hand to answer all our customers’ questions. Building out knowledge bases, particularly around critical information like payments, will reduce the workload on your team by making most of the information customers require transparent. Measures like this help build customer confidence because they don’t have to suffer long wait times or engage with a defective chatbot.
Often, there’s a disconnect when communicating effectively with our customers concerning minor changes. With so much automation at the heart of SaaS migration best practices, it can sometimes be easy to forget the human aspect of things.
Significant shifts will occur as you hone your SaaS pricing strategies and respond to outside forces such as inflation. Every time there’s any billing or payment process change, you must invest in clearly communicating this to your user base. Inform them of tweaks regardless of how “inconsequential” you think these might be, for instance, security improvements, cancellation policy updates, new billing options, or a change of payment processor.
Failed payments are a fact of doing business. Whether the case is expired cards or a technical error, it still impacts your bottom line. Particularly with subscriptions, it’s critical to recoup as much revenue leakage as possible to bolster monthly recurring revenue (MRR). An effective dunning strategy enables your team to protect against revenue losses more effectively.
Modern billing requires effective dunning management to boost revenue and prevent involuntary subscriber churn. Solid strategies should include pre-dunning communications strategies to remind customers that upcoming payments might fail due to expiring cards. Check out this guide to mastering dunning management for a thorough breakdown of how it prevents revenue leakage and helps bolster your subscriber base against churn.
Effective reporting is a crucial component of successfully collecting recurring payments. With extensive user bases, it’s easy to lose track of subscriber churn, so companies should invest in software that automatically generates reports that reflect key churn metrics.
These numbers are essential for understanding growth and financial health and can be valuable tools for customer acquisition and retention. It’s possible but time-consuming to report on these metrics manually, although, for scaling companies, it may not be feasible to keep track this way. Are you seeing a sharp increase in churns after your free trial? Get curious and find out why. Chances are the churn rate is pointing to something your team has the power to fix.
One of the most significant improvements most companies need to make to their recurring payments is increasing the flexibility around billing frequency. Users will often be subject to different restrictions in terms of cash flow. For instance, smaller companies or individuals might struggle to pay an annual fee upfront, preferring to spread the payment over the year. More prominent companies might work with a fixed quarterly or yearly budget and choose to pay upfront.
The point is that your customers not only like but expect to choose. Offering flexible payment terms and frequencies allows customers to decide which day their payments occur. It is as much about reducing failed payments as it is about increasing customer satisfaction. It is also one of the best ways to ensure customers have enough funds available when the bill arrives.
Compliance with GAAP is one of the main concerns of most accountants. The introduction of ASC 606 and IFRS 15 concerning revenue recognition for recurring revenue may make some companies reluctant to take the plunge. Critical to achieving success is keeping track of earned and deferred revenue, and plenty of guidelines are available to ease your team into the transition. With transparent, auditable reporting in place, compliance doesn’t have to be complicated. Check out this guide to ASC 606 for a primer on the expectations for recurring payments.
It’s almost impossible to keep pace with modern billing without implementing subscription management software. Even the most agile teams will struggle to meet month ends if they stick to older accounting processes and systems. Your software should allow customers to pause payments easily, update billing information or upgrade to a different tier of services. All this functionality must integrate with the backend to update accounts automatically without causing unnecessary confusion.
Look for solutions that speak to the nuances of frequent recurring billing. Make sure you invest in software that enables dunning, streamlined reporting, flexibility around payment frequency, and automation of time-consuming processes that slow your team down. Check out the essential features to look for in subscription management software here.
In recent years, the hospitality industry has weathered massive disruptions. To stay afloat, businesses leapt into the subscription economy and adopted recurring billing strategies. Welcoming these innovations introduced a fundamental shift to relational business models, which allowed organizations to retain a steady stream of income even during lean months.
The hospitality industry is comprised of four different sectors: lodging, food and beverage, recreation, and travel and tourism. The most successful businesses centre on novel subscriptions that serve a specific niche within their sector and are taking full advantage of the benefits of a subscription business model, including increased customer lifetime value (LTV) and greater return on customer acquisition costs (CAC).
This blog explores the creative ways leading companies have incorporated hospitality subscription services by analyzing a modern-day example from each of the four sectors.
Interested in a specific sector of hospitality? Click on the example below to skip ahead.
When you think of hospitality, lodging is likely the first sector to come to mind. From hotels to vacation rentals, overnight accommodations for guests are an integral part of the industry. However, a lesser-known fact about this sector is that the pool of potential customers is expanding.
With the increasing prevalence of work-from-home options, some telecommuters have transitioned to a nomadic lifestyle. These “digital nomads” work remotely out of a new city every few weeks to months, necessitating frequent temporary accommodations. Extended stay hotels and multi-location hotel subscriptions are increasingly in demand.
Inspirato is a luxury travel club and one of a few emerging companies that are designed with the digital nomad in mind. The Inspirato Pass allows customers to choose a hotel from over 100 locations and stay for up to two months, replacing nightly hotel rates, taxes, and extra fees with the subscription fee of $2,500/month. Founded in 2010, the enterprise’s estimated value is $1.1 billion and boasts over 13,000 subscribers with 18% growth in the past year alone.
Often confused with the food services industry, the main components of the food and beverage sector include the preparation, transportation, and service of food or beverage to customers. These businesses tend to be some of the most successful and are frequently categorized into the overlapping industries of franchising and retail.
Hotel breakfast bars, catering companies, fast food establishments, cafes, pubs, and five-star restaurants all fit within this sector; however, paired with this ample opportunity is abundant competition. Panera’s coffee subscription is a notable success story within the food and beverage sector.
For context, Burger King attempted to get a leg up on other fast-food giants, like McDonald’s and Starbucks, by offering a daily small, hot coffee for $5/month. Unlike its one-cent whopper strategy, this one completely backfired, and the company discontinued the service shortly after it was introduced in 2019.
So, expectations were low when Panera launched its coffee subscription service for $8.99/month one year later, in 2020. However, Panera’s subscription included hot drip coffee, iced coffee, and hot tea once every two hours with unlimited refills while customers were in the cafe.
These bold differences expertly applied principles of pricing psychology, yielding wildly successful results. In May 2022, Panera unveiled a second subscription service, the Unlimited Sip Club, that offers an expanded variety of beverages for $10.99/month.
The recreation sector is key to the hospitality industry. Local attractions and entertainment play a vital role in providing memorable customer experiences and contributing to the region’s culture. The most common businesses in this sector include amusement parks, museums, art exhibits, zoos, and campgrounds.
These companies rely on admission tickets, merchandise, and concessions sales to generate revenue, which can be a tricky balancing act to pull off through the wax and wane of tourists. Therefore, many of these businesses offer hybrid subscriptions to bolster their income from locals, returning visitors, or guests who want to explore multi-location establishments.
Universal Orlando’s annual amusement park passes start at $23/month after down payment. These subscriptions cover admission and, depending on the tier, a benefits package that includes perks like preferred parking, merchandise and concessions discounts, and early park admission. Florida residents can also benefit from reduced rates for all tiers of annual passes.
Travel and tourism allow customers to experience destinations beyond their hometowns. This sector has the most crossover with its counterparts because it encompasses the entire experience of the trip, not just the transportation to get there.
Travel agencies are one of the most well-known organizations within this sector, often taking on the logistics and reservations for everything from booking flights to choosing a hotel to scheduling business meetings. The endurance of these businesses is attributed to a fact all too familiar to frequent flyers: coordinating travel plans can quickly become an arduous task.
Hotels that partner with Tripadvisor have the opportunity to tap into new customer bases and potentially increase their bookings. For $99/month, travellers can enrol as a member with Tripadvisor Plus and gain access to an array of bundled savings on hotels, food and beverages, and experiences. According to their website, customers save on average $350 the first time they use their membership.
Managing a subscription service can quickly get out of hand without the proper tools in place to handle huge amounts of data, adjustments to complex pricing strategies, and data-driven reporting. Unless you invest in the appropriate technological foundation, it will be nearly impossible to meet the goals of your growth journey. A robust subscription management solution, like Subscription Billing Suite, takes care of the nitty-gritty, freeing up your team to strategize. It’s available as an embedded extension in Microsoft Dynamics 365 Finance, Business Central, and GP.
The recent boom in subscription-based businesses led the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) to develop new accounting standards, ASC 606 and IFRS 15, to regulate and standardize revenue recognition.
Companies must now follow a five-step approach:
1. Identify the contracts with a customer.
2. Identify the performance obligations in the contracts.
3. Determine the transaction price.
4. Allocate the transaction price to the contract’s obligations.
5. Recognize revenue as you satisfy the relevant obligations.
It seems simple enough, but translating these accounting practices to a recurring billing model can become complicated quickly. This blog will walk you through five best practices that enable compliance with ASC 606 and IFRS 15, so you can expertly handle revenue recognition without the headache.
If you’d like an introduction to the topic or want to refresh your memory, check out our previous blog on revenue recognition for subscription billing before continuing. The following advice will help you tackle some of the more advanced aspects of accrual accounting.
Interested in a specific best practice for maintaining compliance with ASC 606 and IFRS 15? Skip ahead by clicking on the topic below.
One of the most important aspects of the five-step approach to revenue recognition is always to recognize revenue after satisfying the contract’s performance obligation(s). Recognizing the entire contract amount upfront before you’ve delivered the service counts as claiming unearned income.
If you claim unearned income, you could face hefty penalties for non-compliance and tricky situations if customers decide to complain, cancel their subscription, or ask for refunds. Maintaining an accurate revenue deferral schedule via an adjustment account is ideal for mitigating this risk.
An adjustment account is a summary account in the general ledger that records internal events rather than business transactions.
Creating an adjustment account to track deferred revenue allows you to accurately recognize revenue as you fulfil the performance obligation(s) and treat unearned income as a liability.
Company A has secured an annual subscription with a client at a flat rate of $18000, and that the client will pay the total upfront. Company A cannot recognize the full $18000 until the service has been provided, so the amount must be evenly divided across the term of the contract: one year.
For the first month, Company A can only recognize $1500 and the remaining $16500 must be booked in the deferred revenue account. For each subsequent month, Company A must credit the deferred revenue account and debit the sales account $1500.
Subscription services often implement pricing models where the quantity or price will fluctuate. Usage-based billing and bundling are particularly common pricing models that require SaaS companies to account for variable consideration.
To maintain compliance with ASC 606 and IFRS 15, you’ll need to record an estimate of the amount considered. At the end of each reporting period, you must revise the estimates and adjust any resulting changes to the transaction price. Detailed below are two methods commonly used for estimating the value of consideration.
The transaction price is determined by summing the probability-weighted amounts of a range of possible outcomes. This method is most appropriate when the reporting entity has many contracts with similar characteristics, such as when a company implements the portfolio method of aggregating customer contracts.
However, companies are not obligated to use the portfolio practical expedient. Management is responsible for making reasonable estimates and applying them to numerous similar contracts such that the aggregate value of revenue must equal the sum of the expected amounts from the individual contracts.
The transaction price is decided as the most likely amount to be received. The best use case for this method is when there are only two possible outcomes because the expected value method is likely to return a significantly different value than the possible outcomes.
Company B offers a support plan with three usage tiers. They charge $1000 if a customer uses under 10 hours of support, $2000 if the customer uses 10–20 hours, and $3000 if the customer uses over 20 hours of support over the contract term.
Company Y is interested in purchasing this support plan. Company B has worked with Company Y for many years and knows that they have a 10% chance of using under 10 hours, a 60% chance of using 10–20 hours, and a 30% chance of using over 20 hours. By summing the probability weighted amounts, they determine the expected value of the contract will be $2,200.
The value of the estimated consideration can only be included in the transaction price “to the extent that it is probable that significant reversal … will not occur” (606-10-32-11).
Determining whether the estimate must be constrained involves significant judgement and must include assessment of the likelihood and magnitude of revenue reversal. Many companies will consider this constraint while calculating the estimated variable consideration.
Recommended reading: What you need to know about ASC 606 for SaaS companies
There are many reasons why customers are unable to pay for goods and services, even after the due date. Bankruptcy, trade disputes, and fraud are a few cases where the amount owed is irrecoverable. So, what do you do if a customer doesn’t pay?
When a customer has not paid even after repeated dunning letters, the amount is deemed uncollectible and written off as bad debt. The amount is adjusted against your monthly recognized revenue during reporting to ensure that your receivables are not overstated in the financial statements.
You have entered an annual contract of $24,000 with a customer for a subscription service in the month of January. Unfortunately, in May it is determined that the customer cannot pay the amount despite repeated dunning requests.
In your financial statement, you will add a credit entry that zeroes out the receivables balance and a debit entry to ensure that the irrecoverable revenue is not recognized in the income statement.
Performing routine revenue analysis will provide you with a deeper understanding of the distribution of earned and deferred revenue across different channels, allowing you to make data-driven decisions and maintain accurate accounts.
Especially in a transaction with multiple deliverables, it’s vital that you implement tools, like multiple element revenue allocation (MERA), to separately track and evaluate each revenue stream.
A typical revenue analysis for a subscription business breaks down revenue sources into three channels; subscription revenue, revenue share from partnerships, and referrals. Within subscription revenue, you can further classify data based on a metered or fixed rate by subscription, customer, and plan.
Recommended reading: Calculating subscriber churn metrics for SaaS companies (with examples)
Financial statement disclosures are more rigorous under ASC 606 and IFRS 15 than under previous revenue standards. The image below outlines the different annual revenue disclosure requirements for public companies.
To bring transparency and clarity to your financial statements, disclosure requirements entail gathering additional explanatory information that covers the amount, uncertainty, timing, and overall nature of cash flow associated with contracts with customers.
Private companies are not obligated to provide certain disclosures, and the requirements for interim periods are significantly pared down.
It is not mandatory for private companies to disclose:
No matter which subscription pricing model you implement or how frequently your bill your customers, a robust subscription management solution can make all the difference when handling complex revenue recognition.
Keeping track of deferral schedules and appropriately handling revenue allocation can become increasingly difficult if you’re relying on manual processes. Subscription Billing Suite ensures that your accounts are accurate, and your invoices delivered on time.
SaaS product pricing is one of the essential questions presented by digital disruption. As companies migrate operations to the cloud, pricing has only grown in complexity. Regardless of industry or location, it’s challenging to effectively transform products or services into reliable recurring revenue streams that enable scalable growth.
The options are almost endless, so teams must take a nuanced approach when considering the value of what’s for sale and their go-to-market strategies. No two plans will be the same. Unlike traditional pricing methods, a competitive analysis will only get you so far, particularly in industries where SaaS pricing disrupts customer expectations. The old rules no longer apply, and pricing should differentiate you from the competition rather than match the market.
Profitability will depend on your ability to understand the value of your offering and add value where it matters most. SaaS product pricing is as much about services as software, so most companies need to rethink how they approach everything from sales incentives to market research and even customer service.
SaaS migration is a complex process that requires strategic insights and flexibility. There are no one-size-fits-all solutions. The content below explores essential factors for getting the price right, but it’s not a template. Instead, companies should use these as guidelines for a deeper conversation around product pricing.
One of the core tenets of effective SaaS product pricing are the SaaS pricing models. Although the finer details of your pricing strategy will come later, it’s wise to familiarize your team with the most popular strategies up front so that you can make an informed decision about which models might be effective for your products and services. Fully understanding the pros and cons of each strategy should help you decide which one suits your needs, and it can be easier to consider the many other factors involved in pricing once you’ve an idea of the kind of billing model you want to implement.
Rather than simply copying what your competitors offer, consider the customer first. Would they prefer monthly or annual billing? Or perhaps a mixture of both? Does it make sense to charge them based on usage and do you think you could cost-effectively run a free trial? It’s hard to really understand the implications of each of these strategies without first briefing yourself on the common pricing models, which is why we’ve included a guide to each one below. Step one should be to brief your team on the strategies that align best with your products and services, so you can start narrowing down your options and making some decisions about pricing and billing structure.
One of the core components of any effective SaaS pricing strategy is perceived customer value. It doesn’t matter what you think your services are worth if your customers don’t also see the value in what you’re offering. Even more so than in traditional models, the perceived value of your products and services must be central to any conversation around price. It should be a higher priority than your billing model, the features, and competitor pricing.
Conduct a deep dive on your target customers and build buyer personas to guide your subscription strategy decisions. At all times, you need to advocate for these personas and understand what they get when they pay for your services, i.e. what pain points do you remove and the core benefits of your product. Understanding how much customers gain in measurable value from your services will make it easier to narrow your price range to something that best fits the target personas.
Several churn metrics will be part of your SaaS product pricing journey, particularly as you tweak pricing over time. However, it’s wise to focus on just two in the initial phase: Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC).
Even rough estimates will influence your sales strategy, and knowing the projected value of a new customer over time will impact the amount you can spend on customer acquisition. LTV needs to be substantially higher than CAC for your pricing to be effective. As common sense might dictate, you need to make more from a customer over time than you spend on acquiring them.
Those used to more traditional sales may want to create awareness that customers often spend minimal amounts upfront for their subscriptions in the SaaS world. Sometimes revenue and acquisition costs won’t align in the first months of a new product launch, and finance teams need to focus on the long-term projected revenue. Otherwise, they risk setting too high entry-level prices to attract a substantial market share.
When deciding how to price SaaS products, it’s essential to understand the role psychology will play in the customer journey. Whatever pricing you decide on, convincing customers of the value and getting them through the sales funnel will require effective implementation of UX and pricing psychology tricks. Not all these methods work for every strategy, but some combination will likely help you successfully launch your SaaS product pages.
It’s also worth spending time considering the transformation for sales. Pricing often directly correlates to bonuses and incentivization programs in traditional pricing models, and with SaaS products, this may have to shift. People are the heart of organizations, and you need to include them in pricing conversations, particularly in departments like sales that the transition will directly impact. It’s better to have sales teams in these conversations and work together to reimagine how SaaS migration will transform roles and payment structures.
Companies default to pricing based on features or product descriptions, often forgetting one of the most valuable components of their offering—people. If you intend to offer customer support and training, you need to include these services as a product feature when calculating how much you can charge. You’d be surprised how valuable the service side is over time. Chat support, knowledge bases, learning centres, and implementation managers are all resources customers will value.
Before you set the price of your product, ask yourself how you’re charging for support and maintenance. Question whether or not you’ve conveyed the value of the service side on your product pages. Excellent customer service may end up being what differentiates you from your competitors.
It’s best to exercise caution when experimenting with freemium pricing or significant discounting. Sometimes these can be good techniques to secure market saturation or as part of a market penetration strategy. However, these strategies run the risk of creating a lower perceived value for your product and services. It can also be challenging to service a large influx of new customers if you estimate conversions inaccurately and find that more people are taking advantage of free or heavily discounted services than you intended.
Being wary of too many new customers might seem counterintuitive. Yet, if users do not receive the right quality of service or training, you may find higher than anticipated churn rates. It will be much more challenging to chase leads who’ve already trialed your service and had a bad experience. It’s much better to think about pricing from the ideal customer’s perspective (presumably someone who pays for your services and products) and limit discounts and free trials.
It’s relatively common in the history of companies to copy competitors. Yet, this approach lacks the strategic edge required to handle the levels of disruption industries are seeing today. It’s not that you shouldn’t take inspiration from what others have done before, but there’s wisdom in looking in unlikely places for ideas that might help you differentiate your SaaS product from all the rest. A hybrid approach to pricing allows you to mix and match between different billing models, frequencies, and psychological tactics, adopting a tailored strategy that best first your product and services.
Once you’ve decided on a price or a range of prices, it’s time to determine how to implement your new strategy. You will need to build out collateral and product landing pages, but there’s also the back-end to consider. You will need the right tools to make the most of your pricing tactics and partner with a company that has experience handling more complicated pricing and billing models.
Subscription Billing Suite allows you to handle the complication of SaaS pricing models for revenue recognition and deferrals. So, whether you want to bill your customers monthly, quarterly, or annually, it may just be the solution for you. Why not find out more in the case study below.
As expectations continue to rise, companies will continue to undertake projects aimed at building relationships with subscribers and adding value to the user experience like creating personalized onboarding tutorials and videos, optimizing the mobile experience, and introducing advanced platform feature notifications. SaaS solutions that empower other businesses to create tailored tools and content can tap into a segment of the market that will likely yield an incredible level of interest, engagement, and revenue growth.
While evolutions in technology open the door for companies to adopt shiny new features and embrace the latest gizmos and gadgets, the beating heart of SaaS remains the loyal subscribers. From innovators to laggards, the point of all these trends and advancements is to make things easier for customers. Above all else, you must keep a clear head and advocate for innovations that will maximize subscriber retention and minimize churn.
Modern SaaS companies rely on subscription management software to offer complex pricing models and ensure that their business runs smoothly; however, it’s not always easy to determine which partners will be a good fit. It’s critical that you look for teams and consultants that understand the nuances of the SaaS landscape and prioritize subscriber retention.
Once you are connected, they’ll be able to make relevant recommendations and it will be evident whether their solutions can support your growth. Even if they can’t share the names of companies they work with, they will be able to provide relevant information based on their industry experience. Speaking with others about their experience partnering with the company should also be possible.
Read our recent blog to learn more about the pros and cons of SaaS migration and download our whitepaper for tips to navigate the future of the rapidly evolving SaaS industry.
Deciding whether to implement an annual or monthly billing cycle is one of the most challenging aspects of migrating to recurring revenue streams. Yet, it’s an integral part of choosing the right subscription billing strategy and cannot be ignored. You may struggle to understand which billing frequency is best. You may even find yourself asking a lot of questions. For instance, what if some customers prefer annual and some prefer monthly? Would some subscribers want a hybrid approach?
One of the most important secrets of successful pricing psychology is giving audiences enough choice without overwhelming them with options. It’s not unusual for customers to have different preferences, and as a result, it’s best not to approach the puzzle of billing frequency with an either/or mindset.
Often, brands ignore pricing psychology and instead opt for whatever is easiest for the accounts team to implement. Worse still, some decide based solely on what their competitors offer. Although this is a standard approach, it fails to put your customer’s expectations front and center. This risk may result in high churn rates and will not allow you to tap into the full benefits of building a subscription base.
Studies show that only one-fifth of SaaS companies let their customers choose between monthly and annual payments. A surprising number for an industry built on customer-centric innovations. Options are essential at most stages of a customer journey and never more so than when it comes to payment. After all, a well-executed strategy can increase your customer acquisitions.
Depending on your subscription billing model, bi-monthly or quarterly billing may make the most sense for your target audience. You might want to implement a strategy that breaks down the cost of monthly payments with an annual fee paid upfront (this approach requires you to understand revenue recognition best practices).
This blog explores multiple subscription billing frequencies (detailing more than just the most common conversation around monthly vs annual billing cycles). Learn the nuances of this aspect of subscription management to decide what works best for your customers.
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Billing frequency is always equivalent to the length of a billing cycle. The period billed to the account is set out in the user contract. For instance, if users subscribe to a monthly service, their billing frequency will be monthly and reflected in the billing clause of the service contract.
The most common billing frequencies are monthly and annual billing cycles. However, given the sheer range of services moving to the cloud and launching subscription strategies, there’s been an increase in frequencies. Many find that quarterly, bi-monthly, or even super-frequent billing better suits the expectations of their audience.
An annual billing cycle covers the cost of an entire year of the service in a single yearly payment. In the instance of subscription billing, the customer is locked into an automated cycle, which will bill them once a year unless they cancel. Annual subscriptions are common across a wide range of billing models, for instance, it can be a particularly effective frequency for hybrid and user-based strategies.
A monthly billing cycle breaks the annual cost down into monthly recurring payments. Generally, customers can cancel at any time as it doesn’t lock them into a year-long contract. SaaS companies with tiered and feature-based billing often use this as their core billing frequency.
A quarterly billing cycle breaks down the cost of the service in 90-day periods. It’s not always aligned with quarterly calendars and can depend on sign-up periods or vary according to when a company accounts for year-ends. It’s particularly effective for utility companies who engage a usage-based billing model and is equally popular with some insurance companies.
A bi-monthly billing strategy is a high-frequency approach that bills users twice a month. It can be problematic as months vary in length, meaning payment dates might not always align. It can be tricky to implement effectively.
A super-frequent billing strategy may bill customers more than twice a month, and in some (unusual) cases customers might be billed daily. It’s highly variable and best suited to companies with an extremely short user lifecycle. Smaller companies often rely on super-frequent billing in the early stages as cash flow might be stagnant otherwise. However, it should be noted that this requires high levels of admin and may result in a frustrating user experience. Meal plan subscription boxes such as Hello Fresh tend to use super-frequency billing cycles.
An annual plan paid monthly means that the user commits for the entire year, but the bill is paid on a month-by-month basis. Customers are usually rewarded with an additional discount than say a typical monthly payment (where it’s easier to opt out after 2-3 months) plan because they’re contracted to a year of service.
As you can see, both billing frequencies have a range of advantages and disadvantages. As a result, the final decision comes down to the type of service you offer and the market you’re targeting. It may also be wise to step outside the annual vs monthly debate and embrace one of the other billing frequencies mentioned about (i.e., super-frequent, bi-monthly, or quarterly). Even so, annual and monthly billing are the most common frequencies for a reason, and many customers will expect to be given these options at the very least (particularly when it comes to SaaS).
Many B2B companies targeting corporations will find that annual billing may be a better choice as this suits the customers they want to attract. In contrast, a B2C company or a B2B company targeting smaller businesses may want to consider the monthly billing frequency as it may be more attractive to their customers.
However, most companies won’t fall easily into these two brackets, and even within these examples, there will be notable exceptions. As a result, most SaaS companies find that a hybrid approach is best. Given the diversity of the pros and cons of each frequency, there’s no reason not to offer both. Each billing cycle frequency will appeal to a different target market. Offering a hybrid allows you to lower the barriers of entry and increase customer conversion by merely giving users more choice.
As you can see there are no easy answers when it comes to annual vs monthly billing cycles. Both billing frequencies have a range of advantages and disadvantages. As a result, the final decision comes down to the type of service you offer and the market you’re targeting.
Many B2B companies targeting corporations will find that annual billing may be a better choice as this suits the customers they want to attract. In contrast, a B2C company or a B2B company targeting smaller businesses may want to consider the monthly billing frequency as it may be more attractive to their customers.
However, most companies won’t fall easily into these two brackets, and even within these examples, there will be notable exceptions. As a result, most SaaS companies find that a hybrid approach is best. Given the diversity of the pros and cons of each frequency, there’s no reason not to offer both.
Each billing cycle frequency will appeal to a different target market. Offering a hybrid allows you to lower the barriers of entry and increase customer conversion by merely giving users more choice.
Choosing the right billing frequency is only part of the subscription management puzzle. It’s important that you fully understand best practices for revenue recognition and deferral schedules, as well as terms like dunning. One of the biggest challenges you will face will be meeting compliance standards such as ASC 606. Below is a short list of resource that will provide you with the relevant information you need to take the next steps.
1. Understanding revenue recognition for subscription billing
3. Everything you need to know about ASC 606
4. Master dunning to reduce recurring revenue leakage
Choosing the right billing frequency is only part of the pricing puzzle. Make sure you read our complete guide to the various SaaS billing models and strategies to get the full picture.
Like any other form of payment, recurring billing has its own unique challenges. Subscription services lose roughly 2% of customers each month due to expired credit cards that aren’t updated. When you start to factor in failed payments caused by spending limits, insufficient funds, payment gateway glitches, or cancelled credit cards the involuntary churn rate accounts for a sizable revenue leak.
Dunning is the process of communicating with customers to recoup such losses. Despite a negative public perception, modern dunning management can contribute to a positive customer experience and significantly increase your monthly recurring revenue (MRR).
Whether you’re implementing a SaaS billing model for the first time or simply trying to ramp up your monthly or annual recurring payments, effective dunning management will be central to your success. This blog answers some of the most frequently asked questions about dunning, so you can master the process to mitigate revenue leakage and involuntary churn.
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It’s normal for businesses to encounter a failed payment at some point. Whether it’s due to insufficient funds, a misconfigured payment gateway, or an expired credit card, you will need a way to recoup your monthly recurring revenue (MRR). Dunning is the practice of communicating with customers to recover lost revenue from failed payments and reduce involuntary subscriber churn.
Although the term “dunning” is still used in accounting, people who work in other departments might explain the same concept using terms like “accounts receivable” or “collections process” instead. For instance, dunning management can be found under the credit and collections feature and optimized with collections process automation for Microsoft Dynamics 365 solutions.
A dunning letter, or collection letter, is the collection notice sent to customers informing them that their last payment has not gone through. Modern subscription businesses rarely contact their subscribers via paper letters, opting instead for digital communication methods like email, SMS, or app notifications.
There are many templates and programs online that can help you generate a dunning letter. Here’s a helpful guide to walk you through creating a collection letter through the accounts receivable feature in Microsoft Dynamics 365.
Voluntary or active churn results from customers making the conscious decision to unsubscribe from your service. Typically, the subscription is cancelled because the service no longer fulfils the customer’s wants or needs.
Involuntary or passive churn occurs when a customer’s subscription is cancelled because something is stopping them from paying. This type of churn accounts for a sizable portion of preventable revenue leakage because the customers often don’t want to unsubscribe—they just aren’t presented with a clear option to fix their payment issue.
Subscriber churn is an unavoidable obstacle that every SaaS business must handle. Fortunately, effective dunning protocols can recover on average 9% of your MRR. Dunning management empowers you to proactively reach out to customers to update their payment method, prevent service disruptions, and facilitate an overall positive customer experience—reducing revenue lost through involuntary churn.
Pre-dunning is the practice of sending reminders to customers that an upcoming payment may fail unless they update their information. There has been an open debate about whether customers perceive this tactic as helpful or annoying.
Pre-dunning used to be a best practice, but in recent years it has started to fall by the wayside as subscription businesses have become more popular and there are more options for preventing failed payments behind the scenes. For example, some SaaS companies may communicate directly with issuing banks to automatically update customers’ credit card information.
Nevertheless, there are still a few scenarios where pre-dunning may be appropriate for your business. It has shown to be effective in the following three circumstances:
According to the Subscription Commerce Conversion Index, the average subscriber holds five different retail subscriptions. It’s safe to say that your customers may struggle to keep track of all their subscriptions and need a reminder to update their payment details. A best practice is to remind them 30 days before and, if they haven’t taken any subsequent action, 7 days before their card expires.
Oftentimes, the longer the duration between payments, the higher the risk of it failing. Businesses that offer billing cycles with bi-annual, annual, or longer options may benefit from pre-dunning to ensure that the customer’s payment method and details are still accurate.
Whether or not your business collects billing information during sign-up, it’s a good idea to establish transparency early in your relationship with the customer. A quick reminder that states when the free trial will end, the amount you will start charging, and the due date for the first payment will help avoid angry customers that simply forgot to cancel their subscription on time.
Manually addressing every customer’s declined or failed payments is an impossible task that would waste valuable time and resources. The only worse solution would be to not contact your customers at all. Automated dunning management (a.k.a. collections process automation) streamlines the process by performing actions like:
In addition to saving your accounting team hours combing through accounts and drafting dunning letters, automated dunning management counteracts involuntary churn by contributing to a positive customer experience. Below covers the top three features that benefit subscribers.
Subscription services have gained a reputation offering peak convenience, but when a payment fails, customers may become frustrated and churn for a few reasons:
Automatic retries with a customizable schedule can address all these concerns and minimize unpleasantness by reducing the frequency and degree to which the subscriber needs to get involved. Fewer barriers to paying for services means more happy customers.
Manually drafting dunning letters for every customer with a failed payment is not only a time-consuming process, but also is prone to error. Sending a collection notification riddled with typos or mixing up which past due invoice email to send to which subscriber can make your business look unprofessional. Automated dunning management organizes customer communications to facilitate enhance customer relations. Some solutions can even make the reminders more friendly by adding personalized touches like the customer’s or business’ name.
A statement of accounts and accounts receivable aging information is indispensable for assessing the financial health of your customers. Without good data management, it’s much harder to strategize feasible methods for decreasing outstanding payments and mitigating bad debt. Automated dunning management generates accurate customer aging reports that provide insights like the number of failed payments, renewed subscriptions, upgrades, and suspended accounts.
Since 2019, there’s been a rapid increase in cloud adoption, with companies increasingly turning towards both using and offering SaaS solutions. Recent reports document the number of SaaS apps used by companies based on their size, showing that those with over 250 employees use over 251 apps to do business. A significant number that indicates the increased complexity of doing business requires the widespread adoption of this technology.
The trend of SaaS migration is referred to in different ways: SaaSification and SaaSify are two common variations. But whatever you call it, the fact remains the same, companies today have little choice and those that don’t adapt, may find themselves falling behind. Although most companies prefer SaaS solutions themselves, many are slow to adopt is as a business model for their own solutions.
It’s understandable as the transition is complex and requires a great degree of planning and consideration. It involves every facet of your organization to make significant changes, and companies need to map their SaaS migration before they ever get started. One of the first steps to creating this map is to first understand the pros and cons of the transition so that you can get buy-in at every level of your organization. Because this transformation will involve everyone from sales to development, it’s important that everyone understands what’s involved.
This blog explores the pros and cons of SaaS migration for those looking to make the transition with their products and services. Get a clear-sighted view of what to expect and the common challenges you’re likely to face. When it comes to SaaSifying your offering, preparation is key, and there’s no better preparation than knowledge.
One of the core reasons companies transition to SaaS is the benefits of having a more predictable monthly income. Particularly in the current economy, where disruption can destabilize organizations at the drop of a hat. Companies can create a robust payment ecosystem that makes scaling growth more predictable by implementing this business model.
One of the ways to do this is to pay close attention to churn metrics. This information helps build sustainable revenue streams, allocate resources, and forecast income more predictably. By using these, good data management, and best practices for dealing with recurring revenue streams (e.g. automating revenue recognition and deferrals), you can alleviate some of the pressure on your team.
Further reading: 10 best practices in data management for finance teams
Traditionally, software development companies might spend months building relationships with prospective clients. Terms need to be negotiated, price settled on, scope and customizations defines, and implementation timeframes established. With the shift towards SaaS solutions, things have sped up considerably. Often all the information a customer needs is available on your website, with transparent pricing tiers, accessible demos, and clearly defined SaaS contracts all just a few clicks away. Many companies balk at the idea of giving this much control to the customer, but the fact remains, that if you don’t, your competitor will.
Figuring out how to operate in an economy where the customer expects to be able to make the decision without ever meeting you can be daunting; it means a sizable investment in UX and less traditional methods of sales enablement. But the advantages far outweigh any challenges here because you’re effectively enabling rapid scaling by taking a process that once took months and, in some cases, reducing it to minutes.
One of the issues many software companies face is building customized solutions for certain clients. The cost of development can quickly add up, and it can limit your team’s ability to scale DevOps because they’re simply trying to keep pace with what’s been promised and reach the implementation deadlines.
With SaaS business models, you can price customizations so that customers will be happy to choose one of your standard options. It’s not that you won’t offer any customizable option; it’s just that by limiting these to higher tiers, you can charge appropriately for developing unique features. Overall, it will cut down on time spent negotiating and allows you to invest resources in better customer services and add valuable features to your core products faster.
It’s important to note that getting the balance right means knowing your audiences and building out the features and functionality that are most important to them at each level. Often companies implement a hybrid pricing strategy, combining elements of both tiered and feature-based pricing to best meet their customer’s needs. If you’re not sure where to start with market research, check out this guide to choosing the right subscription strategy for your company. It details the information you will need to price your services accordingly.
One of the biggest takeaways from the past few years of doing business is that disruption is constant. Regardless of your industry, companies need to be poised to pivot at a moment’s notice. A state which is not limited to internal operations but includes your products and services. Regardless of what you sell, you need to be able to embrace a permanent state of innovation. Whether that’s building a financial transformation backbone, embracing DaaS strategies or tweaking the tiers in your subscription-pricing strategy based on user insights. Migrating to SaaS means equipping your team with the tools they need to survive, regardless of what happens to the market.
SaaS business models allow you to position your products and services to build a broader customer base and scale your growth. Traditionally, long implementation timelines and significant upfront investments hampered the progress of software companies. By moving your offering to the cloud and allowing customers to self-serve, you can build a more transactional product that can lead to more sustainable growth.
Pricing psychology tactics allow you to grow conversions, and freemium or penetration pricing strategies can help you break into saturated markets. If you’re curious about how to market to a wider audience using these tools, check out the following guides: 4 secrets to better subscription pricing psychology.
Prior to the introduction of SaaS solutions users had to install software updates on their own, meaning software providers often needed to assist them and maintain security for versions of the software they were trying to phase out. New releases had long implementation timelines, with some customers stubbornly remaining on older versions for months, if not years.
With SaaSification of your products, feature updates and releases can be implemented across all customers, allowing you to focus on fixing bugs and creating training tools. It’s also possible to do phased releases, rolling out a test version of certain features to trusted customers before making it available to the entire customer base.
SaaS gives you enough control to implement changes in the way that works best for your organization without introducing a cumbersome workload. Most find this flexibility allows their team more time to innovate and improve these updates because there’s no need to provide as much change-management support on the implementation side.
SaaS migration impacts every fibre of your organization. It’s one thing to move your solutions to the cloud, and it’s another thing entirely to poise your team for what will often mean significant changes for their day-to-day workload. From the front office to back-end accounting, prime your entire team for what will inevitably be a cultural transformation. Communication will be critical and is one of the core transformation challenges companies face. Leaders need to sit with each department and troubleshoot what this transformation will mean daily, allowing for better insights into handling the shift to a more agile mindset.
Failure to manage this change can result in high customer churn rates. These can result from many things, but one of them may be customer service which needs to be adapted to meet the demands of any SaaS migration. By keeping a close eye on performance during the shift, leadership will be able to bolster operations where it’s needed the most and enable success wherever gaps appear. Check out this guide to building a comprehensive roadmap for financial transformation.
One of the core challenges companies face when SaaSifying their products is moving away from large upfront payments. Often these “deals” are a large part of how compensation for the sales team is structured, with bonuses and incentivization often tied to the amounts negotiated. Before transitioning, teams need to address the new approach and what it will mean for these payment structures. There will need to be a shift to upselling and renewals, so motivating your team will require incentivizing these actions.
Companies can devalue renewals, but often they require just as much work (if not more!) than landing a new client. Leaders should resist the urge to discount such efforts and take the time to develop new ways to engage their sales department and ensure they’re motivated to hit targets. It’s also essential to work with the team closely to help them manage the upheaval. For instance, those who’ve established workflows for several years may find the change daunting and stressful. Often, it’s just a matter of preparing them adequately and making sure they understand there’s plenty of support to help them succeed.
Moving away from upfront sums means that those migrating to SaaS business models need to be aware of the changes to billing and will require robust recurring billing processes to handle what may be quite a large influx of new customers. Ignoring this back-end detail can result in accounts teams being swamped by end-of-month and unable to invoice customers in time. Setting up recurring billing to automate many of these processes will be central to SaaSification success.
Management also needs to be mindful of operational expenses and keep track of churn metrics to tweak their offering until they’ve maximized monthly recurring revenue. These types of considerations are our bread and butter, so here’s a list of resources we recommend diving into for a better understanding:
One of the biggest challenges facing companies in recent times is security. With SaaS products and services, there’s often a substantial amount of data collection. Teams require a briefing on data regulations for all regions (as they can differ, for example, GDPR in Europe is quite different from privacy policies in North America) and your data protection guidelines and policies.
Critical data must be protected in every eventuality, and the safeguarding of sensitive information is paramount to any software company’s ability to grow. For instance, security is one of the core considerations scrutinized in any merger and acquisition process. Highly regulated industries such as finance or healthcare may require a considerable investment in securing your data. Failure to do so may result in crippling fines and data breaches. There’s also the requirement that you invest in robust tools to protect sensitive data, which can vary based on industry.
Further reading: 5 steps to reduce and address security risk in mergers and acquisitions
Most companies tend to use various SaaS providers, and they often look for solutions that integrate easily with their existing tools. It can be challenging for you to scale the use of your products and services if they don’t easily integrate. One of the easiest ways to increase accessibility is to join open data initiatives, publishing well-documented APIs that allow companies to integrate your SaaS tools.
It’s also worth considering what kinds of files your systems export. Ensure there are plenty of commonly compatible formats such as Excel, CSV, etc. Development teams working on SaaS solutions need to keep integration front and center when introducing new features. Even novel features will go ignored if not easily integrated into project flows.