Pricing can make or break a company. It is mission critical you get your pricing strategy correct which includes free trials, how much to charge, if you should offer discounts, and how often to bill customers. Monthly billing plans are the most common among recurring revenue businesses, but annual billing plans offer benefits for both your company and your subscribers.
In today’s blog you’ll learn how annual billing:
- Increases cash flow
- Creates more stable, predictable revenue
- Reduces churn
- Can benefit your customers
We’ll also discuss how to determine if annual billing is right for your company and how to incorporate annual plans on your pricing page.
Before we dive into the benefits, let’s review the most common ways to bill annually:
- The subscriber commits to an annual contract, but pays monthly
- The subscriber pre-pays and they pay annually (or multi-annually)
Now, to the good stuff…
Advantages of Annual Subscription Billing
Increased Cash Flow
It is important to note an increase in cash flow doesn’t necessarily equal a sudden boost in revenue. This is due to the specific revenue recognition scale subscription businesses follow.
“Time power of money…all things being equal you want money now instead of money later,” advises Daniel Hekier.
Growth requires cash. When subscribers pre-pay and you have cash upfront, that money can be reinvested into your company and product.
Saasmetrics founder Leo Faria gives a good example of the power of increased cash flow from annual billing:
His example is based on a hypothetical subscription-based business with a $4,000 CAC (Customer Acquisition Cost). The subscription fee is $480 per month. The example focuses on a 12 month period (with the understanding that the retention period would ideally be much longer).
“Note the classic problem: all the cash invested on customer acquisition must be spent in the first month, while the revenue comes over a long period.” You can see from the graph, above, the company would have negative cash flow until Q4.
But, if that same subscriber pre-paid for the year the company would receive $5,760 upfront:
In both scenarios the CAC is $4,000, but in the pre-paid annual billing scenario “you don’t get negative cashflow. Actually you get a $1,760 balance that could be use to finance the acquisition of more customers,” points out Faria.
In the graph below, Tunguz plots the cash position of a hypothetical startup over a 24 month period based on monthly, quarterly, bi-annually, post-pay annually, and pre-pay annually billing structures:
At the 12 and 24 months points, the cash positions converge, but note the huge differences in cash throughout the rest of the time frame.
“It’s plain to see that annual pre-pay is the most advantageous position for the company. In the annual pre-pay scenario, the company generates negative working capital. Customers are financing the company’s growth by lending the startup money at effectively zero interest. The startup can take that capital and double down on growth if it makes sense for the business, a luxury the other parallel financial universes don’t allow,” explains Tunguz.
Creates More Stable, Predictable Revenue
Predictable revenue is one of the primary reasons businesses are switching to a subscription-based business model in the first place. We’ve previously discussed the rise of subscription billing in marketing and ad agencies, more traditional industries, and even billion-dollar retailers that are making the switch.
Annual billing takes predictable revenue even further, which allows for long term planning and business stability. ChartMogul’s Annie Musgrove states that “with the predictable revenue of a subscription model made even more predictable through a year-long commitment, these companies can more confidently forecast and make decisions concerning their growth down the line.”
When users commit to a year with your product, your customer success team has more time to help customers see the value of the product. And when customers perceive value in your product, there is less churn.
This is especially helpful in cases where it will take some time before customers start seeing the results of using your product, such as with CRM platforms like Hubspot.
“With the higher retention rate, the company also retains the money it spent in acquiring those customers in the first place. In this way, annual billing stabilizes or lowers Customer Acquisition Cost, and in turn, helps increase Customer Lifetime Value,” says Musgrove.
Ideally, during the year the subscriber has committed to being a customer, your customer success team will not only help the customer get to their “aha moment” where they’re experiencing the value of your product, but also provide the positive customer experiences that lead to having happy customers. Happy customers renew their annual subscriptions, champion your product, and refer new leads, which also reduces CAC:
“My experience is that customers tend to view an upfront annual payment as a sunk cost. This means they will probably have taken more time to make their purchase decision but will also make more effort to get the most from their purchase,” writes Jonathan Gettinger, CMO at Spoken Communications.
The caveat here is that you need to make your product worth a year-long commitment and be able to demonstrate that worth. Knowing customers may take more time to make a purchase via annual billing you may want to provide longer trials, more in-depth demos, etc.
If you have a large portion of users who are unwilling to commit to an annual plan, treat that as a red flag and dig deeper into the issues.
Yes, annual recurring billing has benefits for you and your customers!
Most companies offer a discount (usually 10-20% off) to entice customers to purchase annual plans vs. monthly plans. Customers like the added value, the ability to budget, and the stability of annual commitments. Some customers opt for multi-year deals in order to be able to fix their costs.
Jason Lemkin points out larger customers and enterprise companies “paying larger ticket sizes need to go through procurement. They don’t really want to pay monthly,” so annual billing is particularly attractive to those customers.
Overall, annual billing simplifies billing for customers — something every customer can appreciate, regardless of their budget or company size.
HubSpot only offers annual plans and addresses the benefits of annual billing for customers right on their pricing page:
“Bottom line: Annual contracts make happier HubSpot customers. And we want you to be happy.”
Before you change your pricing page…
Annual Billing Isn’t For Everyone
Here are a few things you should consider:
- Who is your target market?
- What is your ARR?
- How robust are your support and sales teams?
Target market. If you are a B2C or a B2B targeting SMB’s, be aware that the higher price of annual plans can be an adoption barrier.
ARR. Steli Efti advises if your company’s ARR is $1MM or less, you should “keep your customers on monthly plans. Why? Because you want to understand churn first and see how long people stick around by choice and learn from that process.”
Support and sales teams. “Onboarding new customers with annual contracts is also expensive, and you’ll need a proper sales team to justify the value provided in the product if you want to lock in those bigger deals,” writes Tucker Dawson. So, if your teams aren’t already robust enough to handle new customers with annual contracts and you don’t have the capital to ramp up, you’ll need to carefully consider whether annual billing is the right model for you.
Not ready to commit to only offering annual billing?
You’re not alone. Many companies offer both monthly and annual recurring billing plans, usually with a 10-20% discount to further incentivize customers to purchase annually (or even multi-year plans) and lock-in lower rates.
Several companies allow prospective customers to toggle between annual and monthly plans on the pricing page. You can see how Onepager uses monthly and annual “tabs” on their pricing page. In the first image are the monthly billing plans, and the second screenshot shows prospective customers what the “billed annually” options are (notice the discounted prices):
Often companies will break annual pre-pay pricing down into the per month cost to combat the sticker shock and adoption barrier that can be caused by seeing the total annual price on the pricing page.
Appcues also displays both monthly and annual plans in a visually appealing way, with a toggle switch to compare monthly and annual pricing.
Like Onepager, Appcues also breaks down the annual billing into the cost per month, but rather than identify a percentage discount Appcues makes it clear the annual plan gives you one month free:
If you decide to offer both monthly and annual billing options, Kissmetrics former Director of Growth Lars Lofgren says it’s never too early to market an upsell to monthly subscribers:
“One month after a monthly user subscribes, send an email with a link to get your annual discount,” he suggests.
While annual billing isn’t a perfect fit for everyone, if you’ve kept annual plans off your pricing page simply because you were afraid of scaring customers away with larger prices it is time to move past the fear and harness the many benefits of annual billing.
Annual billing increases cash flow, reduces churn, and provides predictable revenue for business stability and long term planning. It can also be more convenient for your subscribers.
If you’ve already offer annual plans, please share your own experiences in the comments below. Do you only offer annual billing or a do you also have monthly billing option on your pricing page?