As more companies apply subscriptions to their businesses, they explore different ways to bill their subscribers. But which model is really best to use? And what are the pros and cons of the model you choose?
In order to understand the complexity of subscription billing, we must first break it down into its parts. The graphic below sets out the basic combination of factors that define various subscription billing models.
- Billing interval – Subscriber is billed when they use the service (on-demand), or at a regular interval, like monthly or annually, etc. (scheduled)
- Fee type – Subscriber is billed a predetermined price (flat), or based on their exact use of the service (usage-based)
Quadrant 1: On-Demand / Flat Billing
A company who charges subscribers a set price for on-demand services is using the on-demand / flat billing model. The real-life example most relevant to this billing method would be in-app purchases for a freemium game.
In games that use a freemium model, subscribers do not pay for basic access to game play. However, premium features in the game (access to special powers, the ability to connect with other users, the ability to add additional avatars or users to your account, etc.) are available for in-app purchase. It’s on-demand because the subscriber is billed immediately, and it’s a flat fee because the price is predetermined.
Because the company sets the pricing ahead of time and are not beholden to subscribers’ fluctuating use of the service, they can better predict incoming revenue streams. The real value to the company using a freemium model that bills upon demand is the vast wealth of user data that customers will provide just to use the service. Free users provide their email addresses, creating an avenue to market premium purchases to them. Their use of the program also helps to weed out glitches and supports the developers’ efforts to improve the service.
It’s also easier to market to customers with this subscription billing model. Timely offers, discounts and persuasive messaging encourage customers to make more in-app purchases. Meanwhile, free users having a good experience become your advocates among their social networks and friends.
There are two potential downsides to this model. First, you may have an overabundance of free users, whose costs are not offset by incoming revenue. And second, because on-demand purchases are not guaranteed, revenue is not as predictable as in a scheduled / flat billing model.
Quadrant 2: On-Demand / Usage-Based Billing
On-demand / usage-based billing occurs when a subscriber is billed for the exact services rendered at the time of their use rather than a flat fee. The ride sharing service Uber may be the most familiar example of this billing model. The subscriber is billed for the amount they use when they use it.
Customers favor this model because they are in direct control over how much they use and pay for the service. In addition, customers are not tied to a billing cycle and literally pay as they go.
This type of billing works well for Uber because they must also pay the contractor (the driver) for their services. The funds are available from the subscriber as soon as the service has been rendered, allowing the company to distribute payment to the contractors in a timely fashion.
The downside for the company with this model is that subscriber use can fluctuate. And traditional marketing tactics are not as effective in encouraging incremental increases in customer use. There is no email that might entice a rider to order their cab to take another spin around the block just to increase Uber’s revenue. This is distinguished from an on-demand / flat billing model, where traditional conversion rate optimization tactics explain the additional value loyal users will derive from purchasing paid features.
Quadrant 3: Scheduled / Flat Billing
When a subscriber is billed a regular amount at a regular interval, that type of subscription is called scheduled / flat billing. Spotify, who bills a set monthly fee to their subscribers, uses scheduled / flat billing. This is the simplest subscription model and provides some key advantages to both businesses and their subscribers.
The regular billing interval and amount means that your company’s revenue is predictable. Likewise for the subscriber, their financial obligation is easily anticipated. For those customers who like to know what they’ll be paying, this model allows for maximum satisfaction.
For a business, the pitfalls include the fact that a customer will be paying the same amount for low usage as they would for heavy usage. The costs associated with using your service may be hard to predict and not tied to the revenue you are collecting.
Quadrant 4: Scheduled / Usage-Based Billing
Finally, when a subscriber makes their payment at a regular interval, but the cost of their subscription is based on metered usage of the service, this is called scheduled / usage-based billing. Anyone with a utility account with their local electric company is familiar with this model. It’s scheduled because the bill is due the same time every month, and it’s usage-based because the amount you pay is defined by the electricity you use.
The advantage for the customer is that they are only paying for what they’ve used. They can control how much they pay by curtailing their usage in a given billing period. Customers who enjoy only paying for what they’ll use are the most satisfied with this model.
Services with costs that increase as usage increases are prime candidates for this billing model, which allows the business to scale their revenue in direct proportion to the customer usage.
The downside to this model is that price fluctuations may have an impact on customer churn. After high-use periods, or an uptick in prices, customers will feel the impact of higher charges immediately. These fluctuations may encourage subscribers to find other providers or reduce their usage (and your revenue).
Whether you are in charge of the financial stability of your organization, or nurturing customer relationships and maximizing customer lifetime value, you will inevitably run into the complications posed by subscription commerce. Exploring the types of subscription billing models in terms of their billing frequency and pricing strategy can help your team discover the pros and cons of each and select the right model for your business.
To learn more, download our guide, Top Three Subscription Billing Challenges today.