In March 2019, vehicle application programming interface (API) provider Smartcar introduced a pay-as-you-go pricing plan. And this business is far from alone.
Many others are adding pay-as-you-go or usage-based pricing plans to their offerings as well, and for obvious reasons.
- These plans can convert free users into a source of revenue.
- Customers like the idea of only paying for what they use.
- Businesses only have to provision products or services as needed.
- The Internet of Things (IoT) enables usage data tracking, thus usage-based billing.
Smartcar’s addition gives its formerly free users access to a higher volume of API requests and active vehicles, as well as more features and customer service without committing to custom monthly subscriptions. However, offering pay-as-you-go pricing doesn’t come without potential challenges and considerations.
For example, MailChimp recently introduced a new pricing model that includes changes to its pay-as-you-go plan.
In response, blog posts such as Time To Ditch Mailchimp? appeared, analyzing the company's expiration of credits and sparking conversations about alternative options.
Clearly, it’s important to roll out pay-as-you-go plans with customer satisfaction in mind. And behind the scenes lies additional considerations for businesses looking into usage-based pricing plans.
Four steps to offering pay-as-you-go pricing
Tracking variable usage and accurately billing for it are a challenge. Yet, these are critical components of a successful pay-as-you-go pricing plan. Fortunately, these tasks are made easier by recent technological developments which pave the way for usage-based and hybrid pricing models.
How? Modern subscription and recurring billing businesses typically follow the path below.
1. Track usage.
The IoT makes accurate usage tracking accessible to businesses across industries. Tracking everything from mileage and gas consumption to agricultural output—and impacting supply chains around the world—IoT sensors are already all around us.
This makes them the perfect source of raw data for usage-based billing models. While the IoT isn’t the only way to track usage, it has undeniably fueled the recent demand for pay-as-you-go models.
2. Rate data.
Whether gathered via the IoT or another method, data must be rated in order to charge customers. This means breaking data into billable units: miles driven, gallons of gasoline consumed, pounds of potatoes harvested, gigabytes of data stored, or any other measurable segment of data.
Every business will need to carefully consider its model to determine an appropriate rating, and the charge for each unit consumed.
3. Bill customers.
Once raw usage data is gathered and rated, charges must be calculated and translated into invoices or bills for customers. At this point, many businesses turn to a best-in-class billing system.
A robust recurring billing platform is secure, automated, and scales alongside a business. It also uses a double-entry ledger system, reducing accounting pain points and keeping accounting and revenue recognition compliant.
With features such as dunning and subscription management, recurring billing platforms not only streamline billing, but also other operations such as sign-up, activation, payment management, and more.
4. Recognize revenue.
Payment may be received, but the journey to pay-as-you-go success isn’t over yet. Businesses that fail to remain compliant with revenue recognition standards don’t just lose out on accurate reporting; they can also be penalized for not adhering to generally accepted accounting principles (GAAP). For example, in 2016 Monsanto was penalized to the tune of $80 million.
Good revenue recognition also supplements long-term strategies such as going public, and it gives businesses a clearer financial picture.
Thanks to GAAP, revenue recognition requires thorough attention from subscription businesses exploring pay-as-you-go options. It’s important to thoroughly research and understand these options and their implications because accounting guidelines affect each recurring billing model in a different way.
Revenue recognition has different levels of complexity
The implementation of ASC 606 changed revenue recognition for subscriptions and other recurring billing models. Revenue is now labeled as “deferred” or “earned”, based on whether products or services have been delivered in full to customers.
In the case of a strictly pay-as-you-go pricing plan, ASC 606 doesn’t create too much of a challenge. Revenue can be recognized as earned immediately since customers only pay for products or services they use. As long as there are no required payments granting access or service for a limited time, there’s no deferred revenue.
However, many recurring billing businesses don’t operate on a strictly pay-as-you-go pricing plan.
While Smartcar and MailChimp keep their usage-based plans separate from their regular subscriptions, this isn’t the case for every business. Take AT&T’s $30 monthly service plan, for example.
ASC 606 dictates an up-front monthly payment can only be recognized as the product or service is delivered. This means even if a customer has paid $30, AT&T can only recognize $1 as earned revenue on the first day of service. The other $29 is deferred. On the second day, $2 is earned and $28 is deferred, and so forth until the 30th day of the month.
This can get complicated if AT&T makes pay-as-you-go data available on the plan. Recognizing earned and deferred monthly payment revenue simultaneously with variable data usage-based revenue—especially across multiple customer accounts—would quickly become a challenge to track manually.
This is why so many businesses rely on an agile recurring billing platform to manage their hybrid pricing.
Netflix, Salesforce, and many others have implemented hybrid pricing, combining recurring billing options with one-time sales in their business models.
Pay-as-you-go: worth the effort for the right recurring billing businesses
Not every business will find success with a pay-as-you-go pricing model. For many, their current pricing isn’t a barrier to customer acquisition. For others, putting a price on unpredictable usage is simply unfeasible.
For those it does works for, taking the time to do it right reaps rewards. Pay-as-you-go options make it possible to offer products in new combinations, such as AT&T’s ability to provide additional data on demand, or Lyft’s addition of subscriptions to its original pay-per-ride model.
With the right usage tracking and recurring billing tools, these businesses are poised to scale by meeting a wide array of customer needs.
As consumer culture increasingly demands pay-as-you-go options, the agility to respond to market needs and competitive pressure will be the difference between businesses that rise to the top and those that get left behind. And along the way and at the top, of course, accurate revenue recognition will be key to sustainable success.