Weighing up the differences between annual vs monthly billing cycles can be quite a challenge. Yet, it’s an integral part of getting your subscription billing strategy right and cannot be ignored. You may struggle to understand which billing frequency your customers prefer. You may even find yourself asking a lot of questions. For instance, what if some customers prefer annual and some prefer monthly? After all, it’s not unusual for customers to have different preferences, and as a result, it can be overwhelming to decide which billing frequency is best.
It may seem natural to go with the frequency that is easiest for your accounts team to implement. Even worse, you might choose your billing frequency based on what your competitors offer. Both of these are standard approaches, but neither of them puts the customer front and centre.
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.
It’s common sense that accepting visa payments alone would reduce conversions and frustrate your customers. So, all you need to do is apply this same logic to billing cycle frequencies. Suddenly, it becomes obvious why giving customers a choice is so important.
In this blog, explore the advantages and disadvantages of both annual and monthly billing cycles, so that you can figure out which system works best for your services.
Defining annual vs monthly billing cycles
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.
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.
Annual billing cycle advantages
- Improves cash flow because payment comes in one upfront lump sum.
- Often lowers churn rate and increases the predictability of revenue as customers pay for the full year in advance.
- Costs less for the customer as you can afford to offer them a lower overall price for an annual commitment.
- More convenient for both you and the customer as it requires only one invoice per year.
- Costs considerably less to implement if you’re using a payment system that charges per transaction.
- Longer commitment gives you more time to help customers get the full value out of your product.
- Reduces your monthly accounting costs as you don’t need to facilitate monthly payments.
Annual subscription billing disadvantages
- Reduces revenue if using discounts to entice customers to sign up for an entire year.
- Increases the cost of customer acquisition as it requires more education and marketing to convince buyers.
- Lacks full visibility of churn rate as customers may drop the service mid-year, and you may not know, therefore losing the opportunity to check-in and educate them.
- Increases risk to revenue as losing a customer is more of a risk given that they pay upfront.
- Might be a barrier to customers who prefer to pay in increments or cannot afford the lump sum.
- Licensing can become problematic for companies who may require a different number of licenses at various points throughout the year.
- Revenue recognition and deferred revenue become more complex (read our blog about revenue recognition for a deep dive into this complexity).
- Customer retention often requires a more significant communications effort so that customers feel they get the full benefit of the service.
- More extended time allowances for chargebacks can lead to administrative complications.
- Upfront costs can be daunting to first-time customers and may seem like too much of a commitment without a trial period.
- Customers can forget the service and the charge and are more likely to dispute charges a year later.
Monthly billing cycle advantages
- Lowers the barrier to entry for new customers who may find the upfront cost is less daunting than a lump sum.
- Shortens the sales cycle so that the cost of customer acquisition is often lower.
- It allows you the opportunity to regularly engage with customers and see if they’re using your products.
- Ideal for B2C customers and smaller B2B companies that may be reluctant to sign up for longer-term services as they do not have the same budgets as bigger organizations.
- Increases revenue as you can charge more for your services when broken down into monthly payments.
- Monthly invoices and payments remind customers to engage with your service and make it hard for them to forget to use it.
- Customers tend to give feedback more frequently when making recurring payments.
- Lowers risk of hefty chargebacks as customers are more likely to let a monthly payment slide than an annual one.
- Easier to administer refunds to unhappy customers without heavily impacting revenue.
- More flexibility to increase prices as hikes in cost will seem much less when diluted down to a few extra dollars a month.
- Customers feel less “trapped” as they can usually cancel at any time.
Monthly billing cycle disadvantages
- Increases churn rate as cancelling a subscription has little cost implications for the customer.
- Forecasting revenue can be volatile as it’s hard to predict churn rate.
- Costs more to implement if your payment provider charges based on the frequency of transactions.
- Larger B2B companies may find monthly payments inconvenient, mainly if multiple departments are involved or they assign budgets annually.
- Customers may cancel before they realize the value of your service.
- Difficult to recoup the customer acquisition cost from customers who cancel early.
- Increases the complexity of tracking payments and following up on missed payments.
- Cash flow may be less as you receive smaller payments in increments.
Annual vs monthly billing cycles | What should you choose?
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.
So, what next?
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.