Why it’s time to move toward usage-based billing structures in SaaS
People give credit to Thomas Edison for inventing the first commercially viable light bulb and advocating for the commercialization of direct current. One thing Edison can’t take credit for, however, is the system that could properly charge and bill for the value of these products.
In fact, Edison was initially pretty bad at charging for his ventures. For example, to charge customers for their electricity, the Edison Illuminating Company’s billing process first consisted of sending employees to count the number of lamps in customers’ houses, which seems ludicrous in our modern, metered electric world.
To be fair, that was the 1880s. The technology of the time limited how Edison could set up a streamlined system to bill customers. Even more, the electric meter wasn’t his invention nor had it become ubiquitous when Edison Illuminating Company charged per-lamp.
That said, more than one hundred years later, there’s no reason why billing needs to be complex or time-consuming as something in the 1880s.
If your billing system doesn’t have the technology to easily track customers’ usage of your product or service, as in Edison’s case, you’re going to have a hard time charging for your product or service.
If you have the technology to track customers’ usage, but your billing system isn’t actually based on usage, you’re also going to have layers of unnecessary logic and a difficult time successfully pricing your product or service. And that’s exactly where SaaS startups’ billing systems are today.
Historically, billing structures started with a subscription — a customer on a particular plan. As technology evolved, billing systems integrated usage tracking to know exactly how much of a product or service customers were using so they could charge customers proportionally.
However, even as usage tracking is now a common feature with most billing systems, the fundamental billing structure has not changed. That means at the end of a billing cycle, your billing system makes a call to your software to ask for your software’s usage data and pricing information to add to an invoice (or charge). In other words, usage data is an afterthought.
When usage data is an afterthought, your billing logic becomes more complex. It means developers have to worry about how to store usage data, information around pricing plans, and other billing logic. And if there’s ever a pricing change, that means developers have to be a the table.
Usage-based billing architecture flips traditional billing on its head, and it should be the go-to billing architecture for SaaS teams.
Simply put, usage-based billing requires the fewest API endpoints out of any billing structure. Instead of worrying about writing logic for subscriptions and pricing, you just need to know what you want to track. Then, your software constantly sends usage data associated with a particular customer to your billing system.
The biggest benefit? Billing code becomes isolated from the codebase and developers can minimize the amount of time they spend in pricing meetings. And that’s a big deal.
Price-market fit — iterating your pricing to find the point that generates the most aggregate value between you and your customers — is a big deal in SaaS. According to a study done by Price Intelligently, “…you need an LTV/CAC ratio of at least 3:1 to run a successful business. But with continual pricing optimization, you can push that ratio to 11:1 and beyond.”
And everytime your company iterates pricing, developers won’t have to touch a line of code.
If Edison had a usage-based billing structure, his company would know exactly how many lamps, appliances, and outlets his service provided power to. Then, Edison Illuminating Company could frictionlessly experiment with various pricing structures that would make their customers the happiest and Edison Illuminating Company the most profitable.
Of course, Edison Illuminating Company would probably still land on eventually charging based on kilowatt-hours, but that’s mostly because electricity didn’t take long to become a commodity.
But if Edison Illuminating Company were a SaaS company? It’d be an entirely different success story.
Wes Wagner is a part of the Content and Community team at Cheddar, a usage-based billing platform that helps you track customer activity, iterate your pricing, and optimize your revenue so you can focus on building awesome products, not billing for them. Cheddar is made with ❤ from the Midwest, USA.
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