After publishing this article, I received feedback prompting some clarification: this piece focuses on B2B SaaS. While B2C also sells subscriptions too, it's a whole different animal - lower retention, higher CAC, and greater volume. So, most points here don't apply to B2C.
Most SaaS companies offer subscriptions, either monthly or annually. Customers obviously favor monthly payments, but annual subscriptions are also popular. Why? Let’s dive into a good and bad of annual subscriptions
Financials
It's a myth that annual contracts boost revenue. In fact, they might lead to earning less.
Let's take a SaaS charging $100 monthly. They might offer a discounted annual billing of $1000. Once a customer pays, you can't add the full amount to this month's revenue. Accounting principles dictate that the revenue be spread over the year, resulting in $83 per month. This process, called revenue recognition. Think of it this way: despite immediate payment, you're committed to a year of service - keeping servers up, handling support, etc.
By offering an annual plan, you've essentially reduced your MRR by 17%, dropping it from $100 to just $83.
Financially, annual plans only make sense when you need to borrow money. You could essentially 'borrow' from your customers if your annual discount is less than a bank's interest rate and save some cash. However, early-stage SaaS startups should hesitate to borrow. With unpredictable revenue streams, they could quickly end up in a bad situation.
Churn
Selling annual subscriptions makes sense if you suspect high churn within the year. If your average customer stays around for nine months, offering a 20% discount on an annual plan could boost your earnings.
You can often spot a high churning products by looking at their pricing page. If the offer more that 20% for annual plans, the product likely has a churn issue, like with VPN services which offer up to a 300% discount.
However, if churn is an issue, it's wiser to address it through product improvements rather than clever billing.
Shelfware
"Shelfware" is a software that's purchased but never used. Skilled sales reps, backed by strong marketing, can often sell to customers who don't actually need the product by inducing a FOMO and using other tactics. These customers are essentially lost from day one. You might theoretically spot such customers through usage graphs, but typically, "shelfware" cases become apparent only when it's time to renew the contract. You'll only realize the customer has churned a full year after it actually happened.
However, there's a counterpoint. Some software requires heavy integration, and a big annual prepayment can motivate customers to invest time in it.
Sales commission
When a salesperson is involved, commissions come into play. For annual prepayments, it's straightforward - just give them 10-20% of that sum. Monthly subscriptions complicate things. If you pay 20% of the annual value upfront, you may find yourself in the red and never recover if customer churns quickly. Paying 20% monthly can make the sales rep too involved with accounting and customer support to ensure retention. And if the rep leaves the company, do you continue the monthly payments?
Sales commissions might be the only solid reason to go with annual subscriptions.
Remember, sales matter when your annual contract value hits $10k. For a $100 per month SaaS, your customers need to get through the sale without any non-automated human contact to maintain a viable unit economy.