A Case for Hybrid Billing Models
This summer, we held our inaugural CTO Summit, where we virtually gathered CTOs from our portfolio companies to discuss trends, challenges, wins, and opportunities. It was a fantastic day full of thoughtful discussions and networking opportunities.
Below is a recap of our keynote session hosted by Eric Anderson, former Chief Technology Officer at Airbrake.io and now Vice President at LogicMonitor. Eric has previously founded three companies and is an expert on SaaS platform pricing models. During this keynote session, he discussed the value of hybrid billing models.
One of the most important questions startups ask early in the journey toward turning passions into profits is how to price for a product or service. There are a few different schools of thought here, but it mostly boils down to a battle between quantity-based billing and usage-based billing models.
Quantity-Based Billing vs. Usage-Based Billing
Quantity-based billing is a simple exchange where customers pay ahead of time for a certain level of service. For example, a customer could pay $50/month and get 10 seats for a software license. In this scenario, customers must know ahead of time roughly what quantity of a product or service they want to use. This is often the most common route to take.
There are a few different versions of quantity-based billing models:
- Volume-based: A fixed price is offered on a per item basis. A common example here is mobile providers who charge based on the number of lines within a phone plan.
- Tiered-based: The pricing per item changes based on how much of an item or service will be used. At a t-shirt company, for example, a customer might pay $50 per t-shirt, up to the first 100 t-shirts, then $40 per shirt if they buy between 101-200 t-shirts, and $30 if they buy between 201-300 t-shirts.
- Stairstep-based: Though similar to tiered-based pricing, the primary difference is that customers pay one set price, regardless of how many units within the tier are purchased or used. Think about a streaming service that charges based on the number of devices on which a customer can stream content. Customers pay a certain amount for 1-5 devices, then a higher price for 6-10 devices.
Usage-based billing occurs on a per item basis and is charged after the usage is consumed. This is the model we see with many consumer applications, like Uber or Lyft. There’s no monthly subscription to use the service; riders simply pay as needed based on the length of their ride and the type of car. This is a completely dynamic pricing model and can be especially useful for companies that find it impossible to predict how much of something they’ll use ahead of time, or who have demand surges that vary throughout the year.
Quantity-based and usage-based billing models both have their merits in different situations. A quantity-based structure helps providers and customers plan ahead — with predictable revenues on the provider side, and predictable expenditures on the customer side — while usage-based models offer valuable freedom and flexibility.
When to opt for each model
So how do you know which model is right for you? Let’s consider a few other examples.
Electricity is a fantastic example of something that makes sense as a purely usage-based billing model. Customers want electricity and they don’t want to have to think about exactly how much they’ll need at any given time. Unrestricted access is extremely important, and a cap or quota on the amount of available electricity would cause friction for the customer.
In other organizations, a pay-as-you-go model could lead customers to abandon a service entirely. Think about an analytics platform, for example. If a customer was charged each time they logged into an analytics dashboard or downloaded a report, they’d be less likely to continue using the service. The value in this type of service is that it's always on and always available, so customers can track performance over time without limits or restrictions.
Sometimes, however, the situation isn’t so black and white. Though quantity- and usage-based billing seem to be distinct, there are ways they can be leveraged together in a hybrid billing model.
Hybrid billing models
Hybrid billing models combine features of both quantity-based and usage-based billing. In a hybrid model, customers prepay on a monthly or annual basis for a certain tier of service, then pay additional fees at the end of the billing period if they use more than what was allotted in the tier agreement.
Hybrids are a particularly good model from a customer standpoint because they protect customers from forced upgrades. Not only can forced upgrades be unexpected and costly — especially when they occur in the middle of a surge where customers are desperate to maintain service and don’t have time to negotiate costs — but they can also create customer frustration and dissatisfaction, ultimately leading to customer churn.
From a provider standpoint, hybrid models provide some level of predictable revenue. They also allow for a more strategic sales approach with customers. Collecting data around how much of a service is used each period enables members of a sales team to effectively lay out a compelling reason for a customer to upgrade to a higher tier of service.
When does a hybrid billing model make the most sense?
If you’re wondering whether augmenting your pricing with usage-based billing elements makes sense for your company, ask yourself:
- Is my customer consumption static or variable? If variable, hybrid may be a great option.
- Is the price of my consumable fixed or variable? If the price is fixed, and it doesn’t cost you any extra to offer customers more of the consumable, then hybrid will work.
- Will a hybrid billing model benefit my customers? If your customers frequently reach their quota in the middle of the billing period, leading them to abandon your service, a hybrid model may provide a good solution for you.
Ultimately, in order to choose the right option for your business, a thorough analysis needs to be done to review the value of your service, the way customers use it, how much your business relies on predictable revenue, and the type of conversations your sales team is having with customers when it comes time to renew service or move up to a new tier.
How to implement a pricing model change
Once the choice is made, it’s time to focus on the arduous task of implementation. To successfully implement a pricing model change, you need to focus on technology and customer support.
On the technology side, it’s essential that your billing system allows for variables and can update data in real time, so customers who cancel their service mid-billing cycle can be accurately billed. Your technology systems must also be able to properly assign usage to distinct customer accounts and keep a thorough record of that attribution. This is especially important when it comes to reporting back to customers and troubleshooting any inquiries about billing that may come through.
It’s important to remember that when implementing a pricing model change, customer education well in advance of the change plays a critical role in avoiding friction with customers. Consider providing visual aides to customers that outline their usage over time, and how the new pricing model will impact them. In any hybrid model that implements an element of usage-based billing, customers may be concerned about getting hit with enormous, unexpected bills because they haven’t kept track of their own usage. Provide options to assuage those fears — like the ability to implement caps on service, or discounts for valuable customers.
Hybrid billing may be the best option for your business
The reality is this: Hybrid billing models offer clear benefits for businesses and customers, alike. Businesses benefit from a level of predictable revenues and avoid much of the sales support burden that quantity-based businesses deal with on a day-in and day-out basis. For customers, it’s easier to deal with surges and remain confident that service won’t be interrupted when a quota is reached.
If your business is able to implement the proper technology tools to support metered billing and adequately communicate with customers about the value of this model, hybrid billing may be your best bet.
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