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Many SaaS brands work on subscription-based models, charging customers a flat monthly fee. That fee typically includes a set number of features, number of users, and total available usage depending on the plan they’ve chosen.
The majority of these brands get paid that monthly fee, whether the user logs in once per month or more than once a day every day. The customer pays whatever the fee is that’s been chosen.
That’s simple enough, but what about the 61% of brands that have adopted usage-based pricing in 2023, and the 21% that were expected to test it in 2023 or later? What about when customers decide to upgrade or downgrade their existing plan now and want that to take effect immediately?
That’s where proration for SaaS businesses and subscription businesses comes into play.
Proration in Your Organization
Here’s how you define proration: It’s the act of dividing something up proportionately. It can refer to wages, equity, and pricing.
Some businesses and startups, for example, may hear about proration in relation to dividing up equity amongst investors. It may also refer to the division of cash and stock in a takeover offer.
For the most part, however, when SaaS and subscription-based businesses talk about proration, they’re talking about prorated billing. That’s going to be the focus of this post today.
How Prorated Pricing & Billing Effects Subscription Businesses
Prorated pricing (also sometimes called “prorated billing”) allows customers to pay only for a specific amount of a service used.
In theory, if they bill clients on the first of every month and they join on the 15th of February, you can provide prorated pricing that only accounts for the time they use your service.
What about rolling sign-ups and monthly flat fees, which is what many subscription-based SaaS plans use? It doesn’t matter if you sign up on the 1st or the 15th of the month; that’s when your plan will renew.
Sometimes, though, there are still reasons to consider prorated billing. This is particularly common when customers want to upgrade their plan halfway through the month. Without prorated pricing, you’ll end up in one of these two situations:
- The customer pays the new monthly fee now to “reset” their plan. While they can take advantage of the new upgraded features now, it also means that they paid for half a month on that lower-level plan which they won’t use. That likely won’t sit well or bode well for your customer retention rates.
- You wait to have the customer upgrade until the next monthly billing cycle. When this happens, the customer may be frustrated if they have to wait to access the additional features or usage they’re looking for, and your business is missing out on half a month of that upgraded revenue.
Prorated billing, however, allows you to do the math. Some businesses may refund half of the lower-cost plan that was already paid for and unused and add half of a new month’s upgraded cost.
Many businesses will process this as either one or two transactions based on their specific billing system. Customers may receive an invoice that shows both the refund and the new upgraded charge. Sometimes, they may communicate the prorated pricing with the customer, who will see a refund or a single charge on a single invoice.
How to Calculate Prorated Pricing
In many cases, it's most straightforward for SaaS companies and subscription businesses to opt for days of usage when conducting proration calculations.
To calculate proration using days of service, you can use this formula:
Cost of monthly subscription x Percentage of month unused = Refund to be issued for prorated pricing
To calculate prorated charges based on a mid-month plan upgrade, you can use this formula:
(Cost of new monthly subscription x Percentage of month to be used) - (Cost of initial monthly subscription / Percentage of month of month unused) = Prorated charges
Let’s look at an example:
You have a $20 per month plan and a $50 per month plan. Customer A decides 15 days into the month they want to upgrade their plan, dividing the month into two equal halves.
You’d use this calculation to find your prorated charges:
($50 x .5) - ($20 / .5) = $15 in prorated charged.
Why SaaS Businesses Should Consider Prorated Billing
There are a few simple reasons SaaS businesses should strongly consider implementing prorated billing, including the following:
- It’s fair. Customers pay for what they’re actually using.
- Customers are happy. They can get access to those upgraded features when they want them, and they’ll love the flexibility your business offers.
- Reduced customer churn. The better the customer experience– and the more you can deliver great support— the better your retention rates.
- Increased profit potential. If you can have customers pay to upgrade for even a few days, why wouldn’t you? An instant increase in income is a boost in revenue.
Prorating for Downgrades & Cancellations
It’s common for subscription businesses to offer prorated rates when customers are excited to upgrade their plans, but what about when they want to downgrade or cancel?
You do not necessarily have to prorate if customers choose to cancel or downgrade. It may be a smart move to offer prorated billing for downgrades in an attempt to increase overall retention and satisfaction rates.
That said, make sure that you are transparent about your cancellation and refund policies on your website. You can also have this information featured prominently in your Terms of Service, which clients sign when they become paying customers.
Just make sure that you’re fair. If you aren’t going to offer prorated refunds, customers should ideally retain full access to their account until the next billing period begins.
At the end of the day, happy customers are longer-retained customers, which is why proration billing can be so helpful.
When it comes to prorated billing best practices, remember to prioritize fairness and consistency. If you have a consistent and transparent policy in place, that’s always a good start. That said, prorated billing can also be offered to help improve relationships with long-term or high-value customers, so you can consider alternate solutions when needed to retain those customers.
Ensure, above all else, that you’re using subscription-focused revenue analytics tools that can help you keep a close eye on how refunds, discounts, upgrades, and prorated billing impact your overall revenue. You want to track your total expenses accurately and in real time.
Baremetrics is a subscription-focused revenue analytics platform with 26 financial metrics to help you track your profit. You can also use it to discover insights about your customers and even resolve missed payments before they happen.
Ready to track the impact of your prorated billing and your overall revenue? Start your free trial with Baremetrics now.