Why do SaaS companies bill annually up front?

I like to teach you to think, so let’s cover what you need to know, to understand the annual thing.

Firstly, billings. Good shout. You got the point already

There are a few concepts to understand:

  • Bookings
  • Billings
  • Revenue

And a few others… as you can see (it’s an example based on assumptions):

If you don’t understand the differences, then read this: Decipher key top line SaaS revenue terms like bookings, billings and revenue

Pricing options

Normally there are four pricing options:

  • Free(mium)
  • Monthly
  • Annual
  • Call us for the enterprise thing

Let’s go through these now.

Free

You start free to show what the product is. Most sites are crap, so users don’t really want to ‘test’ something let alone pay when they aren’t sure.

Lots of details ensue, but this removes friction to help people get an aha moment faster by seeing value. Your issue is a conversion from trial to paid % and relative to CAC, LTV, and payback time.

Monthly

It’s the easiest way to get people on. They have no idea if your thing works, even if they have heard about it from friends. There is the whole “will I use this thing going on”. Some SaaS have real costs so can’t afford to offer free use.

Some sites especially in say SEO you might have tourists like me that know there is value and will pay for a month, but a year is too rich as I’m not dedicated.

When I get dedicated then the fact annual normally have discounts moves me to commit.

When I started a design company I had annual subs to design companies as it just made sense. Now I made my own templates, I just don’t need it. I occasionally pay a month if I need specific things.

Usage and need is a consideration. See, there is a whole lot of psychology going on and your clients aren’t dumb. They will optimise their yield curve.

Oh to be clear, bookings, billings and revenue are the same here, so for accounting, it’s simple.

Annual

You book and bill annually and recognise monthly for revenue.

But… you get all 12 months upfront! That’s money to use to grow and build. This is the obvious reason to do annual contracts. It’s 99% the answer to your question.

You almost always have a 1–2 month discount (Or 15–20%) relative to monthly contracts, and that can help people make the shift if they see the value.

Now, here is the random weird thing. Many SaaS charge annually as they know there are often times that users will get a lot of value and they want to lock them in. I’ve read and talked to a number of SaaS founders that do this and the reason is that they know their market is only so large so by charging annually they make their CAC work.

But it can backfire. There is a tool where I can send videos to my customers after a purchase. It’s a ‘nice to have for me’. But I’m like am I really going to be bothered? I would rather pay monthly to see if I build a daily habit, but they only do annual. So I never tried because I can be weirdly cheap like 99% of people are. $500 of whatever it was isn’t a lot to me but it’s still money.

Another thing to mention is churn. If you have monthly contracts there are 12x per year to say screw this and stop paying. With annual, there is 1x- and many people like me forget, especially with sneaky fu**ers who don’t send pre-notification emails (I know who you are!).

Enterprise

Big-ticket stuff never has a sticker as the salespeople want to price discriminate to milk as much as possible by acting like it’s bespoke and clients like to feel they got a deal. It’s a lot more complicated and I can explain, but this isn’t an essay.

The three key things you need to know to build a great startup

There are only 3 key numbers that matter for a SaaS company

  • How much you acquire people for = CAC
  • How much you make from them = LTV
  • How long it takes to cover the cost of the CAC and recycle the money = Payback time

If you want to understand why and get a free Excel tool then read on: The three key things you need to know to build a great startup

Your question is linked to this. Billing and booking 12 months can help your ratios work.

I’ve literally heard many times founders say “once we moved to annual only, things worked better”.

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