Billing models that allow customers to pay for a product, service, or offering they use – versus a standard monthly or yearly fee – have become popular with an increase in SaaS and direct to consumer offerings. This model is commonly referred to as “Consumption Billing” or “Usage-Based Billing,” and although the terms are often used interchangeably, there is one key difference. Consumption refers to the depletion of a good or service, while usage typically means using a good or service for a particular time. Keeping this definition in mind helps when examining both billing models.
What is Consumption Billing?
Consumption billing generally refers to a pricing model where customers are charged based on the quantity or volume of a service or resource they consume. The key focus is on the total consumption of a resource, and pricing may be tiered or have different rates based on usage thresholds. This tiered pricing typically involves the cost per unit decreasing as the volume of consumption increases. This model typically works to have users consume a set amount to depletion. Consumption billing provides flexibility for customers to scale their usage up or down based on their needs. This can create opportunities for companies to raise or lower prices in response to demand for a particular resource as it fluctuates. Customers have a clear understanding of what they are paying for and use the amount allotted to them in a given period. Consumption billing is common in subscription-based services, particularly in SaaS. Cloud computing services, for example, often use consumption-based pricing where customers pay for the computing resources they use, such as storage, processing power, and data transfer.
What is Usage-Based Billing?
Usage-based billing generally refers to a billing model where customers are charged based on the actual usage of a product, service, or platform in a set billing period, such as weekly or monthly. For SaaS, usage-based billing might involve charging customers based on the number of users, transactions, or other metrics directly related to the use of the software in the agreed-upon time period. Usage-based billing allows for granular pricing based on specific metrics tied to the usage of a service, and it typically does not have the same “complete usage” implications of consumption billing. For service providers, especially, usage-based billing can offer a predictable revenue stream based on the actual consumption patterns of their customers. This data can then be used for future planning and resource allocation.
What Do Consumption Billing and Usage-Based Billing Have in Common?
Both consumption billing and usage-based billing can hit the most complex part of the ASC 606 / IFRS 15 reporting standard, which indicates how revenue may be recognized based on the contract with the customer. The standard has five steps:
- Identify the contract with the customer
- Identify the performance obligation in the contract
- Determine the overall transaction price for the contract
- Allocate the transaction price to the performance obligations
- Recognize revenue when performance obligations are satisfied
Why is ASC 606 / IFRS 15 Difficult for Consumption and Usage-Based Billing?
Companies using either consumption or usage-based billing need to identify, track, and record revenue for ASC 606 / IFRS 15 reporting. With both billing models, fulfillment, delivery, and payment structure can change when revenue should be recognized. For example, companies with either a consumption or usage-based billing model must determine distinct performance obligations within the context of the contract. In both cases, because of the usage or consumption component, the complex ‘Variable Consideration’ portion of the guidance may need to be followed, impacting one or more of these distinct performance obligations. This portion of the guidance asks that a company estimate the amount of usage or consumption that will occur over the term of the contract.
If multiple goods or services are bundled as single performance obligation, as can be the case with consumption billing, companies need to allocate the transaction price against a standard selling price (SSP). This SSP may differ from stated contract prices, and a range may be used for estimating the SSP. To note, consumption models on their own do not trigger the need for allocating against SSP; however, the bundling of multiple goods or services as a single performance obligation triggers the need to allocate. For example, many SaaS offers are bundled with other products or services, such as consulting or implementation services. The allocation process becomes harder in a consumption model because the company must perform the mentioned calculation involving variable consideration to get to the total contract value (TCV).
For usage-based billing, companies may need to evaluate whether the usage is considered variable consideration. Variable consideration is included in the transaction price to the extent that it is probable that subsequent changes in the estimate would not result in a “material reversal” of cumulative revenue. There are a number of approaches to estimate variable consideration, such as “expected value” or “most likely amount.” Price concessions or discounted renewal options may also represent variable consideration.
How SOFTRAX RMS Revolutionizes Both Billing Models
The SOFTRAX Revenue Management System (RMS) offers both consumption billing and usage-based billing along with state-of-the-art revenue recognition and management capabilities, all in a single cloud-based platform. Contact us to learn more about how SOFTRAX RMS can simplify and automate your complex billing and revenue recognition processes.
We’ve helped many businesses scale their consumption billing and usage-based billing across different industries. If you’d like to automate your recurring revenue and billing cycles, contact us, and we can schedule a demo to show you how SOFTRAX can work for you.