Redefining “Buy Now, Pay Later” for SaaS — Part II
Upfront payment or flexible monthly billing — who ya got?
For well established companies, offering the highly coveted annual pay upfront license as the only option can work. For the majority of subscription-based companies, this is not a possibility from the outset if you expect to gain traction with SMBs or even mid-market customers. The logical conclusion is to create the classic two-plan menu:
1. Annual or multi-year subscription billed upfront with an appetizing discount
2. Annual or multi-year subscription with flexible monthly billing
The riskiest option of course is the monthly subscription with no term commitment. This is a double-edged sword as it’s often the highest growth segment and subsequently, the highest churn segment.
For the sake of my argument, let’s zero in on the first two more “traditional” plans. The glorious annual pay upfront plan is not dissimilar to your run of the mill purchase, except for the likely auto-renewal clause which makes it recurring. This isn’t particularly relevant to the Buy Now, Pay Later financing model except if the SaaSCo salesperson exclaims “well we usually charge the entire three-year contract on day 1, but if you sign today, we’ll let you pay it in three annual installments.” What’s interesting about this plan, however, is that when it’s offered in tandem with a monthly billing plan, it almost has to be offered with a mouthwatering discount attached to it from 10–30%+ in order to entice cash flush customers to jump at the sweet deal.
Discounting, like pricing, can be masterfully exploited as it represents an idea — a psychological trick that allows something static like a price tag to become totally malleable, and easily manipulated to the point where said price appears to be incredibly cheap. As an aside, ever wonder why every rug store, regardless of situation, is having a going out of business liquidation sale? A $1,000 dollar rug today that looks expensive could be multiplied by 5 and then discounted by 80% at a fire-sale with a big red tag showing $5,000 slashed by 80%, and the same $1,000 price tag looks quite appealing — what a discount!
Anyways, to get back on track, the caveat with getting paid upfront when you also offer a flexible monthly billing plan is that you have to eat a significant margin reduction on your ACV, and the caveat with only offering an annual pay upfront plan is the opportunity cost of potentially pricing out a significant portion of your addressable market. Even a behemoth like Apple and its posse of carriers realized this caveat was hindering a massive growth opportunity in the consumer segment that either couldn’t afford, or didn’t want to shell out $1000+ for a new phone. When this thesis was quantified and resulted in a market opportunity in the billions, the consortium dove headfirst into the Buy Now, Pay Later revolution with its now-ubiquitous subscription plans. So to summarize, the annual pay upfront model is a CFO’s dream, but it is wrought with potential issues like reduced margins and self-induced addressable market constriction (assuming non-enterprise buyers).
When Buy Now, Pay Later is called… an annual contract with monthly billing
This leads us back to the prime example of SaaS as a new, sexier take on extending credit to buyers; the annual plan with monthly billing. Whether you think of offering flexible monthly payment terms to buyers as simply a wildly popular business model or a type buyer financing offered by thousands of SaaS vendors (as opposed to a bank sitting between the two parties), one thing is clear — the monthly payment plan is a masterful technique to secure a year or more of recurring revenue while offering serious flexibility to buyers. The best of both worlds. But to reiterate, if you assume your product is worth x if paid in full, the annual plan with monthly billing of 1/12x is buy now, pay later for SaaS. A user receives your service upfront, and pays for it over time. What’s beautiful about SaaS is that a contract could theoretically be perpetual, with the upper bound of revenue simply being the point at which a customer decides to cancel the subscription. As an example, I have a strong feeling that Amazon’s margin on my Prime subscription far exceeds the non-recurring revenue earned on my individual transactions through their marketplace.
Collect Now, Bill Later?
With the annual term, monthly billed SaaS contract, BNPL is the standard, not the add-on perk. The seller is actually at a disadvantage because BNPL is expected, and while buyers love the flexibility, the splitting of a single transaction into twelve payments over time spikes accounts receivable, and crushes cash flow. This is a tough position to be in, but paradoxically, it represents the ideal situation for a high-growth SaaSCo as topline growth is typically prioritized over profitability.
How then can one enhance the BNPL standard? By creating a synthetic pay upfront contract to collect on day one while maintaining flexible monthly billing, of course. Unlike converting a one-time transaction into a twelve-month payment plan with a single financial entity, this use case involves two levels of financial engineering:
1. Buyer financing (offered by the seller)
2. Seller financing (offered by a third party underwriting the viability of both the aggregated buyer data and the financial position of the seller)
Collect now, bill later. This idea is contradictory at face value, but it’s really just another iteration of BNPL that levels the playing field for sellers who want to optimize for growth via flexible payment terms for buyers, AND for rapid cash conversion by accelerating future cash flow tied to underlying subscriptions. With this “dual financing” approach, a SaaSCo can automatically convert a 6-month average receivables turnover cycle (assuming 100% annual contracts billed monthly) into essentially real-time cash conversion, all while customers face no disruption or financing agreements — they simply keep paying the SaaSCo directly each month.
In this situation, the financial imperative of incentivizing customers to pay upfront by dangling a fat discount in order to prudently manage cash flow becomes obsolete. Finally, the subsequent cost savings can be allocated directly towards reinvesting into growth by driving customers towards the highest ACV, lowest friction annual term, monthly billing plan. The subscription business model is here to stay, and with this concept of Collect Now, Bill Later, both the buyer and the seller end the day satisfied, alleviating the fundamental structural flaws of SaaS contract pricing.