Summary
Prepaid usage contracts offer customers a compelling way to secure discounted rates by forecasting and prepaying for their consumption. This model involves a rating engine meticulously tracking an initial credit balance, applying ongoing debits from usage, and managing any additional credits or expirations. Understanding how these systems calculate opening balances, process monthly drawdowns, and handle potential overages is crucial for both providers and consumers leveraging this flexible pricing structure.
Key Takeaways
- Prepaid usage contracts allow customers to access discounted rates by committing to future consumption, making them ideal for predictable usage.
- Effective management of prepaid credits by rating engines involves both precise tracking of the evolving balance and consistent monthly drawdown of usage.
- Prepaid credits typically come with expiration dates, meaning customers must consume their allocated volume within a specific timeframe to avoid forfeiture.
- When prepaid balances are depleted, businesses can implement auto-replenishment or overage billing, each with distinct pricing mechanisms.
Why Customers Purchase Prepaid Credits for Usage-Based Pricing
In scenarios where a customer is able to accurately forecast the amount of usage they will consume for a specific product over the next year, a prepaid usage contract can be an attractive option. The customer will prepay for all (or a percentage) of their forecasted usage amount in exchange for a discounted rate. Each month as the product(s) is consumed, there is a drawdown against the prepaid usage balance until it is depleted. Prepaid usage credits typically come with an expiration date, which means the customer needs to consume a certain volume of the product before the deadline.
- Tracking Prepaid Credit Balance – The current balance of prepaid credits will need to be determined by analyzing the usage over the prior periods as well as applying any new debits or credits.
- Monthly Drawdown of Prepaid Credits – The current month’s billable usage quantity will need to be calculated and debited against the prepaid balance. If the customer has depleted all their credits then a new invoice will be generated to cover the deficit or replenish the balance.
Let’s review the process for how the rating engine computes charges for contracts with prepaid usage in more detail with examples.
Step 1
Tracking Prepaid Credit Balance
- Ending Balance – The end balance from the last billing period (last month) will be looked up for each account.
- Apply Credits – Some SaaS and cloud providers offer entitlements such as “free units” or “included units” in each billing period. These additional units will need to be credited to the account balance.
- Apply Debits – Prepaid usage typically has an expiration date associated with it. The rating engine will need to review the expiration dates for the units and deduct any which expired in the period.
- Calculate Opening Balance – Last period’s ending balance will be adjusted by adding the credits and debits to arrive at an updated opening balance for the period.
Suppose that a customer purchased 10,000 prepaid units of product A in January. At the end of last month (September 30), the customer had 4,000 prepaid units remaining. Each month the customer is entitled to 500 included units at no additional cost. In addition, some of the units purchased in January expired after 9 months. Specifically, 1,000 of the remaining 4,000 prepaid units expired on September 30th. To arrive at the updated prepaid balance, the rating engine will perform the following steps:
- Last Period Ending Balance = 4,000
- Credits = +500 included units
- Debits = -1000 expired units
- Opening Balance = 4,000 + 500 – 1000 = 3,500
Step 2
Monthly Drawdown of Prepaid Credits
Next, the rating engine will need to determine the billable usage quantity based upon the customer’s actual consumption during the period. The billable usage quantity will be deducted from the opening balance to arrive at an updated, ending balance.
Continuing the example from above, suppose the billable usage quantity for the month of October was 1,500 units. The rating engine would perform the monthly drawdown calculation as follows:
- Opening Balance = 3,500
- Billable Usage Quantity = 1,500
- Adjusted Balance = 2,000
Since the customer has sufficient prepaid units to cover the month’s usage the customer does not owe the SaaS or cloud provider any additional funds. A $0 invoice may be issued to the customer, but no payment will be required.
However, suppose that the monthly billable usage in October was 4,000 due to a spike in usage during the period. The rating engine would perform the monthly drawdown calculation:
- Opening Balance = 3,500
- Billable Usage Quantity = 4,000
- Adjusted Balance = -500
- Auto-Replenishment – The customer agreed to replenish low (or negative) balances automatically. In such a case, a new invoice would be generated for the auto-replenishment quantity. If the customer has a negative balance, the replenishment quantity will be adjusted to cover the deficit.
- Overage Billing – The customer is billed for the additional units that were not covered by the prepaid balance. The rating engine will need to determine the price for the overage units. The price could be 1) the list price, 2) the same price the last prepaid units were purchased at, or 3) another pre-negotiated price.
Continuing the example from above, suppose that the customer had an auto-replenishment trigger established to purchase 5,000 additional units in a low balance scenario.
- Price per unit (discounted) = $1
- Invoiced amount = 5,000 x $1 = $5,000
- Adjusted Balance = -500
- Auto-Replenishment Quantity = 5,000
- Ending Balance = 4,500
Alternatively, the customer could be billed for the overage at the list price of $2 per unit.
- Negative Balance = 500 units
- Price per unit = $2
- Invoiced Amount = $1,000
Conclusion
Prepaid usage contracts offer a powerful incentive for customers seeking cost savings on predictable consumption, while providing providers with revenue predictability. The sophisticated process of tracking prepaid balances—accounting for initial purchases, ongoing usage, additional credits, and expirations—is fundamental to the system’s integrity. Ensuring clear contract terms for balance management and handling overages is paramount for a smooth customer experience and accurate billing.
Frequently Asked Questions
What is usage-based billing with prepaid credits?
Usage-based billing with prepaid credits is a model where customers pay in advance for a certain amount of service or usage, represented as credits. As they consume the service, their credit balance decreases. This model combines the predictability of prepayment for the customer with the flexibility of paying only for what they use.
How does a prepaid credit model differ from a postpaid usage-based billing model?
In a prepaid credit model, customers pay upfront for a set amount of credits, and their usage is deducted from that balance. In contrast, postpaid usage-based billing charges customers at the end of a billing period based on their actual consumption during that period. Prepaid models offer customers more control over spending, while postpaid offers more flexibility for unpredictable high usage.
What happens when a customer exhausts their prepaid credits?
When a customer runs out of prepaid credits, the service typically stops, degrades, or prompts the customer to top up their account. Businesses can configure various actions, such as automatically recharging their account, sending notifications, or temporarily suspending access until more credits are purchased.
How can businesses manage rollover credits or credit expiration in a prepaid model?
Businesses have several options for managing unused credits. They can allow credits to roll over indefinitely, set an expiration date for credits (e.g., after 90 days), or implement a combination where a certain percentage rolls over. The chosen strategy impacts customer satisfaction and revenue forecasting.
What are the revenue recognition considerations for prepaid SaaS credits under ASC 606?
Under ASC 606, revenue from prepaid SaaS credits is generally recognized as the customer consumes the service or as the credits expire, not when the cash is received upfront. Businesses must establish performance obligations and allocate the transaction price to these obligations, recognizing revenue proportionally as those obligations are satisfied.
What kind of software is needed to implement a usage-based prepaid credit system?
Implementing a usage-based prepaid credit system typically requires specialized billing and subscription management software. This software should be capable of tracking real-time usage, managing credit balances, automating top-ups, handling various pricing models, and integrating with other financial systems for accurate revenue recognition.
