What are Spend Commitments for Usage-Based Pricing?
Spend commitments are useful in scenarios where a customer expects to spend a high dollar amount with a SaaS or cloud provider, but is not sure exactly which products they will consume and when they will consume them. With a spend commitment, the customer agrees to purchase a certain dollar amount within a single quarter or year in exchange for a discounted rate on the services. If the customer does not satisfy the spend obligation during the contracted time period, there may be a “true-up” payment required to settle the balance.
- Current Month Spend – The engine will calculate the current month’s spend.
- Balance Accounting – The rating engine will determine the opening balance for the spend commitment. In other words, it will calculate how much has the customer spent so far and what is the remaining obligation.
- True Up Calculation – If the current month is the last one in the commitment period, the rating engine will determine if the customer has satisfied the obligation. If the actual spend levels did not reach the commitment, a true up invoice will be generated.
Let’s review the process for how the rating engine computes charges for spend commitments in more detail with examples.
Step 1
Calculate Current Month Spend
First, the rating engine will calculate the monthly spend for the customer during the period. The billable quantity of each product and the applicable price will need to be determined for each product. Price and quantity are then multiplied to arrive at a sub-total for each product. The sub-totals are then summed up to arrive at a total, actual monthly spend.
Note: In some cases, certain products may be ineligible to be included in the monthly spend totals. These ineligible product should be subtracted from the monthly spend total.
Suppose, for example, that a customer has three products:
- Product A – Cloud-based service with usage-based pricing
- Product B – Professional services fees billed for time and materials
- Product C – Cloud-based service with flat fee, subscription pricing
For the latest month (March), the actual monthly spend for each of the products is
- Product A = 1,000 units x $2/unit = $2,000
- Product B = 20 hours x $200/hour = $4,000
- Product C = $1,000 per month
- Total Spend = $2,000 + $4,000 + $1,000 = $7,000
Only recurring revenue products are eligible for the spend commitment. As a result, the professional services revenue will be subtracted from the total:
Eligible Spend = $7,000 – $4,000 = $3,000
Step 2
Tracking Spend Commitment Balance
Next, the rating engine will need to calculate how much the customer has spent so far against the contract obligation. In other words, as of the end of the last billing period, how much has the customer spent in the prior months of the contract term? The rating engine will then use a simple subtraction operation to determine how additional spend is required to satisfy the contract obligations:
Total spend commitment – Spend for months 1 through last month = Remaining spend obligations.
The remaining spend obligations will then be updated by subtracting the current month’s eligible spend (as calculated in step one above).
Continuing the example from above, suppose that the customer signed up for a quarterly spend commitment of $25,000 for the year starting in January. As of the end of last month (February), the total spend was $15,000.
- Quarterly Spend Commitment = $25,000
- Spend as of End of Last Period = $15,000
- Remaining Spend Obligations = $10,000
If we add the current monthly spend (for March) the $3,000 to the total cumulative spend to date in the quarter, we get an updated balance (remaining spend obligations) of $7,000.
- Current Month Eligible Spend = $3,000
- Updated Total Spend = $18,000
- Updated Remaining Spend Obligations = $7,000
Step 3
True Up Calculation
If the current month is the last month in the spend commitment window, then the rating engine will need to determine if the customer has satisfied their obligations. If the total spent commitment was not satisfied then a true-up payment may be owed.
Continuing the example from above – The customer signed up for a quarterly spend commitment from the period of January 1 through March 31st. Since the current month, March, is the last month in the period the rating engine needs to calculate if a true up is owed and what the amount is. The relevant calculations from above:
- Quarterly Spend Commitment = $25,000
- Spend as of End of Period = $18,000
- Remaining Spend Obligations = $7,000
The customer only spent $18,000 against an obligation of $25,000. The spend commitment was not satisfied and therefore the customer owes a true up payment for the difference of $7,000.
