Explained: What is pro-rating and how can you use it in your subscription business?

When it comes to a business that’s part of the subscription economy, there are a variety of ways to bill your subscribers. You can arrange it as a flat fee, a tiered/levelled fee, add up the costs per user, or you can base how much you charge your clients on how much they make use of the service, product or app.

But how do you bill a customer when they have decided to end their contract with you early? Or what if they’re downgrading or upgrading their plan in the middle of the billing month? Then you need to learn about what is prorating billing. Here, we’re going to look at what it is, how you use it effectively in your business, and the benefits of doing just that.

What is pro-rating?

Prorating is the term used to describe billing the customer for a specific period of time, rather than strictly at the end of a predefined billing period. In a subscription business, it’s highly relevant because you may find customers do not use the service for the entirety of a billing period, or may opt to change their service level if the business operates on a tiered system.

As such, the billing amount depends not only on the service level they choose, but also the length of time for which they’ve been subscribed to it. In many cases, a subscription business doesn’t have to rely prorated billing all the time. Rather, you may instead have a regular recurring payments arrangement with your customers most of the time. However, if the customer wants to switch plans, change their services, or cancel before the billing date, that adds a challenge.

Know what does Prorating mean?

Prorating is all about calculating specifically how much the customer owes based on the amount of days left in their billing period. Their bills are going to be proportional to how much of the billing period they have subscribed to the service.

How to prorate your charges

There are different methods of prorating your charges, all depending on how your service bills your users. If you bill your users at the end of a month/billing period, for instance, then it’s easy to work out the overall amount they owe simply by figuring out what percentage of the month they used one tier or the service vs the other tier. For instance, if they were on the $200 tier for 50% of the month and the $100 for the other 50%, then boiling it down proportionally means they would owe $150.

If you bill at the start of the month, however, then you need to follow up after the fact. For instance, let’s say they start at the $100 tier, and you bill them $100. However, they move up to the $200 halfway through the month. You would have to send them an additional invoice explaining the prorated charges of $50. If they move down a tier and end up paying less, then you would have to send them a refund for that period, as well.

You may want to figure out which method of prorating you wish to use and the pros and cons of each. It all depends on when you bill your customers and whether you’re willing to change that for the sake of prorating your charges.

What are the benefits of prorating for a subscription service?

  • If your subscription business has a premium price range, then people can be scared away by the notion that they have to pay a full billing period, no matter what. Prorating your charges for customers who cancel early may make it easier for them to convert to customers in the first place.

  • If you’re running a tiered subscription business, then you make it safe for your customers to change their package at any point. If a customer has to wait until the end of a billing period simply to get their “money’s worth” out of a certain tier, then it can breed discontent in the long run. It also makes it much simpler for your team to work how they’re being billed for any transitionary period.

  • Prorating can help establish trust between your business and your customers. If they believe that they are only paying for what they use, then they are less likely to complain. It can help with customer service and satisfaction.

  • Prorating ensures you’re missing revenue where you might be making it. By prorating higher tier services, when they’re used, you can make sure that you’re never charging less for services that your customer should be paying more for.

  • It also makes it much easier to introduce new plans and add-ons without having to worry about losing customers. Since pro-rating makes it easier for customers to switch between tiers and to add/remove features of their service as suits their needs, you can get a lot more flexible with what tiers and services you test and launch.

Making pro-rated billing easy

One of the key barriers to prorated billing for many subscription businesses is that it requires tracking a lot of customer data. Processing different bills for each individual user is a lot of work to do manually. However, with modern subscription management tools, you don’t have to do it manually.

Modern subscription billing software, for instance, can figure out the prorated billing amounts per customer based on the metrics of how much they have used a service. All you need to do it outline the standards for how much a customer pays at what threshold and it can do the rest.

Does pro-rating work for your business?

Not all subscription businesses need to or should prorate charges. However, if you have a tiered business or if your customers don’t pay up-front at the start of the month, then you could end up missing out on revenue when they upgrade, downgrade, or change their plan.

Hopefully, the points above better explain what prorating is, how does prorating work for your subscription business, and why it’s worth considering. Prorating is key for a lot of subscription businesses, so it’s crucial to understand how does prorating work.