Usage-Based Billing

Usage-based billing is a way of charging customers in which the amount due depends on measured consumption instead of a fixed fee. A cloud provider bills for computing hours and storage, a telecoms company for minutes and data, a utility for kilowatt-hours, and a payment processor for each transaction it handles. The customer pays more in a busy month and less in a quiet one.

The model is also called consumption-based or pay-as-you-go pricing. It is often combined with subscription billing, for example a monthly platform fee that includes an allowance, with further use charged on top. The measurement side of the process is known as metered billing, and the two terms are frequently used as synonyms.

Usage-based billing has four stages.

1. Metering. The product records each billable event, such as a call to an application programming interface, a message sent or a gigabyte stored, with a customer identifier and a timestamp.
2. Aggregation. Events are collected and totaled for each customer over the billing period. Duplicate events must be removed, which is why each one usually carries a unique identifier.
3. Rating. The price plan is applied to the totals to calculate the charge.
4. Invoicing and collection. An invoice is issued at the end of the billing cycle and payment is taken or requested.

Because the charge is known only after the period ends, usage is normally billed in arrears, in contrast to fixed subscriptions, which are billed in advance.

• Per unit. A flat price for each unit consumed, such as a per-transaction fee.
• Tiered or volume pricing. The unit price falls as usage rises, either for all units once a threshold is crossed or only for units within each band. See tiered pricing.
• Allowance and overage. A fixed fee covers usage up to a limit, and units beyond it are charged separately.
• Prepaid credits. The customer buys a balance in advance and usage draws it down, with an automatic top-up when it runs low.
• Committed spend. A business customer agrees to a minimum annual amount in return for discounted rates, and is billed for any shortfall.

Many providers also apply a monthly minimum fee so that very small accounts still cover the cost of serving them.

Variable amounts complicate payment. With a card on file, the business charges the calculated amount at the end of the period as a merchant-initiated transaction. Card network rules for such unscheduled charges require the customer to have agreed in advance to the basis on which amounts will be calculated. With a direct debit, scheme rules generally require the customer to be notified of the amount and date before each collection.

Arrears billing exposes the seller to credit risk, because the service has been consumed before payment is attempted. A customer can run up a large bill and then fail to pay. Providers limit this in several ways: billing as soon as usage passes a threshold instead of waiting for the month end, requiring prepaid credits from new customers, placing a pre-authorization on a card at sign-up, and suspending service when a payment fails. Failed payments go through dunning in the same way as subscription renewals, and business accounts on invoice terms are managed through ordinary accounts receivable processes.

For customers, the main appeal is that cost follows value. A small user can start cheaply without committing to a plan sized for a larger one, and nobody pays for capacity they do not use. For sellers, revenue grows automatically as customers grow, without a sales conversation about upgrading, and the low starting cost makes it easier to win new accounts. The model suits products whose costs to the provider also vary with use, as in cloud infrastructure and payments.

The corresponding weakness is unpredictability on both sides. Customers find it hard to budget and may receive an unexpectedly large invoice after a spike in activity, sometimes called bill shock. Sellers offer spending alerts, caps and dashboards showing usage in near real time to reduce disputes. Revenue is harder to forecast than under fixed subscriptions and falls quickly when customers' own business slows, so measures such as monthly recurring revenue have to be adapted or supplemented.

The systems are also more demanding. Metering must be accurate and auditable, since every invoice can be challenged, and it must cope with very high event volumes, late-arriving data and corrections. Errors in either direction are costly: over-billing damages trust and can breach consumer law, while under-billing is lost revenue that is rarely recovered. Accounting follows the pattern of consumption, and under standards such as IFRS 15 revenue from variable usage is generally recognized as the usage occurs, with prepaid credits held as a liability until they are used or expire.

The payments industry is itself largely priced on usage. Processors, gateways, card networks and banking-as-a-service providers charge per transaction, per account or as a percentage of volume, usually with minimums and volume tiers. Their business customers in turn need billing systems capable of rating millions of small events, which has made usage-based billing tools a distinct category of financial software.