Monthly vs annual billing: how much discount to give

Almost every subscription business ends up offering two ways to pay: by the month or by the year, with a discount for paying a year up front. The questions that follow are always the same. How big should the discount be? Is the up front cash worth it? What happens when an annual customer wants a refund, or wants to upgrade halfway through the year? This guide answers each with numbers. (For the short definition, see annual billing in the glossary.)

What each option gives you

Monthly billing is the easy yes. The customer commits to one month at a time, the first payment is small, and there is no big approval to get. The cost is that every month is a fresh chance to leave, and every month is another card charge that can fail.

Annual billing asks for more commitment up front and gives you three things in return: a year of revenue collected on day one, one renewal decision a year instead of twelve, and one card charge a year instead of twelve. The cost is the discount you give to get it.

The "2 months free" convention, in numbers

The most common annual offer is "2 months free": the customer pays for ten months and gets twelve. It is worth knowing what that means as a percentage, because it is not 20%.

Take a plan at $30 a month.

• Twelve months at the monthly price: 12 × $30 = $360
• Annual price, 2 months free: 10 × $30 = $300
• Discount: $60 off $360, and $60 ÷ $360 = 1/6, which is about 16.7%
• Effective monthly price: $300 ÷ 12 = $25

The same plan with other discounts, for comparison:

Annual discount	Annual price	Effective per month
10%	$324	$27.00
16.7% (2 months free)	$300	$25.00
20%	$288	$24.00
25% (3 months free)	$270	$22.50

"2 months free" is popular because it is easy to understand and easy to say, and at about 16.7% it is a meaningful saving without giving away a quarter of the year. A very small discount gives people little reason to switch, and a very large one makes the monthly plan look like a penalty.

Is the discount worth it?

Here is the useful way to think about it. At 2 months free, an annual customer pays you $300 for the year. A monthly customer pays $30 for each month they stay.

• A monthly customer who stays fewer than 10 months pays you less than $300.
• One who stays exactly 10 months pays the same $300.
• One who stays the full year pays $360.

So the annual discount is a bet. You give up $60 from customers who would have stayed all year anyway, and you gain from customers who would have left in the first ten months but are now paid through twelve. If many of your monthly customers leave early, the annual plan earns you more. If nearly all of them stay for years, it earns you less, but it still reduces failed payments and gives you the cash sooner. Look at how long your monthly customers actually stay (your churn rate tells you) before deciding how generous to be.

Cash flow: collected is not earned

Say 100 customers pick the annual plan. You collect 100 × $300 = $30,000 on the day they sign up, instead of 100 × $30 = $3,000 in the first month. That money can fund hiring or marketing months earlier than monthly billing would.

Two cautions. First, you have not earned it yet: it covers twelve months of service, so for reporting you count $2,500 a month ($30,000 ÷ 12), and your MRR should show $2,500, not $30,000. Second, some of that money may have to go back as refunds, which brings us to the policy you need before the first annual sale.

Refunds on annual plans

Decide your refund policy before anyone asks. Three common versions:

• A short full refund window. Full refund within 14 or 30 days, then no refunds. Simple, and it covers the customer who signed up and changed their mind straight away.
• Prorated refund of unused months. A customer who cancels after 4 months of a $300 year gets back 8/12 of it: 8/12 × $300 = $200.
• Prorated, but the discount goes too. The months they used are charged at the monthly price: 4 × $30 = $120 used, so $300 minus $120 = $180 back. This stops customers using the annual plan as a cheaper monthly plan with an exit.

Any of the three is defensible. Write it on your pricing page and in your terms, and apply it the same way every time. A credit note keeps the paperwork clean when you do refund.

Upgrades in the middle of the year

Annual customers upgrade too, and the usual answer is proration: credit for the unused part of the old plan, a charge for the rest of the year on the new one.

Say the $300 a year plan runs for a 365 day year, and a customer upgrades to a $600 a year plan after 146 days, with 219 days left. The fraction left is 219 ÷ 365 = 0.6.

• Credit for the old plan: 0.6 × $300 = $180
• Charge for the new plan: 0.6 × $600 = $360
• Net due now: $360 minus $180 = $180

Their renewal date does not move, and next year they renew at $600. Downgrades in the middle of a year are usually handled differently: most businesses schedule them for the renewal date, so the customer keeps what they paid for and pays less from next year. If your plans are priced per seat, how to bill per seat walks through adding seats partway through an annual contract.

Renewals need their own care

An annual renewal is one large charge, twelve months after the card was last used. Cards expire and get replaced in that time, so annual renewals can fail even when the customer fully intends to pay. Send a reminder before the renewal with the amount and date, give customers an easy way to update their card, and have a retry schedule ready for the ones that fail. Dunning matters more, not less, on annual plans, because each failure is a whole year of revenue. And if the renewal carries a price rise, give notice well before it: see how to raise subscription prices.

How yRecurring handles it

In yRecurring a price can bill monthly, yearly, or on another period, so the same plan can carry a monthly and an annual price side by side. Mid-year changes are prorated by the day, with the credit and the charge shown as separate lines you can open to see the calculation, and a change can be scheduled for the end of the term instead. We follow the convention ourselves: our pricing is flat monthly plans, and paying annually gets two months free.