How to Think About Annual Contracts, Up-front Payments

I’ve helped several teams lately go through an analysis of when to consider annual prepayments for services. These are some of the decision criteria and metrics that I use to consider if an annual contract or pre-payment should be considered.

As a baseline, calculate the full amount that you would pay monthly. For most software products, this is the regularly advertised price. Make sure you are looking at the actual monthly plan proce though. A lot of services have started advertising as “$x per month billed annually“. Make sure to select the monthly payment price whe you see that. Some services, like commercial insurance charge a small per-payment fee for “installment plans” that should be included.

Next, calculate the full price if paid up-front. Of course, you need to include discounts that are offered. Sometimes, an offer may make it a period other than one year, such as “buy now and get 13 months for the price of 12”, which makes it a little more complex. In that case, you could consider the annual price as 12/13 of the amount you pay. Or, if the extra month is not really material, you may chose to ignore the extea month.

After you’ve got those two numbers (the annual and monthly prices), you should consider the other terms and internal needs.

Consider if your usage of the service is expected to change much over the next 12 months.

Also, consider how much flexibilty you lose with an annual pre-payment. Some services, like Slack give you a credit if usage decreases. Others have no flexibility and you pay that amount, even if usage decreases or you cancel.

In general, I expect around a 15% discount for a full up-front payment and very flexible terms for changes in usage or cancellation. If terms are more strict, I’d aim for more like a 30% (or more) discount for the commitment and up-front payment.

Finally, consider your own cash flow and capital positions. If you have an plenty of cash in the bank, you can lean toward the saving of an annual prepayment. If you don’t have a lot of cash, You’ll favor the monthly terms.

What are your thoughts and experience? What else should be considered when evaluation annual payments?