SaaS: how outcome-based pricing affects revenue recognition

Companies are keen to implement new pricing models, but understanding the accounting impacts is critical before moving forward.

In brief

• SaaS companies are shifting to outcome-based pricing models as GenAI becomes commonplace, and there are significant implications for revenue recognition.
• Understanding the inherent promises in the company’s customer offering is critical and requires careful evaluation.
• The distinction between the promise of access and delivery makes a major difference in how revenue is booked.

Rapid growth in the use of generative artificial intelligence (GenAI) is delivering significant user benefits to software as a service (SaaS) offerings — reducing the need for human intervention, resolving issues more consistently and enhancing customer satisfaction.

As the software itself evolves through GenAI, SaaS companies are rethinking their pricing models, with outcome-based pricing emerging as a key strategy.

This shift is introducing unique considerations for revenue recognition — particularly around determining the nature of the entity’s promise, accounting for variable consideration, and the timing and pattern of recognition.

In outcome-based pricing, the software customer pays only for interactions where the artificial intelligence (AI) successfully delivers the service without human intervention — for example, when an AI chatbot resolves a transaction complaint without a customer service representative getting involved. While this approach offers many benefits, SaaS companies will need to understand the impact on revenue recognition as they transition from seat-based pricing to outcome-based pricing.

Here are some key elements — taken from the Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (ASC 606) — that SaaS companies must consider.

Determining the nature of the promise

When identifying performance obligations in AI-enabled SaaS arrangements, companies must carefully evaluate the facts and language in their contracts to appropriately identify the nature of their promises to customers.

Is the nature of the promise — as written in the contract — access to a good or service, such as a stand-ready obligation to provide access to the SaaS platform? Or is it the delivery of the underlying good or service — for example, successful AI-enabled outcomes?

This distinction is critical because it affects the accounting for the contract, both at inception and throughout the life of the contract, as well as any disclosures. In some cases, significant judgment may be required to determine the nature of the promise in AI-enabled SaaS arrangements.

If the promise is a stand-ready obligation

In a stand-ready obligation, a SaaS company makes its SaaS platform (and all the associated AI-enabled functionality) available continuously for a customer to use as and when the customer decides to do so for a specified period of time. At contract inception, the SaaS company is obligated by the terms and conditions of the contract to provide access — and the customer is obligated to pay for those promised goods or services.

The customer’s subsequent actions to utilize the service may affect the measurement of revenue (if the arrangement includes variable consideration). But they do not obligate the SaaS company to provide additional distinct goods or services beyond those promised in the contract.

If the promise is for underlying goods or services

If the nature of a SaaS company’s promise is the delivery of the underlying good or service — for example, successful AI-enabled outcomes — its responsibility is to provide the quantity of goods or services specified in the contract, if any. The customer has the right to choose the amount of additional distinct goods or services it will purchase.

The SaaS company is not obligated to provide any additional distinct goods or services until the customer exercises the option. Prior to the customer’s exercise of that right, the SaaS company is not obligated to provide (nor does it have a right to consideration for transferring) those goods or services. In this situation, the SaaS company will also have to determine whether the right to purchase additional distinct goods or services granted the customer a material right, which would be accounted for as a separate performance obligation.

Applying the series guidance

Once the SaaS company has determined the nature of its promise, it should consider whether the AI-enabled SaaS arrangement meets the criteria to be accounted for as a series of distinct goods and services. To make this assessment, the SaaS company should evaluate whether the distinct goods and services in a contract represent separate performance obligations that are substantially the same.

For example, if a SaaS company concludes that the nature of its promise is to provide continuous access to its platform (for example, there is an unspecified quantity of service to be delivered), the SaaS company would evaluate whether each day of service is distinct and substantially the same. However, if a SaaS company concludes that the nature of its promise is to deliver a specified quantity of the underlying service (such as a specified quantity of successful AI-enabled outcomes), then the SaaS company would evaluate whether each quantity of service is distinct and substantially the same.

To qualify as a series, the distinct goods and services in the contract must also have the same pattern of transfer, such as performance obligations satisfied over time using the same measure of progress. Goods and services that meet both criteria must be combined into one performance obligation and accounted for as a series of distinct goods or services. That is, accounting for goods or services as a series is required if the specified criteria are met. This determination is important because it will affect the allocation of variable consideration and the accounting for any future contract modifications.

In general, the EY point of view is that stand-ready obligations will meet the criteria to be accounted for as a series of distinct goods or services. If the nature of the SaaS company’s promise is to deliver the underlying distinct good or service, it will need to evaluate the nature of the underlying distinct goods or services to determine whether those goods or services meet the criteria to be accounted for as a series.

Recognition of revenue in SaaS arrangements

How a SaaS company recognizes revenue in an AI-enabled SaaS arrangement will depend on the nature of its performance obligation and on how fees are structured. Here are five key considerations for how the fee structure in different types of AI-enabled SaaS arrangements could impact revenue recognition.

The promise is a stand-ready obligation

Fixed-fee arrangements

The nature of the performance obligation in an AI-enabled SaaS arrangement may be a stand-ready obligation to provide access to the software platform for a period of time. In these cases, the service is typically provided on a consistent basis from period to period, and the performance obligation is satisfied evenly. It is rare for a SaaS company whose promise is a stand-ready obligation to have a different pattern of performance.

Accordingly, revenue for a fixed-fee SaaS arrangement that is a stand-ready obligation — with no variable consideration — would be recognized ratably over the contractual period. This recognition commences on the date the service is made available to the customer, unless the SaaS company’s performance is not provided consistently from period to period.

Success-based variable fee arrangements

Alternatively, fees in an AI-enabled SaaS arrangement that is a stand-ready obligation may be structured as variable consideration. For example, the consideration in the arrangement is based entirely on successful AI-enabled outcomes from customer usage.

If the success-based fees relate specifically to the SaaS company’s efforts to satisfy the performance obligation to provide access to the platform or to a specific outcome from satisfying its performance obligation, the consideration should be allocated to the period in which the successful AI-enabled usage occurred (assuming that this allocation is consistent with the allocation objective in the standard).

If the success-based fees do not relate specifically to the SaaS company’s efforts to satisfy its performance obligation or to a specific outcome from satisfying its performance obligation, then the variable consideration would be estimated at contract inception and recognized ratably over the contract term. These estimates of variable consideration must be updated at the end of each reporting period.

The promise is for the underlying goods or services

If a SaaS company determined that the nature of its promise to the customer is to provide the underlying good or service — for example, successful AI-enabled outcomes — then the SaaS company should determine how to recognize revenue. This review should carefully consider the enforceable rights and obligations between the parties, including the contract duration; whether the consideration is fixed or variable; and the timing of transfer of the successful AI-enabled outcomes.

Fixed-fee arrangements

If a contract obligated the SaaS company to deliver a specified quantity of goods or services for a fixed price, and the SaaS company determined that the performance obligation was satisfied over time, the SaaS company may determine that an output measure of progress — for example, successful AI-enabled outcomes delivered — faithfully depicts the entity’s performance in transferring control of the goods or services promised to its customer.

Accordingly, revenue for a fixed-fee SaaS arrangement that is a promise to deliver a specified quantity of goods or services would be recognized based on its selected measure of progress, such as when each underlying good or service is delivered.