Okay, so you’ve come up with a great SaaS idea that you’re ready to bring to market. But that’s only half the battle – because now you have to figure out how to charge for it.
Even if your idea really is the best thing since sliced bread (which actually took a little while to catch on), finding the right pricing strategy and model can still be the difference between success and failure.
Charge too much, and you risk putting off customers who could have provided you with years of recurring revenue, throttling your growth. Charge too little, and you’ll lose any chance you had of making a profit and kill your SaaS in its crib.
These aren’t exactly the business secrets of the pharaohs here – don’t overcharge or undercharge, is what we’re saying – but it can be difficult to know how to strike the right balance between providing value to your users and growing your revenue.
That’s why we’re going to break down the most common pricing strategies and models that SaaS companies have to choose from, and figure out which ones might apply to your business.
What’s the difference between a pricing strategy and a pricing model?
‘Pricing strategies and models’ might sound redundant, but pricing strategies and pricing models are actually two different terms that shouldn’t be used interchangeably (although they often are).
Pricing strategies are the principles that guide you to your price point. Essentially, your pricing strategy boils down to whether you choose to charge based on what your SaaS costs you to run; what value it provides for your customers; or what your competitors are doing.
Pricing models are the different ways you can format that price, and the ways you can package your service. Will you charge a flat price for every subscription to your service, or get funky with it and offer different prices based on things like how often people use the service, or which features they use?
Let’s break down your options.
This is the most straightforward way to price anything, including your SaaS. You add up your costs – for a SaaS company, that’ll include things like development and design time, paying your team, and paying for any software services you need to run your own SaaS – and then you add a few percentage points to ensure you make a profit. Voila, that’s cost-plus pricing.
The pros of this model are pretty obvious – it’s simple enough to calculate, and as long as you add on a decent markup, you’re guaranteed to make a profit with every sale. Seems like a no-brainer, right?
But there are downsides to this model. Firstly, it doesn’t take the market – i.e. competitor pricing – into account. More damningly, it doesn’t take your customers into consideration. Just because something costs you a lot to develop doesn’t mean it’ll be worth that price to your customers.
On the other hand, if your costs for delivering each individual account are low, but the value your service provides to those customers is high, then you could be leaving money on the table if you’re not charging them what they’re willing to pay for it.
Consider, too, that this is a subscription service, and your inputs are likely to fluctuate. Cost-plus pricing makes a certain amount of sense for physical products, when you know exactly what goes into producing each discrete unit that you’re selling, and customers expect a certain level of inflation over time.
It’s not as effective when you’re setting the price of a subscription service, which customers don’t expect to change regularly – and suddenly your profit margin starts getting pretty, well, marginal.
That said, you have to start your thought process around pricing somewhere, and cost-plus pricing can help to guide you in the right direction.
This strategy puts aside your own costs, and instead uses what your competitors are already charging for their services as a benchmark. This can be a good option if you’re just entering the market, and don’t have the data to provide any other framework for the value you’re providing to customers.
Again, it’s pretty simple – looking at what your competitors are doing gives you a sense of the market, and what your customers are willing to pay. After all, your competitors have likely already done the research, so why not use their hard work to your advantage? You can then decide if you want to:
- Price below the market (a good way to win customers and aggressively gain market share, if not to grow your profits);
- Price at the market rate (also known as price matching); or
- Price above the market (in which case you’ll really have to prove to customers that your SaaS has features and functionality that goes above and beyond your competitors).
Generally, if you’re a new entrant to the market and you don’t want to look ridiculous, you can price your service somewhere safely in the middle of the lowest price on the market and the highest.
The problem with this strategy is that you don’t know how your competitors arrived at their prices. If they’ve made a mistake, or if their costs are substantially different to yours (maybe they’re underpaying their workers – you don’t know!), then you could be setting yourself up for failure.
Besides, how similar is your service to what your competitors are offering, really? The odds are that there’s something unique or different about your service that made you want to bring it to market in the first place, and if you’re not taking that into account in your pricing, you’re cheating yourself. (And if there really is nothing separating your SaaS from your competitors, why are you in business at all?)
Competitor-based pricing is a solid strategy for new entrants looking to find their place in the market, but it’s not necessarily sustainable. Over time, as your knowledge of the market and your customers grows, you’ll want to move towards a pricing strategy that reflects your SaaS’ value.
Yes, we said penetration. This pricing strategy sees you offer your service to the market at a low initial price, in order to grab as large a chunk of the market as you can before you raise prices to a more sustainable level.
The benefit of this strategy is that you can capture a large number of subscribers to your service with artificially low pricing, and if they see value in what you offer (or they just forget to unsubscribe), then you can hold onto them when you raise your prices up.
The downsides are that it obviously hurts your revenue in the short term; it can make your service look cheap (in a bad way); and it can lead to a high rate of churn if customers don’t feel like your service offers value at the higher price, or they simply resent falling for the ol’ bait-and-switch.
Again, like competitor-based pricing, this can be a solid strategy for new players, but it’s not your endgame.
Value-based pricing uses the perceived value of your service to your users as the benchmark for your price, instead of what your service costs you to provide.
This is arguably the most sustainable pricing strategy, because let’s face it – if your service isn’t providing value to your customers, at a price that they’re willing to pay, then your SaaS isn’t long for this world anyway.
Proponents of this strategy often refer to the ‘10x rule’ – the idea that whatever price you’re charging your customers, you’re providing them with at least ten times that much in value.
The downside of this strategy is that it takes time and data, two things you probably don’t have if you’re looking to take your SaaS to market now. The only way to know how much your customers are actually willing to pay for your service is to ask them, to dig deep into how your service actually benefits them (and what that’s worth to them), and to test how they react to different price points.
It can also lead to increased costs, as you might need to spend more on your service in order to ensure you’re providing a premium offering that justifies its price point.
If you know you offer more value than your competitors, and you can prove that to your customers, then a value-based pricing strategy is the way to go. But because of this strategy’s complexity, it should be where you end up once you’ve established goodwill in the market and you have a better sense of what your service is worth to your users – not necessarily where you start out.
And that’s okay, by the way! You can’t be raising your prices every month, but SaaS pricing doesn’t need to be completely rigid, either. You should reevaluate your strategy every so often (every six months or so seems to be the magic number), and change your tactics as the marketplace and your place in it evolves.
Mirror, mirror, on the wall, what’s the simplest SaaS pricing model of them all? The answer is flat-rate pricing – a single product with a single set of features that you charge at a single price for all subscribers.
There are no add-ons, no tiers, and no difference in price regardless of how much (or how little) they use the service. The only choice customers usually get under this pricing model is whether they pay monthly or annually (with a discount offered for paying annually).
Pros of flat-rate pricing
- Simple to communicate. There’s one clearly defined message to take to every type of customer – this is what our service does and this is what it costs. You can focus all your sales and marketing efforts on this one offer, and simplify your landing pages and collateral.
- Simple to understand. Potential customers won’t feel like they’re overwhelmed with options when they get to your pricing page, and they won’t worry that they’re missing out on a particular feature. This eliminates the ‘paralysis by analysis’ that can lead you to lose out on a sale.
- Simple to project revenue. With only one product on offer, it’s easier to project how much you can expect to make from recurring billing.
Cons of flat-rate pricing
- Missing out on revenue. If you’re charging power users and large enterprises the same amount to use your service as an SMB who doesn’t use it as often or as extensively, you could be missing out on opportunities to upsell. (You could be penalising those lighter users, too, if you have to increase prices to service the larger users.)
- A lack of nuance. With flat-rate pricing, you’ve only got one shot to sell your service. Either they want it or they don’t, and you haven’t got any custom options that are better suited to their needs to persuade them with.
Should I adopt a flat-rate pricing model?
Flat-rate pricing could work for you if you offer a simple service with limited features and few options for customisation, that won’t cost you significantly more to provide to customers who use it more often.
This model ties the cost of the service directly to how much a customer uses it, so heavy users pay more than light users. You can either charge a recurring monthly fee and then add on extra charges for extra usage, or if you want to live dangerously, scrap the recurring fee altogether and only charge customers for what they use.
You can charge users based on things like the amount of data they use, how many requests they make, the number of posts they schedule and so on – whichever metric makes the most sense for your SaaS.
Pros of usage-based pricing
- Lowers the barrier to entry. This pricing model can appeal to a wide range of customers with different needs, so even the smallest of start-ups on the tightest of budgets can sign up and be secure in the knowledge their price will only rise with their usage. You can bill it as a plan designed to grow with their business.
- Takes heavy user costs into account. With flat-rate pricing, or any other fixed price model, there’s always the chance that heavy users of your service will take up a disproportionate amount of your resources. This way, you know you’ll be fairly compensated for increased use with increased spend.
Cons of usage-based pricing
- Harder to predict your revenue and expenses. The downside of customers being able to call their own shots is that it becomes much harder to predict and manage your revenue and expenses from one month to the next.
- Can lead customers to use your service less. If you’re charging customers each time they use your service, then you’re essentially incentivising them not to use it – and that might lead them to find alternatives.
- Can disconnect price from value. Is the value of your SaaS really in the sheer number of times a customer uses it throughout the month, or is it in what you can do for them that other services can’t?
Should I adopt a usage-based pricing model?
Usage-based pricing models can be a good option for companies that want to keep their prices affordable, but also need to limit access to their service in order to maintain their profit margin. Dropbox, for instance, charges users based on the amount of space they need, because it costs Dropbox to host those users’ files on their servers.
On the other hand, you can achieve a similar effect with tiered and freemium pricing models, while keeping a tighter rein on your monthly recurring revenue (MRR).
This model splits users into tiers – usually three, four or five tiers at most, to avoid overwhelming users at the sign-up stage.
Each tier unlocks different features at different fixed price points. These tiers should be tailored specifically to meet the needs of particular buyer personas, and each tier should be labelled clearly, so users can see how they would benefit if they chose to unlock the next tier up.
This pricing model is often combined with the Freemium model described below.
Pros of tiered pricing
- Appeals to a broad range of customers. Unlike a flat-price model, which only gives you one shot to appeal to customers, a tiered model gives you the opportunity to tailor packages to a wider range of customers (e.g. individuals, SMBs, large enterprises).
- Maximises revenue. By being able to target specific personas with specific tiers, you’re not leaving money on the table like you would be under a flat-rate model, which removes the opportunity to charge heavier users more and offer a cheaper tier for lighter users.
- Easy upselling opportunities. Upselling is built into the tiered model, which gives customers an obvious route to the next price point once they outgrow the tier they’re on.
- Allows you to charge proportionately for delivery-heavy features. If you know certain features of your service cost you significantly more to provide than others, and your service will still be of value to some users without those features, then you can lock them behind a more expensive tier.
- Revenue is predictable. Enabling customers to choose from a range of fixed-price packages gives you the advantage of being able to charge heavier users a higher price (as long as you package your tiers correctly), while still making it easier to predict your MRR than it would be under a usage-based model.
Cons of tiered pricing
- Can be overwhelming. If you offer customers too many tiers to choose from, or don’t make the differences between tiers clear enough, they might put your service in the ‘too hard’ basket at the sign-up stage, and you’ll lose conversions.
- Can contribute to churn. If users initially sign up for the wrong tier, they may drop your service altogether, rather than simply switching to another tier that might be perfect for them. Again, it’s essential to communicate how the different tiers you offer apply to different users.
- Heavy users are still a risk. If subscribers to the top tier are still exceeding their expected usage, you’re out of options to collect extra revenue from them. You’re already on 10 – where can you go from there?
Should I adopt a tiered pricing model?
Tiered pricing model is the most common model used by SaaS companies, to the point that it’s really become the default model. If you offer a range of features that you can unlock at different tier levels, then a tiered model can work for you.
Essentially just a type of tiered pricing model, this one specifically bases the tiers on the number of team members that can be added to an account – so 1-10 users might be one tier, for instance, followed by 11-50 users, and 51-100 users, and so on. (Alternatively, you can literally charge ‘per user’, which is just applying the flat-rate model to every different team member who uses your service.)
Pros of per-user pricing
- Simple to understand. As far as tiered models go, this one is incredibly simple – rather than unlocking new features, customers are simply adding more users with access to the same features at each price point.
- Revenue is predictable. As long as your users aren’t wildly growing or shrinking their teams every month, per-user pricing makes it easy to calculate your MRR.
- Revenue rewards adoption. The more users of your service there are within a company, the more revenue you get – as opposed to a flat-rate model, where users scaling up their team and/or their usage of your service wouldn’t necessarily benefit you.
Cons of per-user pricing
- Users can cheat. Customers can share logins between multiple team members, enabling freeloading ‘users’ to access your service.
- Disincentivises adoption. Companies that use your service may actively seek to limit adoption of it to their most essential team members, rather than encouraging everyone to use it, in order to keep their costs down.
- Can contribute to churn. If companies are deliberately limiting the amount of team members that use your service, then it’s easier for them to stop using it altogether. But if everyone at that company is using your service, it’s less likely they’d abandon it.
- Can disconnect price from value. This is similar to the question you have to ask yourself when adopting a usage-based model – is the value of your product really reflected by the number of team members who are using it, or in what that team is getting out of it?
Should I adopt a per-user pricing model?
A per-user pricing model has many of the same advantages as the tiered pricing model above. If your service isn’t geared towards unlocking different features at various price points, then separating your tiers by user numbers is a good alternative.
Per active user pricing
This is the per-user pricing model with a twist. In this case, it doesn’t matter how many team members are signed up to use the service, it only matters how many of them actually use it.
Slack is a famous proponent of this pricing model – no matter how many members of your team are signed up for Slack, you’ll only pay for those who are actively logged in and using the platform.
Pros of per-active user pricing
- Customers don’t waste money. Your customers don’t have to worry about wasting money on unused seats, and will only pay for what they actually use. This can remove a barrier to adoption.
Cons of per active user pricing
- Customers don’t waste money. SaaS subscriptions can be very much like gym memberships, in that the real profit comes from people signing up for services they don’t use. Eliminating this wastage is great for the customer, but not so great for you.
- Can be overly complicated. Compared to a straightforward per-user plan, pricing by active users can get complicated and contested – particularly when it comes to defining an ‘active user’. It also makes it much more difficult to predict your MRR, as the number of active users will change from one month to the next.
- Won’t move the needle for SMBs. If a team doesn’t have many members to begin with, then tiering your prices ‘per active user’ won’t make much difference to them.
Should I adopt a per-active user pricing model?
This model can be useful in one specific circumstance – if you’ve had trouble convincing enterprise organisations to sign up to a per-user model. In that case, a less risky (from their perspective) per-active user model might encourage them to get on board.
This is a form of tiered pricing where you offer the first tier for free. You give users access to a basic set of features so they can see the value of your service for themselves, but lock the more advanced features behind paid tiers.
Paid tiers can also be based on capacity (exceed your free allowance of storage, for instance, and you’ll need to upgrade to a paid tier), use (take a conference call for 100 minutes for free, and pay after that), or use-case (individuals can use the free service, but SMBs and enterprises need to pay).
Pros of freemium pricing
- Supercharges adoption. Freemium pricing gives you a foot in the door and a chance to win over skeptical customers. It can enable you to start building a large customer database straight away, and it can give you an opportunity to start building word-of-mouth, if not revenue.
- Can be ad-supported. Offering advertisers a chance to pitch their wares to your freemium customers means you can still make money from this tier, even if those users don’t move up to a paid tier.
Cons of freemium pricing
- Can be a revenue killer. If you’re not able to support your freemium tier with advertising, and your freemium tier isn’t leading to a lot of paid conversions, then it’s draining your resources without generating any revenue. It’ll be up to the users on your paid tiers to shoulder the cost of acquiring and servicing all of your users.
- Can contribute to churn. When we don’t pay for things, we tend to value them less. A freemium tier makes widespread adoption possible, but it also makes widespread churn possible, and can devalue your product in the eyes of your potential customers.
Should I adopt a freemium model?
A freemium model can be a good option for SaaS businesses that need to raise awareness of what they do, as long as it’s offered in conjunction with a tiered pricing model based on features, users or usage. Get them hooked – but make sure you make them pay.
Not sure which SaaS pricing strategy or model is right for you? Reach out to us here at SBO Financial, where we help SaaS solutions and start-ups ensure their growth is profitable and sustainable.