SaaS startups are bad at pricing. On second thought, I take that back. They actually know how to determine prices for SaaS software. What they don’t know is how to figure out how much customers want to pay. And the difference between the two is quite profound when it comes to effective monetization.
We at Eleken have helped dozens of SaaS companies with UI/UX design and noticed one paradoxical pattern. Startups put acquisition and retention higher than the work on the monetization of their services. They put tons of effort into their home page. The price page they often set once at the beginning and then forget forever.
This is despite the fact that monetization has the most significant impact on the bottom line, leaving retention and acquisition far behind. According to the study published by Price Intelligently, a 1% improvement in pricing results in a 12.7% profit increase. Acquisition and retention affect the bottom line not nearly as much.
It looks like working on how to price your saas product is the most important thing you can do for success. But in fact, for an average SaaS startup, it takes only six(!) hours to decide on pricing. That is not per week or per month — six hours, overall, to set, test and sharpen everything.
The anatomy of SaaS pricing strategy
Pricing a product is much easier than pricing a service. Pricing innovative SaaS service is a hundred times harder than pricing any everyday stuff. No wonder that the SaaS pricing process often reminds of picking numbers out of the air. Guesswork doesn’t count as a SaaS product pricing strategy.
Whatever price you guess, it will fall somewhere between one that is too high to generate any demand and one that is too low to cover expenses. You’ll hardly know if your customers appreciate your service more and you are leaving money on the table. You’ll figure out that you were overpriced only after you scare away a bunch of potential customers.
SaaS companies need some tools to narrow down the pricing search. In this article, we’re providing three SaaS software pricing strategies for you to come to the rescue. Each of them has its place in business, but (spoiler alert) SaaS companies need to pay particular attention to the latter one.
Cost-plus pricing strategy
This strategy embodies what people basically mean by business — selling items for more than the cost of production. It is the most widespread strategy for manufacturing and retailing companies.
Cost-plus pricing's advantages are its simplicity and predictability. It requires no formulas, it doesn't need a deep understanding of your market or your customer. You spend $2 to brew some coffee and want a 50% markup that makes $1. Slap the numbers together and voila, you get $3 and put it on a price tag. You're guaranteed to make that $1 with every sale.
The cost-plus pricing model lacks the flexibility to fit SaaS companies. What if you need to intensify marketing or hire a new employee? The cost may change swiftly. Subscription prices can't be modified all the time to absorb every cost fluctuation, which means the margin will take a hit.
And by the way, why do many startups put so much emphasis on internal cost when determining price? Customers are not interested in your costs. Just like they don’t think about the price of components when buying a bottle of cola, they don’t care about how much you spend on development. Cost-plus pricing may be convenient for a company, but it has nothing to do with customers’ expectations.
If you sell software as a service, the value your products deliver is probably
much greater than the cost to produce them. Start looking beyond your product to stop missing out on money.
Competitor-based pricing strategy
When you enter a new market, you don't usually know how to price SaaS. You don't want your price to look ridiculous when compared to similar offers. You look left to find the lowest price, then you look right at the highest price and take a safe place somewhere in between. Your monetization is competitor-based.
The main advantage of the strategy is, again, simplicity. It takes half an hour to browse the competitors' websites and a bit of math in your head (or a spreadsheet for advanced users) to have the price ready. “So, my competitor’s price is $3, and I will charge the same because they probably did their homework and know that $3 is what the market used to sustain, right?”
Yes and no. On the one hand, it’s a good idea to bear in mind what your competitors charge. Businesses that compete in a highly aggressive space may depend on this strategy completely since a slight price difference defines the users’ choice. Consider you decided to open a coffee-to-go shop. You won’t attract many customers with the price twice as high as the coffee shop next door.
On the other hand, no one ever made a major breakthrough by copying someone else's (not necessarily correct) decisions. You’re probably offering a service that differs from others somehow and has more value than your competitors’ service. Otherwise, why would you stay in business? Putting a price tag based exclusively on matching your competitor, you’re losing an opportunity to stand out, to separate yourself from the others. You’re losing your chances for rapid growth.
Value-based pricing strategy
It's the process of systematically identifying the best opportunities to deliver your audience what matters most. The truth is that the journey has no endpoint. You can never have a good enough understanding of your prospects.
Therein lay the biggest downside of value pricing — its сomplexity. You don’t have all the needed information ready, as in the case of cost-plus. You also have no opportunity to gather all the data in 30 minutes of going through competitors’ sites, as we’ve done with the previous strategy.
Yet, the value-based option is highly recommended for SaaS.
This SaaS model pricing strategy gives you two significant advantages. Firstly, you can charge more than your competitors, given that the audience is ready to pay for the value you’ve prepared for them. While healthy SaaS businesses have a lifetime-value to a customer-acquisition-cost ratio (“LTV:CAC”) of at least 3:1, value-based pricing can kick that ratio far beyond, skyrocketing their growth rate and profitability.
Let's take an example of a social media marketing tool HootSuite. Its cheapest plan was $4.99/month in 2010. Since then, they've updated their pricing year after year to reach the price of $19/month for a starting package, it's almost four times costlier.
Secondly, you can raise prices as you develop new features and add more value to your services. Development costs may stay the same, but as customers appreciate your services more, they will be ready to pay more. Who really cares that Dropbox went from $9.99 to $11.99 per month if the shift was followed by four times more storage offered?
This strategy assumes that you’ve learned your audience and can split it into buying personas to offer every persona a feature mix of its dream. Let’s see how it works for a real-life B2B SaaS pricing strategy.
Slack is one of the most successful SaaS businesses in the world, that hits 12.5 million users, including ourselves. Slack uses freemium pricing to offer a basic set of features for free plus three more upgrade plans. The company splits its offer into packages to fit a wide range of customers: for small and medium, large and very large businesses. Slack knows what features each group cares most (and least) about and includes the list of killing features to each package.
- The Free plan exists to convert interested users. Here you pay $0 but get limited by up to 10 app integrations and only 10,000 last messages available.
- In the Standard plan, you pay $6.67 per person per month to get app integrations and message searches unlimited.
- In the Plus plan, you pay $12,50 per month per person to get enterprise-level services in terms of security, compliance, and administration on top.
- The Enterprise Grid is for companies too big to work in a single workspace. It allows the creation of multiple interconnected workspaces. Pricing for Enterprise Grid is open-ended to fit any company too big for a pay-per-person approach.
We at Eleken do something similar with pricing for our design services. We also have three pricing packages, but in our case, the criteria for differentiating is not the size, but the challenge customers come with.
The essence of the value-based strategy is the continuous work on your target persons' profiles. The results you get are useful not only for pricing but also for product, design, and marketing. A deep dive into the values of your audience will help your team stay focused and make consistent decisions. It will help you prioritize product updates. It will help you avoid feature creep.
7 Types of SaaS Pricing Models
Many SaaS companies we've worked with to design their products struggle to find the right pricing model. We want to help people like them understand the difference between the most popular pricing models and make an informed decision based on the industry's best practices.
We have analyzed seven of the most common SaaS pricing models on the market. Let’s see which models Zoom, Zapier, Zendesk, TextMagic, Active Campaign, PreCog use to charge their clients.
- Freemium
One of the most common models to price a SaaS product is Freemium. You let your customers use your software for free offering them a basic set of features. In other words, you let your users see what your service is capable of without making them pay for it. To go to the next level and get the most experience of your SaaS they will need to upgrade to a paid plan. Freemium is not used as a single pricing model on the market and is usually combined with Per Feature or Tiered Pricing (will cover them further).
Zoom is a good example of a well-integrated Freemium pricing model. The most popular video and audio communication SaaS platform is widely used not only because it has an awesome set of features but also because it offers a Basic Personal Meeting plan. You can sign up for free and get access to an unlimited number of 1 to 1 and group meetings on Zoom platform with additional video conferencing features (screen sharing, recording). This plan is quite popular among single-users and small teams.
Gains:
- Usually, it costs a pretty penny to attract customers to a business. Freemium pricing model will help you acquire leads faster and cut marketing costs.
- You will build a big customer database. Collecting emails of Freemium users will help you further interact with them, test your marketing funnels, and convert them to use your additional features or sign up to one of your paid plans.
- Awesome tools with useful free features become viral very fast among users. It nurtures word-of-mouth marketing and PR.
- Freemium plan is a viable playground to test your SaaS features on different buyer personas.
Losses:
- Serving an unlimited number of freemium users can affect your financial, operational, and time resources.
- You may struggle to qualify your customers and establish the value of your service. What used to be free at the beginning, hardly becomes paid in the future. People like freebies and will try to get the most of them.
- Flat Rate
It is a simple pricing model. You have one price for one product with the same features offered to all of your customers. The only choice you give is to charge monthly or annually to use your SaaS product.
One of our clients, Precog implements a Flat Rate pricing model. Precog is a data preparation solution that simplifies the process of data analysis. It provides software for letting business teams, as well as data engineers, access any data regardless of source, size, or structure and turn it into analytics-ready tables in minutes. The customer is only offered to choose between Monthly or Yearly subscription plan, no trials, no complex pricing structure.
Gains:
- 3Es - easy to communicate, easy to market, and easy to manage.
- Communicating value. Choices are good but people sometimes struggle to make decisions. Flat rate pricing offers one option and a clear end result for everyone.
- Allocating marketing resources. You concentrate on one product and build clear funnels to promote and sell it.
- Managing revenue. You can automate all your financial operations and build an accurate financial strategy.
Losses:
- The Flat rate model limits the diversity of buyer personas you can attract. For example, if you price your product for the enterprise market, that price might be too high for mid-sized businesses.
- Upsell and scale is not your story. In other words, it deprives you of additional revenue streams and decreases LTV (Lifetime Value), as your customer can overgrow your SaaS.
- Acquisition becomes a lifetime battle. You will have to invest a lot in ads to find your audience.
- Usage-Based
Usage-based Pricing Model is pretty clear and fair for your customers. They pay only for the volume they use. An alternative name is “pay as you go”. It is like a regular utility bill with a counter but for SaaS companies. You can charge for the number of transactions, requests, data used, scheduled posts, issued invoices, calls, messages. It works well with Tiered and Freemium pricing models.
Usages Based pricing model was the best option for our good client TextMagic. It is an all-in-one text messaging service that has been successfully helping small businesses around the world do mobile marketing. They offer to create a free account and use all features. You only pay for the number of outbound text messages (sent from personal or business email, virtual, or existing mobile number). Inbound messages are free of charge. So by the end of the billing period, TextMagic customers only pay their bills.
Gains:
- A transparent financial model helps you avoid miscommunication with your clients and makes them responsible for charges.
- Price is not the key criterion for your customers. The price for usage is usually low. You can attract your first clients pretty fast.
- A wide audience. Usage-Based pricing fits all business sizes, as a result, your market share can be pretty high from startups to huge corporations.
Losses:
- Your business growth becomes highly dependent on your customers. The scale is only possible if your clients’ business grows.
- Unpredictable revenue. MRR (monthly recurring revenue) or ARR (annually recurring revenue) are fluctuating metrics for your SaaS product. It will be difficult to forecast and manage them.
- User-Based
One type of “pay as you go” pricing strategy is based on the number of users actively or passively operating your SaaS platform. There are two types of this pricing model: user-based and active-user based. You charge clients either for the total number of signed up users or for only for active users. With a user-based pricing model every time they create an account and assign it to an employee, they have to pay a monthly fee. Active user-based is more convenient for your clients as you only charge them when their accounts are used (employee is logged in, makes calls, checks reports, schedules posts, etc.). They do not have to keep track of inactive users (those who do not work anymore or on a sabbatical vacation). The user-based pricing model can be combined with a Feature-Based or Tiered one.
Zendesk, a CRM (Customer relationship management) system to manage customer relationships and contacts databases, uses an Active User-Based pricing model. They charge per active agent on a monthly or annual basis. Besides charging for a number of accounts, Zendesk also offers to choose between different tiers and features. You can choose the Essential plan and pay $5 per month per agent who will be able to communicate with customers via emails and social media messengers, keep the history of communication, create clients’ cards, and use widgets. Or you may pick Team plan and pay $19 per agent/monthly, and in addition to all Essential features provide access to dashboards and integrate additional apps for each active agent.
Eleken worked with Clientjoy, a client experience platform for freelancers and agencies that allows them to build sales funnels for potential clients, prepare proposals, track the project stages, issue invoices quickly and easily. They implemented a clear User-Based SaaS pricing model and also created different tiers to serve customers of different-size. Features are the same for each plan, the numbers of users differ only. If you are a Solopreneur, then the Basic plan is your best option, if you run a small agency or work as a team of three professionals, you may choose the Plus plan.
Gains:
- It is easy to get your head around the User-Based pricing model for your clients as they pay for the number of accounts/people who need access to the SaaS platform.
- You can gain control over RRM (Recurring Revenue Management) and forecast revenue based on the number of users.
Losses:
- Upsell is not an option if you choose to charge per User. Unless you actually combine it with multiple pricing models, add tiers, or offer additional features.
- Cheating is possible. Very often users share their account information with other people instead of adding them as users. Log in abuse significantly decreases product value.
- Feature-based
If you offer a wide range of features, then your best option would be to stick to the Feature-based pricing model. You can combine this model with Tiered pricing and create multiple plans with a set of features for different customers.
ActiveCampaign, a platform for marketing automation processes, email marketing, and customer support, uses a Feature-based pricing model. Their customers can upgrade as they scale their business or need additional features. Active Campaign also integrates user-based and usage-based pricing models. You can choose the Lite plan for $9/mo (provided with a yearly subscription) and send an unlimited number of emails (newsletters, forms), provide chat and email support to your clients for 3 users. If you also need to communicate with your Facebook audience, to manage your content and leads, to integrate other apps and grant access to a SaaS platform for more than 3 users, your better option is Plus plan which is $49/mo.
Gains:
- Customers pay only for relevant functionality and can choose from clear offers. You build several plans for businesses of different sizes (small, medium, big) and suggest choosing the one which fits their needs.
- When you have multiple predetermined plans you can divide your audience and adapt your marketing and communication strategy to each of the groups.
Losses:
- You will need to work with buyer personas meticulously to understand which features can be combined together in a way that benefits their business at the different growth stages.
- Customer acquisition is tightly bonded to your plans. If you don’t combine features in relevant plans you won’t hit the target and lose the lead. It is obvious when a client can’t find what he needs, he/she chooses your competitor.
- Tiered
Tiered Pricing model combines all the possible features of your SaaS in predefined packages and allows your customer to choose what better suits his or her needs. You create from two to five plans at a specific price with a set of functions for each. With the Tiered Pricing model, you serve B2C (business to customer) and B2B (business to business of different sizes). It is usually combined with Freemium or Feature-Based Saas Pricing Models.
Zapier is an online tool that connects apps and atomizes repeated and time-consuming tasks. They offer to choose among tiers that are developed for different types of customers (Starters, Professionals, Teams, Companies). What is even more interesting, they combined the Tiered Pricing model with Feature-based and Usage-based and Freemium.
Gains:
- Increased market share (B2C and B2B) due to a bigger audience: individuals, small businesses, and enterprises.
- High Lifetime Value (LTV) because you can offer more useful features to your customers as they scale. They will be loyal to your business, prolong their subscription, and do not consider shifting to your competitor.
- Qualified database of clients to upsell and interact with for further development and SaaS growth.
Losses:
- You will need to spend a lot of financial and time resources forefront to run detailed research of your targeted audience to carefully combine features in tiers.
- Blended
The better you know your product the optimal pricing model you will be able to choose. For some market players, it is difficult to fit all functionality into one pricing model. Therefore, they mix a few models to sell their products to different people. With a blended pricing model, gains are pretty clear, but losses are great as well. You have to manage your Pricing as separate Products and engage immensely in controlling and forecasting (if it is possible) your revenue streams.
Vimeo, a streaming platform, is hitting that road. They combine Feature-, Usage-, User-based, Tiered, and Freemium pricing models to get the most of what they can offer to their clients. Despite it is a bit unclear from their pricing on a website but you can try a plan for 30 days for free or start with Vimeo Basic plan - Freemium pricing model. Then they offer different tiers (Plus, Pro, Business, Premium) with predetermined sets of features for each package. We can see Tiered and Feature-based pricing models combined here. Each of the plans also offers different storage to your business size and number of users who can access the platform and work with videos. Pretty awesome!
The key takeaways:
- You can not copy-paste the pricing model of your SaaS competitor. Even one different feature you offer may influence the choice of pricing model. Put on the table all that you can offer to your customer and see how you can deliver your market value, meet customer needs, and make your business profitable long-term.
- If you can’t measure it, you can’t improve it. Your SaaS Pricing Model directly influences your total revenue. There are important metrics that you have to work with to understand whether this model fits your SaaS business or not. We have mentioned LTV (Lifetime value - the amount of money which you can receive from customers over their usage of your service) and CAC (Customer Acquisition Cost - how much will you need to invest to attract clients). Churn ratio (percentage of revenue you lose due to subscription cancellations or downgrades) and Expansion MRR (earnings from upsells) are also connected to the type of pricing model.
- The SaaS pricing model is not a rigid choice for your business. You may change it as your service develops additional features or scales on the market.
