With the growing adoption of subscription or SaaS pricing models, figuring out how to price and bill for software has become an intricate process requiring data and insight into your customers’ mindsets. Traditional pricing models such as cost-based pricing (i.e. figuring out your costs and adding a profit margin) have fallen by the wayside. Many SaaS companies are implementing subscription services that focus on adding value and increasing recurring revenues through a mixture of different billing models.
Deciding on the right subscription pricing strategy takes time. You need to make sure products and services are profitable and set recurring billing up to make it easier to predict revenue, handle revenue recognition, and scale with your customers as they grow. In this blog, we will explore the pros and cons of each pricing model and discuss some examples of each of them in action.
Looking to explore a specific pricing model? Skip ahead to your preferred model by clicking on it in the list below:
- Usage-based or pay as you go
- Bundling or roll your own
- Freemium or ad-supported
A pricing strategy based on how much customers use the service. It can use one or several different metrics. For instance, phone companies often use this billing model and break it down into different subsets, e.g. the number of texts sent, data used, minutes used. Pricing can also be changed based on time of use so that peak hours of usage may have a different rate.
Many companies implement usage-based pricing to appeal to a wide range of customers with different needs. It’s important to note that it can be a complex system, and you need to think about how to implement the pay as you go strategy in a way that transparently shows customers the value of your service. Some companies will charge a recurring monthly fee with add-on charges for extra usage outside of the proposed plan. Others may only have customers pay for what they use.
Usage-based or pay as you go is often a cheaper and more flexible option from the customer’s perspective, and you may find that the people most interested in this option see it as a means to save money and stick to their budget more consistently.
Digital Ocean, a hosting company that simplifies cloud computing for developers and their teams, has perfected the transparency of usage-based billing, allowing potential customers to easily see what their usage will cost for any of the services on offer. Not only do they clearly display the monthly rate, but they clearly show memory, CPU and disk usage, as well as the hourly spend.
A breakdown of the pros and cons of usage-based subscription pricing models
- Customers don’t need to pay a lot of money if they are using only several features.
- Flexibility allows users to try out your service and increase payments as they build it into their lifestyle.
- Heavy users are charged appropriately for the services they’re utilizing.
- Less friction at sign-up as it’s easy for potential subscribers to understand pricing.
- Possible to give access to more customers by introducing lower tiers with different usage rates.
- Recurring billing and revenue recognition are both straightforward and easy to manage.
- Conveying the value of discounts and special offers is usually simple.
- It can be complicated to set up and difficult for customers to calculate their costs accurately.
- More usage may not correlate to more perceived value from the customer’s perspective.
- Your expenses and revenue may fluctuate more dramatically from month to month.
- Has been shown to lower overall consumption as customers change their habits to avail of off-peak pricing.
- May elongate the sales cycle if customers are unsure of their usage requirements.
- Customers may not necessarily understand hikes in their billing as they scale.
Per-user billing is simple to understand and implement for both the customer and the SaaS company. It also reduces the complications that come when companies onboard multiple team members.
The per-user pricing model allows the customer to pay for each user that uses the software. One thing to be aware of is that people often try to cheat the system, using one login for multiple users. If the fees are exorbitant, it’s common to find companies trying to lower the number of accounts they need.
Microsoft is an example of user-based pricing that is familiar to most. They have successfully implemented this billing model for their Microsoft 365 solutions. Their pricing page is a good example of knowing how to explain the service offered as well as highlighting and making clear what products customers will be able to access.
A breakdown of the pros and cons of per-user SaaS pricing models
- Both you and your customer can implement the system hassle-free.
- Set easy and tangible growth targets as your revenue scales in line with adoption.
- Forecast revenue with accuracy and ease.
- Users have equal access to the features of the product.
- Streamlines budgeting and cash flow as calculations are relatively simple.
- Limits adoption as customers only add seats they need.
- Incentivises companies to cheat the system with multiple users logging in to the same account.
- Susceptible to a high churn rate as only a few people use the tool.
- Customers can be surprised by the increase in price when adding new users during high growth periods.
Tiered pricing is the most common billing model used by SaaS companies. It allows for a lot of flexibility in the software’s offering while giving customers the opportunity to level up as they start to see the benefits of the features. The tiered SaaS pricing model combines well with other strategies. Companies will often base the tiers on features, usage or users.
On average, there should be between three to four tiers to prevent confusion, but anything up to five is reasonable. The only issue with too many options is that it can be hard for customers to know which one they need. They may be overwhelmed and go elsewhere.
The most significant advantage of tiered pricing for SaaS companies is the ability to upsell and build their recurring revenue. Tiered pricing must be strategic, with obvious benefits and advantages made available at each tier, so that customers know what value they are currently getting and what other features or usage they can benefit from if they unlock features as they scale.
Hubspot is an example of feature-based tiered pricing laid out intelligently. As you can see from the landing page below, they’ve carefully mapped out the benefits. One interesting thing to note is that they don’t merely list features at each level, each tier has a distinctly different list of business advantages.
A breakdown of the pros and cons of tiered subscription pricing models
- Attract a wide range of personas and scale with companies as they grow.
- Easier to increase revenue through upselling customers once they’ve trialled more basic tiers.
- Tailor your tiers to meet the needs of a variety of businesses from small mom-and-pop shops to more prominent corporations.
- Gives customers more choice and flexibility.
- Boosts overall conversion rates as your pricing page can appeal to a wider range of audiences.
- Marketing can focus efforts on specific target audiences for each tier.
- Confusion over too many tiers can leave customers feeling overwhelmed and unsure about your product.
- Top-tier users may take advantage of the system with heavy usage.
- Can attract the wrong customers by being an “everyman” solution and offering options that are not necessarily profitable for your company to maintain in an attempt to widen the appeal of the product. Sometimes catering to a specific, niche audience can reap better results.
- Users may select the wrong tier resulting in a high churn rate.
- Requires a deeper understanding of potential audiences and price points to execute effectively.
A one-size-fits-all strategy that cuts down the possibility of confusion for your customers. Companies charge all customers the same amount regardless of usage, users or features needed.
A flat-rate pricing strategy means that companies can make their value offering very clear, and there’s no confusion over which features will be available to customers. Sometimes, more complicated pricing and tiers can lead companies to misunderstand what they’re paying for at the lower price points.
Flat-rate pricing is best used by companies who have a clear picture of who their ideal persona is as their landing page is likely to appeal to a specific audience. Basecamp is an example of a tool that uses this particular billing type effectively.
A breakdown of the pros and cons of flat-rate SaaS pricing models
- It’s simple to use and easy to understand.
- Revenue projections are more accurate as there are fewer complications.
- Easier to create landing pages and marketing collateral as you’re only conveying the value of one price point.
- Cuts down the decision-making time and can increase conversions for new customers as there’s less to consider.
- Simplifies revenue recognition for recurring billing.
- One-size-fits-all may be immediately off-putting to customers who want custom options.
- Lack of choice can cause some customers not to take your offering seriously, as it feels as if customers are all treated with a blanket approach.
- Companies want to know you care, and sometimes flat-rate pricing has the negative (and unintended) side effect of making them feel you won’t go the extra mile.
- No opportunities to upsell. If companies scale and use your product more, you don’t make any additional revenue.
- Scaling will be problematic as your flat rate price will only appeal to a specific market/persona.
For software that comes jam-packed with impressive features, it may be best to build tiers based on those features. Users pay more when they extend the functionality. The highest tier usually offers considerably more functionality than the lower ones. This is commonly referred to as feature-based pricing.
One reason this can work well is that users get used to using your product, building trust and a customer relationship. Often growth will mean that companies will face new challenges that your solution can manage. Companies strategically make sure each new tier is a natural progression.
Canva uses feature-based pricing, and below you can see how they’ve laid it out to make it quite clear what problems each tier solves.
A breakdown of the pros and cons of feature-based SaaS pricing models
- Upselling is more natural as the incentive to upgrade to the next tier is clear.
- Allows you to charge appropriately for complex functions that are only needed by select customers.
- Customers can trial your lower tiers to see if they like your software, without having to invest large amounts of money when still unsure.
- Customers can easily understand pricing.
- Ideal for hybrid pricing strategies such as a combo of tiered and featured models.
- Too many features or tiers can lead to confusion.
- It’s challenging to divide features into the appropriate tiers.
- Some basic features need to be in lower tiers, while still putting enough important features in higher levels to incentivize upgrades. It can be a tricky balancing act!
- Resentment can build if the customer feels locked out of too many features despite their monthly fee.
- Redundant features are sometimes built to offer more functionality at every level. Make sure each feature solves a distinct issue and is not just built to sound good on a landing page.
Sometimes feature-based or usage-based pricing can neglect the expenses incurred on the human-facing side of your enterprise. It may not be easy to break your product’s features down into tiers or usage-based categories. Maybe it’s the case that some functionality will be necessary to one set of users, but not another, and there’s no simple way to cater to a more nuanced audience. Perhaps you also find that you spend a lot of money on training new users, and consulting with them on business issues.
Often a selection of bundles is the best way to cater to the many needs of a SaaS company, allowing them to appeal to more of the market with strategic packages built for specific targets. Sometimes, premium customers want the option to roll their own by creating a bundle with the features and functionality they require, as well as consulting services that will help them make the most of the new software.
Many would argue that price bundling should be a part of any SaaS company’s strategy. A breakdown of the pros and cons for feature-based pricing there will always be users who want tools catered to their industry and by packaging bundles for various markets, you can increase your sales.
One innovative use of a bundling strategy can be seen on Humble (a game streaming subscription site) that sells time-sensitive bundles, including stats for each one like how many sold, and when it will expire. This creates a sense of urgency and it’s also easy to see the value of each bundle as they display the total cost of the bundled games.
A breakdown of the pros and cons of roll your own SaaS pricing models
- Customers feel they get better value with bundled services.
- Speeds up the sales and implementation process.
- Easy to show overall value by listing bundled services in marketing collateral.
- Adds value without having to add new functionality or features.
- Increases revenue from each customer.
- Opportunity to build partnerships in order to enhance bundles with new features.
- Cost of management and accounting overhead may increase as the accounting team has to create different line items for bundles or have a more robust system that can manage bundles.
- Bundling can introduce complications for revenue recognition. It may also make it harder to perform margin analysis on different revenue streams.
- Confusing if there are too many bundles and limiting if there are too few.
- Customers may be unable to pick the exact option they want or feel a bundle includes features they don’t desire.
Partnerships with other brands to add features to your bundles may be distracting and cause you to lose sight of your value offering.
The freemium pricing model is widely used by SaaS companies that want to give people a taste of a limited version of their product. This strategy allows them to attract new users and gives those customers the opportunity to upgrade to the paid version. Free-versions are often ad-supported.
Dropbox uses its free trial to lure in customers. Users can avail of premium features and see if they’re happy with the performance. This has been a successful strategy for Dropbox with high adoption of their services over time.
A breakdown of the pros and cons of freemium subscription pricing models
- Customer acquisition costs are lower.
- Free trials tend to lower the barrier to entry.
- Drives faster product adoption across companies as everyone can try the tools and it’s not confined to one or two people on a team.
- Ad-supporting your premium plan can help you make money even when customers are using the service for free.
- Free trials are likely to spread faster by word-of-mouth, reducing the amount you need to spend on marketing efforts.
- Free versions can be an ideal place to experiment with new features.
- Decrease the perceived value of your product.
- Conversion rates from free to paying customers is often lower than it is from lower-priced tiers to premium ones.
- Free users can become an operational burden that requires support without having paid for any services.
- Inflated churn rates at the end of free trial periods.
- An enormous volume of customers is required to recuperate costs.
You may have noticed that there’s a lot of cross-over between the different pricing models, and you may be struggling to understand the difference between tiered and bundling or usage and per user. That’s normal. The truth is that most SaaS companies will try a combination of these approaches. Using a hybrid billing model helps companies better price their subscription services. There’s no one-size-fits-all billing model, and it will take time, as well as thorough customer and market research, to figure out the best path forward.
Our guide to 5 of the most popular hybrid pricing models gives you several more examples in action. You can download it as a booklet here.
Implementing the subscription pricing strategy that’s right for you
Once you’ve considered all the SaaS pricing models, it’s time to decide what works best for your company. It will make sense not only to choose the right strategy but the right tools to help implement it. Generally, you’re going to need to partner with a company that has experience handling more complicated pricing and billing models.
Subscription Billing Suite allows you to implement all of the SaaS pricing models. So, whether you want to bill your customers monthly, quarterly, annually, it may just be the solution for you. Why not find out more below.