The 7 Key SaaS Pricing Models, Explained
This is part one of my three-part series, taking a deep-dive into SaaS pricing strategy. I’ll be covering key pricing models, strategies for hitting your growth goals, and psychological hacks for optimising revenue.
Finding the right balance between value and revenue — your ability to help customers and be fairly compensated for that help — will make or break your SaaS company.
Undercharge, and you’ll cripple your business with uncompensated development and delivery costs; overcharge, and you’ll throttle your growth and drive away thousands of would-be customers.
To help you get the most from your SaaS product, I’m looking at the seven major SaaS pricing models, and exploring the pros and cons of each.
Whether you’re tied-up in tiered pricing or frustrated by freemium, the pricing models covered here should help you identify the optimum way to market, sell and grow your SaaS business.
1) FLAT RATE PRICING
Flat rate pricing is probably the simplest way to sell a SaaS solution: you offer a single product, a single set of features, and a single price.
In this way, flat rate pricing bears a lot of similarities to the software licensing model used before cloud infrastructure existed, but with the added benefit of (usually) being billed monthly.
EXAMPLES OF FLAT RATE PRICING
Examples of flat rate pricing are few and far between (the most famous example from recent years, Buffer’s Awesome plan, is now one of many pricing packages the company offer) — but the practice is still used by eCommerce SaaS CartHook.
A single monthly price of $300 (or $2,400 billed annually) grants access to all features of the company’s product:
PROS OF FLAT RATE PRICING
- Easier to sell. Offering a single product at a single price makes it possible to focus every ounce of sales and marketing energy on selling a single, clearly-defined offer.
- Easier to communicate. SaaS pricing models can get complicated, and quickly — but flat rate pricing is quick and easy for any would-be customer to understand.
CONS OF FLAT RATE PRICING
- Difficult to extract value from different users. If you’re targeting SMBs, and use an SMB-friendly pricing strategy, you’ll miss out on a fortune in revenue if any Enterprise companies decide to adopt your tool.
- One shot at securing customers. There’s no nuance or flex in flat rate pricing: either would-be customers want the package, or they don’t — and there’s little you can do to sway them.
2) USAGE BASED PRICING
Also known as the Pay As You Go model, this type of pricing strategy directly relates the cost of a SaaS product to its usage: if you use more of the service, your bill goes up; use less, and your spend decreases.
In practice, this pricing strategy is most common within infrastructure- and platform-related software companies (like Amazon Web Services), where companies are charged based on the number of API requests, transactions processed, or gigabytes of data used.
Increasingly though, SaaS companies are finding new ways to adapt the model, like social media tools that charge for scheduled posts, or accounting tools that charge per invoice.
EXAMPLES OF USAGE BASED PRICING
Usage based pricing works particularly well for recurring billing platforms like Chargify: by directly correlating price with revenue, you can guarantee that price increases only happen alongside periods of increased revenue, ensuring that customers will always be able to afford and justify the change in price:
PROS OF USAGE BASED PRICING
- Price scales alongside usage. It makes sense to correlate usage and price: if you have volatile demand, and use less of a service in a given month, why should you expect to pay the same amount as a boom month?
- Reduces barriers to use. There are no big up-front costs with usage based pricing, and even the smallest startups can get started with your product, safe in the knowledge that prices will only increase alongside their usage.
- Accounts for “heavy user costs”. With fixed price packages, there’s always the risk of “heavy” users taking up a disproportionate amount of your delivery resource, without compensating for it with increased spend.
CONS OF USAGE BASED PRICING
- Disconnects value from the product. Do your users really care about the number of API requests they generate? Or do they care more about seamlessly integrating two crucial pieces of software?
- Harder to predict revenue. Usage based pricing typically means that billing amounts will vary month-to-month, making it much harder to forecast revenue.
- Harder to predict customer costs. The same problem applies to customers: those with volatile usage may see wild (and potentially unexpected) fluctuations in their monthly bill.
3) TIERED PRICING STRATEGY
Flat rate and usage based pricing are relatively uncommon in mainstream SaaS, and it’s tiered pricing which is the de facto model used by most companies. At its heart, tiered pricing allows companies to offer multiple “packages”, with different combinations of features offered at different price points.
The average number of packages on offer can vary hugely, but the average clocks in 3.5 — often geared towards low, middle and high price points.
TIERED PRICING EXAMPLE
SaaS content marketing company HubSpot employ tiered pricing to great effect: each tier is designed around the needs (and budget) of a different type of potential customer, ranging from “those new to Inbound marketing” to “professional marketers” and “marketing teams”:
PROS OF PRICE TIERING
- Appeal to multiple personas. With a single package, you have one shot to resonate with your target customer; with tiered pricing, you can tailor packages to suit multiple buyer personas.
- Leave less money on the table. By appealing to multiple personas, you can maximise the revenue generated from different types of customer: offering a single $100 package will overcharge users with a $10 willingness to pay, and undercharge users willing to spend $200.
- Clear upselling route. When your customer outgrows their current package, there’s a direct route to the next price point.
CONS OF PRICE TIERING
- Potentially confusing. Choices can quickly become overwhelming, and trying to decide between ten price tiers is a rapid route to an abandoned sale.
- Appeals to too many people. It’s tempting to create a wide range of packages to appeal to every possible need — but as the adage goes, you can’t be everything to everyone.
- “Heavy user risk”. If top tier users regularly exceed their allocated service usage, you have no recourse for collecting extra revenue to compensate.
4) PER USER PRICING
Spend a few minutes browsing pricing pages and you’ll come away with the impression that Per User Pricing (also known as Per Seat Pricing) is the go-to SaaS pricing model.
Pacific Crest’s annual SaaS survey backs-up these findings: across the companies surveyed, per user pricing was the most popular pricing model used:
This popularity can largely be attributed to simplicity: a single user pays a fixed monthly price; add another user, and that price doubles; add a third user and, you guessed it, the monthly cost trebles.
This makes it extremely easy for customers to understand what their monthly subscription buys them, and easy for SaaS startups to manage and predict their revenue.
PER USER PRICING EXAMPLE
For an archetypal use case of per user pricing, look no further than roadmapping SaaS ProductPlan. The only variable in their Business Plan is the number of users added to the account, and the per use price is the same, whether you’re a single user or a team of 100.
PROS OF PER USER PRICING
- Simplicity. Per user pricing is one of the simplest, most direct pricing models, making it easy for would-be customers to calculate monthly costs: great for users, and great for simplifying the sales process.
- Revenue scales with adoption. With this pricing model, revenue scales directly alongside adoption: if you’re able to double the number of users within a company, you’ll be rewarded with double the revenue.
- Predictable revenue generation. SaaS companies are reliant on the recurring revenue model, and per user pricing makes it easy to calculate and forecast each month’s revenue generation.
CONS OF PER USER PRICING
- It limits adoption. By charging per user, you provide a reason to avoid adding new users to the tool. This also provides an incentive to cheat, and wherever possible, share a single login between multiple team members.
- It makes it easy to churn. By limiting adoption, you also make it easier for customers to abandon your service. After all, who’s more likely to churn? A team of 100 people using your product, or a team of 10?
- It doesn’t reflect the real value. Does it make a difference to a customer whether they’ve got three users or four?
5) PER ACTIVE USER PRICING
One variant of the per user pricing model is active user pricing. Many SaaS companies (particularly those targeting the enterprise) encourage yearly billing cycles. This can mean that a new customer could pay for hundreds of employees, up-front — without any guarantee that those employees would actually use the software.
Per active user pricing tackles this problem head-on, encouraging customers to sign-up as many users as possible, with the safeguard that only active users will actually be billed for.
PER ACTIVE USER PRICING EXAMPLE
Slack are the most famous example of this SaaS pricing model: no matter how many users you pay for, you’ll only be charged for those that actually use the software.
At Slack, you only get billed for what you use. So you don’t pay for the users that aren’t using Slack. And if someone you’ve already paid for becomes inactive, we’ll even add a prorated credit to your account for the unused time. Fair’s fair.
PROS OF PER ACTIVE USER PRICING
- Customers only pay for active users. This means no money is wasted on unused seats: customers only pay for what they actually use.
- Reduces the risk of widespread adoption. If you’re selling into an enterprise company, you want to encourage as much adoption as possible. Per active user pricing makes it easier for companies to take the risk and initiate a company-wide roll-out — if it doesn’t work, they don’t pay.
CONS OF PER ACTIVE USER PRICING
- Doesn’t work so well for SMBs. This pricing model works great for improving adoption in enterprise organisations, but when cash is tight and team sizes are small, per active user pricing doesn’t offer much extra incentive to bite the bullet.
6) PER FEATURE PRICING
For the previous two SaaS pricing models, users were the common variable, but it’s completely possible to use features as your value metric instead.
Per feature pricing separates out different pricing tiers according to the functionality available in each, with the higher priced packages associated with a greater number of available features.
PER FEATURE PRICING EXAMPLE
The primary differentiator between Evernote’s Basic, Plus and Premium packages is the different range of features on offer, with new functionality “unlocked” with each upgrade.
PROS OF PER FEATURE PRICING
- Strong upgrade incentive. Per feature pricing offers a clear and obvious motivation for upgrading: you unlock extra functionality.
- Compensate for delivery-heavy features. Some of your features may require a disproportionate amount of resources to deliver — per feature pricing allows you to appropriately compensate, by putting these features into your top-tier packages.
CONS OF PER FEATURE PRICING
- Difficult to get right. How do you know which features your users will want? Getting the balance wrong can discourage adoption, as crucial features end up in overpriced tiers, or the bulk of your product’s benefit ends up in your cheapest package.
- Leaves a bad taste. It’s easy to feel resentful with per feature pricing: you’re paying a monthly fee to use a product, and still, you’re missing out on some of their functionality.
7) FREEMIUM BUSINESS MODEL
Thanks to high-profile success stories like Slack, Evernote and Dropbox, many SaaS companies use freemium pricing: offering a free-to-use product, supplemented by additional paid packages.
The freemium business model is typically used as part of a tiered pricing strategy: the regular paid packages are supplemented with a free, entry-level tier.
That tier is then limited across certain dimensions in order to encourage users to upgrade at a certain level of usage, typically employing feature-based (if you want X feature, you need a paid package), capacity-based (if you exceed your allowance, you’ll need a paid package) or use-case (you can use the free package internally, but not for managing customers) limitations.
EXAMPLE OF FREEMIUM PRICING
Live chat SaaS Drift use freemium pricing to great effect.
Their “Free” package allows small companies to talk to their first 100 contacts for free: when demand for the service increases beyond that point (most likely correlating with company and revenue growth), it becomes necessary to upgrade to their paid packages.
PROS OF FREEMIUM PRICING
- It’s a foot in the door. Initial adoption is one of the biggest challenges facing a SaaS business, and the freemium model makes it as easy as possible for customers to get started with your product.
- Viral potential. With such low barriers to use come significant viral potential: companies like Dropbox grew so rapidly because of user referrals, as their existing users passed on the product to friends and colleagues.
CONS OF FREEMIUM PRICING
- Freemium is a real revenue killer. Free users don’t generate any revenue for your company. This means that your paid users need to generate enough revenue to support the cost of acquiring and serving all of your users — paid and free.
- It’s easier to churn on a free package. The more we pay for things, the more we value them. While a free-to-use version of your SaaS product makes widespread adoption simple, it also makes it easy for users to adopt a throwaway mentality, increasing churn as a result.
- It can devalue your core service. If your product solves a painful, expensive problem for free, your users have may resent having to eventually pay for the service.
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