Are you one of the more than 16,000 US-based Software-as-a-Service (SaaS) companies? If so, you’re in one of the fastest-growing market segments the economy has seen in recent times. According to Gartner, the SaaS industry is currently worth upwards of $145 billion, and its growth rate is expected to continue at an accelerated pace. With its unprecedented growth, the question begs to be asked… Is having a SaaS company the silver bullet to profitability? Unfortunately, without a strong SaaS pricing strategy in place, the answer is no. Like any business, SaaS companies face challenges that if not identified and resolved can lead to diminishing revenue and profitability. Topping the list of issues that SaaS companies encounter are pricing models and strategies that leave money on the table.
Common SaaS Pricing Models
With no shortage of pricing models to choose from, each provides benefits and disadvantages. In addition, certain pricing models are better suited for some companies and their customers than others. Before we get into a SaaS pricing strategy, let’s look at the most common SaaS pricing models, their descriptions, examples of companies that use each of the pricing models, advantages, disadvantages, and when to use.
1) Freemium
A common SaaS tier-based pricing model, customers gain access to basic functionality and features at no cost. When they outgrow capacity limits or require additional functionality, paid upgrade plans are easily acquired. An example is Zoom, which offers a free plan that allows up to 100 concurrent participants to communicate for up to 40-minutes.
Advantages
- Low customer acquisition costs (CAC): Marketing and sales costs are significantly reduced since this pricing model lends itself to quickly acquire new customers.
- Promotes rapid growth: The low entry barrier encourages customer adoption, giving businesses the opportunity to have their offerings go viral.
Disadvantages
- Low conversion rate: Conversions from freemium to paying customers typically hover between 2 – 5%, which can have a negative effect on revenue and operational resources.
- Increased churn: It’s human nature to put higher value on products that cost money than for those that are free. With this mindset, the freemium model lessens product value, making it easier for customers to churn.
Best used when
- The target market for your SaaS offering is sizable
- The freemium model includes hard limits such usage, functionality, etc.
- Products and services have the breadth to encourage conversions to paid upgrade plans
2) Flat-Rate Pricing
Based on a ‘one-size-fits-all’ pricing strategy, this pricing model is no longer widely used. A fixed fee is charged for a predetermined set of features and functionality, regardless of the number of users, how often the product is used, or the number of features accessed. Companies like Basecamp, a project management communications solution company, charges $99 per month, giving an unlimited number of users access to all features and to limitless projects.
Advantages
- Easy to sell: A single product is sold at a predefined price, providing for more focused sales and marketing efforts.
- Easy to understand: SaaS pricing can quickly become complex. This clearly defined pricing structure eliminates customer confusion and product selection deliberation.
- Simplifies financial tracking and revenue forecasting: With consistent price points, financial tracking and revenue forecasting is easier and more accurate.
Disadvantages
- Lacks wide customer appeal: Basically a ‘take it or leave it’ pricing plan, the opportunity to purchase a solution that best meets a customer’s needs and requirements is greatly diminished.
- Limits growth opportunities: Since buyer personas are very specific to this ‘one-size-fits-all’ pricing model, target markets are limited, making scaling for growth difficult.
- No upsell opportunities: Without optional upgrade plans, upsell or cross-sale opportunities are non-existent.
Best used when
- Target market consists of a single (or very similar) buyer persona.
- Sales are focused on the SMB segment and not enterprise organizations.
- Customers value simplicity over product and feature choices.
3) Tiered Pricing
Widely used by SaaS companies, this pricing scheme enables companies to offer a variety of ‘packages’ that contain different combinations of products and services at varying price points. The most typical tiered pricing structure consists of three pricing tiers, for example:
- Basic: provides essential functionality at a reasonable price
- Standard: features and functionality are added to the basic package and sold at a mid-range price
- Premium: provides a mix of products and services that meet the majority of customer requirements with plans priced accordingly
HubSpot for example offers three pricing tiers – Starter, Professional, Enterprise – for each of their software solutions. This enables them to appeal to a wide range of market segments.
Advantages
- Wide buyer persona appeal: Provides the ability to target small, medium and enterprise companies, as well as virtually all budget sizes. The target market widens even further when packages can be tailored to meet customer specific requirements and budgetary constraints.
- Upsell opportunities; As the customer’s requirements increase or they outgrow their current package, there’s a clear upgrade path to the next tier.
- Enhanced customer experience: Customers receive what they want and need when they require it, improving customer satisfaction.
Disadvantages
- Confusion caused by complexity: A variety of plans at different price points can quickly become overwhelming to prospects and customers. For this reason, it’s best to keep the number of tiers at between 3 and 5.
- Potential revenue loss: ‘Heavy’ users can quickly exceed the usage parameters for which the tier was planned. This plan leaves no recourse to collect additional money once the customer reaches the highest tier.
- Billing complexities: Tiered plans can make billing more complex. This is especially true for subscription-based companies.
Best used when
- Your offerings appeal to a variety of business needs and budgets.
- The products and services can be packaged to meet the requirements of a variety of buyer personas.
- You’re able to simplify the pricing structure to avoid customer confusion.
4) Usage-Based Pricing
Also known as ‘pay-as-you-go’, this pricing plan charges based on consumption. Customers are charged only when they use the product or service and only for the amount consumed, e.g., number of Emails sent, per API requests, per call, per transaction, number of gigabytes of data used, etc.
One of the first companies to introduce a usage-based cloud computing model was Amazon Web Services (AWS). This straightforward pricing strategy is based on consumption, with no additional costs or termination fees.
Advantages
- Scales based on usage: This pricing model easily adapts to the customer’s fluctuating business needs, providing them with best value for money spent.
- Incorporates ‘heavy’ users: Since billing is based on usage, you’re compensated according to resources used.
- Appeals to a wide variety of customers: With low or no up-front costs and no hidden fees, entry barriers are eliminated.
Disadvantages
- Difficult to associate value with the product: Unlike many of the other pricing models, usage-based pricing doesn’t incorporate the same level of product value into the pricing scheme.
- Forecasting revenue is difficult: Since usage is unpredictable from billing cycle to billing cycle, predicting and managing revenue can be challenging.
- Difficult for customers to predict costs: Like the bullet above, but from the customer’s perspective, which can affect budgetary planning.
Best used when
- Your customer base and target market consists of a high number of ‘heavy’ users.
- Customer usage is unpredictable, and their expectations are that of a scalable pricing plan.
5) Per User Pricing
Also known as ‘per seat’ pricing, this pricing model is widely used by SaaS companies. Pricing is based on the number of users (active or passive), and as additional individuals are added to the account, revenue increases. Aha! Is a product development software company that uses this SaaS pricing strategy. They offer three solutions – Ideas, Roadmaps, Develop – at various user price points. For example, Ideas provides customers with two options – Essentials and Advanced. Both require a minimum of three paid users and the solution can be purchased on a monthly or annual basis.
Advantages
- Revenue is predictable: Since the number of users is a known quantity, calculation of monthly recurring revenue (MRR) and forecasting is simplified.
- Revenue increases with adoption: Revenue increases as the number of users adopt the solution.
- Easy to understand: One of the more basic pricing models, prospects and customers can easily forecast monthly spend.
Disadvantages
- Hinders adoption: For a variety of reasons such as to avoid paying for infrequent users or to reduce costs, companies may restrict the number of users.
- Increased customer churn: Since this pricing model inherently limits adoption, fewer people using the product means an increased likelihood of churn.
- Login abuse: Multiple individuals may use a single account, which not only reduces revenue potential but decreases the value of the product.
Best used when
- Your offerings appeal to a wide range of buyer personas that have different business needs and budgets.
- Offerings can be packaged to meet a variety of needs for small, medium and enterprise companies.
6) Per-Active-User Pricing
A variation of per-user pricing, this pricing scheme charges for active users only. For example, a company may sign up for 100 users, however if only 25 users are active during the billing cycle, the company is only charged for 25 users. Zendesk does just that with its service and sales applications. It charges based on the number of active users on a monthly or annual basis.
Advantages
- Incentivizes customers: Reduced risk encourages companies to adopt the product. In other words, if the solution doesn’t meet the company’s needs, little to no money is lost.
- Reduces the risk of customer’s exceeding budgets: Since customers only pay for active seats, no money is wasted on inactive users.
Disadvantages
- Revenue is unpredictable: Because the number of active users fluctuates, forecasting revenue is difficult.
- Defining ‘active’ seats: What does active user mean? If a seat is used only once during the billing cycle, does that represent an active user? Putting too many restrictions on the definition can lead to less active users, resulting in revenue loss.
Best used when
- Your target market consists primarily of enterprise customers.
- Defining and explaining active users is easy to accomplish.
7) Per-Feature Pricing
A popular SaaS pricing strategy, per-feature pricing is based on the number of features and functionality within each of the packages. Baremetrics uses this SaaS pricing strategy. To help customers select the right package, plans start with a question to determine the company’s current analytics tool. Each plan consists of four options that include a free trial.
Advantages
- Promotes upselling: As customers require additional functionality, this pricing model inherently encourages upgrades, which increases revenue.
- Compensates for heavy resource allocation: Features that require a disproportionate amount of time, money, or resources can be placed in more costly plans.
- Aligns offering value to price: Feature value is closely aligned to price of the package.
Disadvantages
- Difficult to determine the right balance of features: Without extensive research, knowing the target market’s feature preferences and the value they place on certain features can be challenging. Getting it right will take ongoing package and pricing adjustments.
- Customer dissatisfaction: Customers that are paying for unused or infrequently used features may become disillusioned, which can limit upgrades.
Best used when
- Feature options, pricing, and upgrade paths are easily explained and understood.
- Offerings have wide customer appeal, including different market segments and a variety of buyer personas.
8) Hybrid pricing
Consisting of two or more pricing models, this blended strategy enables companies to optimize pricing while providing customers with pricing models that best meet their needs. Vimeo offers six plans (Freemium, Basic, Plus, Pro, Business, and Premium), each consisting of a 30-day trial period. These tiered packages consist of different combinations of features and are billed annually.
Advantages
- Realize revenue potential: Since features and functionality are tightly associated with the pricing strategy, SaaS companies are better able to align value with pricing.
- Provides wide customer appeal: By combining pricing models, SaaS companies can provide more personalized pricing structures.
- Ability to create the ‘right’ pricing strategy: The hybrid pricing model eliminates many of the restrictions found in other models, enabling SaaS companies to mix and match pricing models to create pricing schemes that are best suited for their SaaS business and for their customers.
Disadvantages
- Can quickly become complex: Not only is this pricing model complicated for the SaaS business, but it can also quickly become overwhelming to customers. For this reason, it’s best to limit pricing selections.
Best used when
- The value of your offerings can’t be captured in a single pricing model.
- Pricing models take into consideration multiple products, services, features, and functionality.
When building out your SaaS pricing strategy with the various pricing models at your disposal, how do you know which one is right for your business?
Why a Strong SaaS Pricing Strategy is Important
Getting your pricing right takes more than selecting one of the pricing models. Determining the right SaaS pricing strategy for your offerings is critical. Pricing that is too high will limit demand. Alternatively, prices that are too low may not even cover your costs. For this reason, establishing a SaaS pricing strategy needs to be done in advance of selecting a pricing model.
To get you started on maximizing your profitability, we’ve listed the three most popular pricing strategies.
- Competitor-based pricing strategy: This is one of the simplest pricing strategies. It provides a good starting point for startup SaaS companies, as well as when you’re planning to launch a new product or service. This strategy only takes into consideration publicly available competitor pricing information and not other factors such as production costs, market demand, etc. While the research obtained is invaluable, it shouldn’t be the only consideration when making pricing strategy decisions.
- Cost-plus pricing strategy: Also referred to as mark-up pricing and cost-based pricing, it’s relatively straightforward. Essentially, it uses the production cost and adds other factors such as CAC, cost of goods sold (COGS), and your desired margin. While widely used by many industries, it lacks the flexibility SaaS companies require and may prove inefficient over the long term.
- Value-based pricing strategy: The most complex of the pricing strategies, it’s also the most suitable for SaaS companies. Designed to enable you to determine exactly what your customers want as opposed to what they will spend, the focus of this pricing strategy is on the perceived value your products deliver to customers.
While each of the pricing strategies take into consideration different company objectives, the one certainty is that to realize your growth and profitability goals you need the right pricing strategy and pricing model for your SaaS business. This leads to the question… How do you know if the SaaS pricing strategy and pricing model chosen are delivering on expectations?
To begin, there are a handful of key performance indicators (KPIs) that should be consistently tracked and reviewed.
- Costs (including, but not limited to employee, equipment, business software, professional fees, CAC, etc.)
- Customer lifetime value (LTV)
- Churn rate
Achieving profitability means that recurring revenue consistently exceeds CAC costs. A quick calculation (LTV/CAC) provides insights into whether you’re running a profitable business or losing money on CAC and churn. For SaaS businesses to be profitable, the LTV/CAC ratio needs to be greater than one, however many believe that for optimal profitability it should be three or greater.
Finally, your SaaS pricing strategy and pricing models aren’t a one-and-done activity. To ensure profitability over the long term, they should be reviewed and revised periodically.
Get the Most from Your SaaS Pricing Strategy and Model
Is your pricing model and SaaS pricing strategy leaving money on the table? Has it been a while since you’ve considered either? If so, a billing solution that was built to give you the flexibility to drive SaaS profitability can help!
BillingPlatform puts you in complete control of managing and growing your revenue. Our billing models were built with SaaS companies in mind, enabling you to execute any pricing strategy and pricing model easily and accurately. With BillingPlatform you have the power to support any combination of one-time charges, subscription, consumption, hybrid, and more – all on a single, cloud-based platform. Don’t take our word for it though, request a demo to see for yourself.
