SaaS Pricing: Choosing the Optimal Model for Your Product
Last updated on
December 2, 2022
Forming a price for your software is one of the last steps you’ll take before sharing your product with the world. Choosing the optimal model is also arguably one of the most important and complex aspects of operating a SaaS business.
This article will provide you with some very useful insights and a strong starting point for setting the value of your product. We’ll discuss trends in SaaS pricing and provide an overview of the most common pricing models available to SaaS founders.
This post is full of industry tips and helpful examples from companies who hit the mark with their pricing and achieved success.
Let’s begin with an elaboration of what SaaS pricing means.
Table of Contents
Overview of SaaS Pricing
The SaaS business model is innovative in many ways. Pricing constitutes one of its most novel features, as SaaS companies deliver their products to customers in the form of a subscription, rather than a perpetual license.
This makes paying for software much more digestible and making software products more accessible to everyone. Individuals, startups, SMBs, enterprises, multinational corporations—all kinds of businesses can reap the benefits of using excellent software solutions.
Since software users vary dramatically in their needs and purchasing power, providers need to diversify their approach to pricing. In addition, software products cover a wide range of needs and solve many different problems, so it doesn’t make much sense to price them the same way.
For these reasons, SaaS companies developed different pricing models and strategies. These enable them to maximize profits, while also giving customers exactly the service they need for a price they can afford.
Articulating the optimal pricing strategy and selecting the right pricing model remains a crucial step for SaaS founders building their companies from scratch. However, it also poses a significant challenge for any company.
It’s essential to think about your pricing very early on, and it’s equally important to let it evolve as your business grows.
Difference Between Pricing Strategies and Pricing Models
At the beginning of this discussion, it’s important to differentiate between pricing strategies and models. The two are sometimes used interchangeably, but they actually mean very different things.
Pricing strategies are approaches to pricing. They represent the why behind your price and answer the question: “What do we want to achieve with our price?”
For example, suppose you’re launching a new product and aim to build a strong customer base as quickly as possible. In that case, your pricing strategy might be to start offering your product at a very low price.
With this strategy, you would be offering a valuable product while making it affordable to a vast number of customers. Once you have a firm customer base, you could start gradually raising your prices to bring them closer to the actual value of your product.
This approach is called penetration pricing, and it’s been used by many SaaS companies, including giants like Netflix.
On the other hand, pricing models are the how in SaaS pricing. They represent the system each SaaS company uses to bill customers for using their product monthly or yearly.
For example, if you want to price your product according to how many people use it within one customer’s company, you might be best served by using the per-user pricing model.
As you can see in the example above, the price depends on how many users access the product within the customer’s organization.
Your pricing strategy is an internal matter for your company. It’s how you plan to achieve your financial goals in the short or long term. You’d never see it in marketing materials, and it isn’t communicated to customers.
Conversely, pricing models are the options you communicate to your customers on your pricing page or in your marketing and sales efforts.
Related posts: How to Increase Sales in Your SaaS Business
Why Is It Important to Get Your SaaS Pricing Right?
The average SaaS company devotes as little as six hours total to set a price for their software. This is why so many companies end up over or undervaluing their product.
Unfortunately, poor pricing practices can lead to all sorts of trouble. In the worst-case scenario, they can even spell out doom for your business. That’s because running out of funds, implementing a flawed business model, and pricing issues are some of the main reasons why tech startups fail.
Since pricing is a common struggle for the entire SaaS industry, hitting the mark with it can give you a competitive edge. And in an industry that’s been growing at the rate of almost 16% a year, every competitive advantage should be seized.
Moreover, giving serious consideration to your prices and optimizing them consistently can help you unlock massive growth for your business. That’s because even minor improvements (proper monetization) can compound and cause huge improvements in revenue.
In fact, a Profitwell study of 512 SaaS companies has shown that just a 1% improvement in monetization can lead to a 12.7% increase in revenue. That makes pricing more effective than both retention and acquisition in unlocking company growth.
Finally, keeping your eye on pricing and finding ways to improve it is the best way to find the perfect balance between the two most important metrics for your company’s success: Customer Lifetime Value (CLV) and Customer Acquisition Costs (CAC).
To ensure you’re not operating at a loss, your CLV needs to outweigh CAC. For a healthy and successful company, the ratio between these metrics should be approximately 3:1.
However, optimizing your pricing at every turn can help you push that ratio to as far as 11:1 and send your growth rates skyrocketing!
In conclusion, pricing has a major impact on how your company will grow once your product hits the market. So do your best to provide enough attention to this aspect of your SaaS business.
Related posts: Five Tips on How You Can Start a SaaS Business in 2021
What Pricing Models Exist for SaaS?
Now that we’ve established the importance of good pricing practices, let’s look at some common pricing models available to SaaS companies.
We’re starting the list with the most straightforward pricing model in SaaS business. As its name suggests, flat-rate pricing means charging a single, flat rate for access to your product. Regardless of the client’s profile or their actual needs, all customers pay the same price every month or year.
For instance, Basecamp, the project management software, has used this approach for years to great success.
This model has some excellent benefits, especially if you’re operating a startup that’s still getting to know its audience.
Flat-rate pricing is also exceedingly easy to implement, and it makes key KPIs like recurring revenue and annual growth very predictable. Going forward with this pricing model, you can expect very few rude surprises down the line.
Moreover, flat-rate pricing is customer-friendly exactly because it’s uncomplicated. This is of great assistance to your marketing and sales teams. They have an effortless job explaining the pricing model to your prospects.
However, keep in mind that your potential customers can vary dramatically.
For instance, say you adapt your price to SMBs who are your best customers, but many enterprises also subscribe to your product.
In that case, you’re missing out on a veritable fortune that could be made if you billed enterprise clients at a higher rate.
Another drawback is the lack of flexibility in this pricing model. Oftentimes, customers just need a bit of persuasion to decide to buy a SaaS product.
With flat-rate pricing, you can’t entice indecisive customers with an inexpensive, basic version of your product so they can test drive your software. That means you’re missing out on many sales opportunities.
Overall, the flat-rate model is most appropriate for startups still trying to get their bearings and figure out who their customers are, as well as companies who offer simple products that don’t offer a great variety of features.
This model builds upon flat-rate pricing by splitting a company’s offerings (as well as its customer base) into tiers.
This results in multiple versions of software or packages that differ in the level of service provided or the number of features available. These cater to a diverse customer base allowing for differences in purchasing power, company size, or expertise level.
Trevor.io also offers tiered pricing plans.
The greatest benefit of tier-based pricing is that it allows you to tailor your service to different customer profiles. This makes for happier customers, but it also allows you to collect more revenue, while still signing on customers who would have been boxed out by your prices on the other.
Finally, tier-based pricing opens up a whole world of cross-selling and upselling opportunities.
This is your opportunity to scale growth because a large portion of your revenue can actually come after the initial sale.
On the downside, tier-based pricing requires your customers to be more conscious of their real needs. Offering this pricing model, you may come across prospects who will opt for a cheaper plan even if it doesn’t quite meet their needs to save money.
These customers may become dissatisfied with their plan and end up churning. So it’s important to correctly estimate your customers’ needs and connect them to the right plan.
Also, using this model, you’re at risk of miscalculating your tiers and losing revenue because of it. For example, this can happen when you offer enterprise services at SMB prices. To avoid undervaluing your product, focus on establishing correct cut-off points.
All in all, tier-based pricing combines simplicity with a high level of customization, which is why it’s the most common pricing model out there.
You can expand your tier-based pricing model in a couple of ways. One of those ways is to charge your customer for every individual user within the customer’s company who accesses the product.
This is called per-user, user-based, or per-seat pricing, and it represents an older pricing model that’s still used to a great extent as many SaaS companies see “number of seats” as their most valuable pricing metric.
Some of the most famous SaaS companies, like Slack, DocuSign, Asana, and Salesforce, have succeeded while using this model.
Let’s look at an example to see how per-user pricing works.
DocuSign offers different service tiers to cater to different client profiles, but they also charge per user. So, let’s say you want five people in your company to use the standard version of the product. In that case, you would pay $125 monthly.
Per-user pricing is a perfect fit for products that provide the most value when entire teams use them.
Take communication platforms like Slack, for example. The larger number of users who have access to Slack within a company, the higher the value this product can bring to the customer.
Similarly, project management and CRM software work best when people use them to collaborate on company projects. Therefore, it makes a lot of sense to charge these types of products per user.
However, if your SaaS product doesn’t fall into one of the aforementioned categories, you might find that this model isn’t a good fit. That’s because “number of seats” isn’t a good value metric for most SaaS products.
To sum up, if your product provides the most value when used collaboratively, you should definitely look into per-user pricing. If not, this pricing model probably isn’t going to work for you.
This is where things get a little more exciting. Usage-based pricing is a newer pricing model that bills the customer according to the amount of the service used, and nothing else.
This puts the customers in charge of their billing, and it ties your revenue directly to the success your customer is experiencing because your revenue grows the more a customer uses your product.
The key to applying this model to your business is to decide on a single value metric and a way to measure it precisely for every customer. That’s why it’s a great model for cloud storage companies.
For example, Amazon’s cloud computing service, AWS, charges users for the amount of storage they use on Amazon’s servers.
Usage-based pricing has achieved some awe-inspiring results for companies that took a chance on it. For instance, the data cloud service Snowflake reported 124% revenue growth in a single year.
Their CFO, Mike Scarpelli, believes that they owe their success, at least in part, to their decision to implement the usage-based pricing model.
As you can see above, they developed a pricing model that combines tier-based and usage-based models. You can find more information on hybrid pricing in the next section.
Apart from unlocking accelerated growth, usage-based pricing also correlates with customer retention. That makes sense because this model allows customers to scale their usage of the service. They can limit their use if their business hits a rough patch, yet never churn because they don’t need to.
Read more about customer churn management here.
Finally, a great benefit of this model is that it allows you to access the widest possible audience. Even if customers are on the fence about buying into your service, they can test it at a minimal cost.
There is a downside, though. Usage-based pricing is fairly unstable as you can’t know how your customers will behave in a specific time period. That makes revenue unpredictable and long-term investments risky.
Nevertheless, if you’re offering a scalable product and have a way to measure it for every customer, this pricing model might be right for you. However, it might be a good idea to hold off on implementing it until your company is financially stable.
You may have already noticed a couple of examples of hybrid pricing in this list. Still, it’s a good idea to emphasize that in most cases, pricing models work at optimal levels when they are combined.
Ultimately, what you’re offering to your customers is a complex piece of software and a unique blend of support and scalability that goes along with it. You’re providing unique value, so don’t be afraid to price your service using a unique method.
Let’s analyze the SEO tool Ahrefs as a great example of hybrid pricing. Ahrefs offers a wide range of services pertaining to search engine optimization.
To capture every revenue opportunity and provide an exceptionally flexible service for their customers, they combine tier-based, usage-based, and per-user models in their pricing.
With a hybrid pricing model, you’re distinguishing yourself from the competition—and in the busy marketplace of SaaS products, being able to stand out from the competition matters.
Additionally, you’re creating a unique service that will help you attract a broader customer base. That’s because a hybrid pricing model allows for a greater number of product combinations that can cater to more customers than if you were using a more rigid payment structure.
For example, ActiveCampaign features a classic tier-based approach complemented with a convenient slider that allows customers to customize their service according to the number of contacts they have.
On the other hand, combining multiple pricing models creates a payment system that is more complex and, therefore, more of a challenge to understand. To reiterate a previous point, the more difficult it is for your marketing and sales teams to explain your pricing model, the less likely your prospects are to convert to full customers.
To sum up, hybrid pricing is very common in SaaS business. It’s an excellent way to express the true value of your product and cast the widest possible net to attract customers.
However, be careful not to make your pricing model too complex because that may turn customers away.
How to Choose the Right Pricing Model for Your SaaS Company?
Developing a pricing model for your SaaS product is more of a process than a one-time event.
There’s a lot of trial and error involved. The work is never truly complete as your pricing evolves parallel to your software. The image below can illustrate just how experimentative this process can be.
As you’re developing your pricing model, remember that it needs to reflect both your product and your customer base.
A vital product consideration is your value metric, as we’ve mentioned before. Different value metrics correspond to different pricing models.
For example, if your SaaS product offers storage, your value metric might be “volume of cloud storage,” pointing to the usage-based pricing model. On the other hand, if you offer project management software, your value metric could be something like “how many users can collaborate on a project,” meaning the per-user pricing model would best serve you.
Additionally, if the product has many features, a tier-based or hybrid pricing model might be the best solution.
As for customer considerations, try to think about how you want to approach your target market.
Do you want to attract a massive client base with an inexpensive and straightforward product? Then you might want to keep your pricing as simple as possible. In that case, consider applying flat-rate pricing.
Netflix has millions of users worldwide, so it makes sense that they’ve kept their pricing straightforward. Imagine the size their customer support team would have to be if they had to explain their pricing to millions of people.
Conversely, if you’re offering complex software to an audience of industry experts and expect to have a small client base with large contracts, don’t be afraid to make pricing more complex. Consider tiered models expanded by seat or usage pricing as well as hybrid models.
Remember, the secret to finding the right pricing model is knowing your product as well as your customer base intimately. So keep learning, testing, collecting data, and adjusting your pricing model every step of the way.
Related posts: Understanding ACV for SaaS Business
Over time, many different models of pricing have been developed, and this article has discussed the most common models available to SaaS founders today.
As complex as SaaS pricing can get, it’s driven by the need to provide customers with true value as well as the ambition to bring excellent software to as many people as possible.
Hopefully, the article has given you a strong starting point to consider your options and begin formulating a pricing model that will do justice to your product and make for a happy, successful customer base.