How to Structure a Software Pricing Model?

Are you planning to develop a strategic software product and wondering how to structure a software pricing model?

Let us now see how to structure a software pricing model in detail.

Do Software Product Vendors Structure Their Software Pricing Models Rationally?

Many companies develop and launch software products of various kinds. However, they often don’t structure their pricing models rationally. Several reasons exist for this, e.g.:

• A narrow definition of value: What value does a software product deliver? Remember that value isn’t the same as functionality. What matters is how a software product fulfills the needs of potential customers and present users.
  • Companies that build software products might not define value adequately. A narrow focus on features alone doesn’t help to define software pricing models rationally.
• Development-oriented focus: Businesses focus exclusively on designing and developing a great software product. They might not sufficiently focus on the pricing.
• Extensive focus on customer acquisition: A company might have developed a great product, and then it focused exclusively on customer acquisition. It might have shelved the task of rationalizing the pricing structure.
• Pioneering product: A software product might be the first of its kind. It fulfilled a need of end-users that no other product fulfilled earlier. No benchmark exists for the price of the product. Therefore, the provider didn’t have enough data to arrive at a rationalized pricing structure.
• Inadequate data collection from the market: A software product might have a large market. There might be market segments based on region, demography, and other factors. A great deal of data might exist to guide the provider about the pricing. However, the data is massive.
  • The provider might not have collected adequate data from the market. This makes the task of rationalizing 
• Resistance to change: A software product vendor might have intuitively created an initial pricing structure. Over time, the company has acquired a considerable customer base. It now understands that the pricing model isn’t a rational one. However, it resists changes.

How the Lack of a Pricing Strategy Can Impact a Software Product Company?

Arriving at a price point by intuition and avoiding a pricing strategy can have adverse impacts on a software product vendor. These impacts can be the following:

• A diminishing customer base: Customers might buy a software product initially despite the lack of a sound pricing strategy. When competitors offer cheaper products delivering the same value, there might be customer churn.
• Declining profits: A pricing plan based on intuition only might help a software product vendor to acquire customers initially. However, the lack of a pricing strategy might create long-term pressure on the financials. The pricing strategy should align with the business model of the company.
• Too few new customers: A software provider had acquired customers without a solid pricing strategy. Then, competitors arrive with comparable products and rationalized pricing structures. Our software provider will find customer acquisition much harder.
• A lack of product innovation: Diminishing profitability makes it hard for a software provider to invest in research and development. This slows down product innovation. The company loses its competitive edge.

Why Rationalize Your Pricing Page: The Benefits of Having a Sound Pricing Strategy

What benefits can you get if you rationalize your software pricing structures? These are as follows:

• Competitive advantage: Many software product vendors don’t have rationalized pricing models. Your competitors might not have them either! You gain advantages over your competitors if you rationalize your pricing models.
• Communicate value to customers: In order to succeed, a software product needs to deliver value to clients. Think of the buyer in the client’s organization. Buyers need to justify purchasing software products from you before they can buy your product.
  • You communicate value clearly if you have a rationalized pricing model. In turn, that helps buyers in the clients’ organization.
• Unlock revenues that you didn’t get earlier: Did you sell your software product too cheaply earlier? Rationalizing your software pricing structure can increase your revenue. 

A Broad Approach to Structuring Software Pricing Model

We now talk about how you can structure a software pricing model. It’s an involved process. Take the following steps:

1. Define your larger business model: Are you selling SaaS, subscription, or on-premises software?

You can’t use a cookie-cutter approach for software pricing. Your business model greatly influences your decisions. Define your business model first.

You might sell a software product using one of the following approaches:

• SaaS (Software-as-a-Service): SaaS vendors deliver software products over the Internet. Customers don’t have an upfront investment in IT infrastructure.
  • Vendors or their 3^rd party cloud services providers host their software products. Clients buy the rights to use the software. The transaction includes the use of the necessary IT infrastructure, maintenance, support, and new versions.
• Subscription: Several startups and small businesses build on-premise software products and sell subscriptions. Such subscriptions include the rights to use the software. They also include maintenance and support.
  • Note that the subscription model isn’t limited only to small companies. Larger software product vendors also use this approach.
• Traditional licensing for on-premises software products: Licenses for these on-premises software products include the rights to use the software. These licenses don’t include maintenance and support. Customers need to buy separate maintenance and support plans.

Think through your business model carefully and determine where you belong.

2. Familiarise yourself with different enterprise software pricing models

You need to understand how the popular enterprise software pricing models work. These models are as follows:

Flat-rate pricing model

Among various pricing options, the flat-rate pricing model is the simplest. You launch a software product with a set of features. You set up one pricing plan for the product.

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This pricing model offers the following advantages:

• Easy to sell: Your marketing and sales team needs to explain only one pricing plan to potential customers.
• Easy to understand: Your potential buyers can understand this pricing structure easily.

The flat-rate pricing model has a few disadvantages. These are as follows:

• Doesn’t cater to different market segments: A flat-rate pricing with one set of features might work with one market segment. Other types of buyers might look for different features and prices.
• The lack of flexibility: You lack flexibility when trying to acquire a new customer. What if the customer doesn’t find your pricing plan suitable? You can’t offer an alternative.

Usage-based pricing model, also known as the “pay as you go” model

People often call the usage-based pricing model the “pay as you go” (PAYG) model. This pricing strategy links the price of a software product to its usage.

Users pay more if they use the product more. On the other hand, they pay less if the usage is less.

Cloud computing platforms like Amazon Web Services (AWS) or Microsoft Azure often use this model. This model uses metrics relevant to the product, e.g.:

• Data used;
• The number of API requests;
• Pageviews, video plays, and impressions;
• The number of transactions processed.

This SaaS pricing model offers the following advantages:

• Scalability: The price of your software product changes based on usage. Your customers pay more if they use the product more. They pay less when their need for the product is less.
• Lower barrier to use: This pricing model reduces the upfront costs for your clients. This especially helps small businesses and startups.
• Accounts for “heavy user costs”: This advantage is especially relevant to SaaS businesses. “Heavy” users can consume a lot of resources from software companies creating and offering software products. The usage-based pricing model can account for such users.

There are a few disadvantages to this SaaS pricing model, e.g.:

• The challenges of tying “value” to the price: Assume you use the “number of API calls” as the metrics. On the other hand, end-users give more weight to integrating two software systems. Communicating “value” can be hard with this model.
• Lack of clarity over your revenue stream: How much will clients use your product in the next quarter? Answering this can be hard, therefore, predicting revenue isn’t easy.
• Customers lack clarity over projected costs: Customers might not know the future usage of your product. How will they estimate their costs?

Tiered pricing model

A tiered pricing model allows software vendors to offer multiple pricing packages. Software providers often offer different bundles of features for different price points.

You might target different market segments with your software product. While conceptualizing your product, you might have created different buyer personas. They have different needs.

Different pricing tiers help you to cater to these different segments.

This model offers the following advantages:

• Cater to different buyer personas: Your software product will serve several market segments. You create different pricing tiers for them.
• Better chances of customer acquisition: One flat-rate pricing structure discourages buyers that don’t need all of the features. Pricing tiers with lower prices for fewer features will appeal to these buyers.
• Better chances of upselling: Some of your clients use a lower pricing tier currently. They might need more features in the future. You have a tier for that set of features.

The tiered pricing model has a few disadvantages, which are as follows:

• Lack of clarity: Customers will find the pricing plans hard to understand if you create too many tiers.
• Catering to too many market segments: Creating many pricing tiers will enable you to cater to many market segments. However, that might dilute the key values offered by your product.

Per-user pricing model

The per-user pricing model enjoys plenty of popularity. This model directly correlates the price of a software product to the number of users.

Clients pay a higher price if they buy the product for more users in their organizations. On the other hand, they pay a low price if they have fewer users.

This pricing model offers the following benefits:

• Clarity: Potential customers know that the per-user price is constant. They pay more if they buy it for more users.
• Incentivizes innovation: You as the software product vendor would want to increase the adoption of your product. That increases your revenue. This incentivizes innovation.
• Predictability: You know the number of users in each of the organizations that bought your software product. Therefore, you can easily estimate your revenue.

The disadvantages of this model are as follows:

• The risk of malpractice: A few client organizations with a history of malpractice might try to effectively get a few free users. They might share login credentials for this.
• Defining value: The number of users might not translate to value.
• Resistance to adoption: Clients know that they pay more for more users. This could limit the adoption of the software product.

Pricing model based on active users

Assume that customers buy a software product using the per-user pricing model. They buy a pricing package upfront for a certain number of users.

However, some of the users don’t utilize the software product. Customers end up paying more than what they should pay.

This active user-based pricing model solves this challenge. It’s a variation of the per-user pricing model. It charges customers on the number of active users only.

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You can see the advantages to customers clearly. Software product vendors benefit from this model too. Customers can undertake a large-scale adoption of the product.

They will pay for active users only, which mitigates their risks. Large-scale adoption of the product helps software vendors.

Clients that are small and medium businesses don’t benefit much from this active user pricing customers model. These companies have smaller teams, therefore, this model doesn’t offer noticeable value.

Per feature pricing

Software providers use this model to provide different pricing plans for different sets of features. Customers that need fewer features can choose a cheaper pricing package. On the other hand, customers requiring more features can opt for the more expensive package.

This pricing model offers the following advantages:

• Incentivizes upgrades: Customers using fewer features can see the list of features that they can get if they pay more.
• Ensures the right price for “delivery-heavy” features: Some features of your product might require plenty of resources. You can offer them in the higher-priced packages. This allows you to get the right price.

The “per-feature” pricing model has the following disadvantages:

• Complexities: Creating a features-based pricing plan can be hard.
• Customer dissatisfaction: Some customers feel that they don’t get all the features despite paying for the product. This can cause dissatisfaction.

Freemium pricing model

You can think of the freemium pricing model as another form of tiered pricing model. Software vendors offering this model offer a free version of their software product. Many customers use this version.

The company then offers a premium version of its product, which offers much more.

The free version is suitable for use with certain limitations. The software vendor designs these limitations in ways that encourage users to buy the premium version, e.g.:

• Feature-based limitations: The free version offers limited features, and add-on features are in the paid version.
• Capacity-based limitations: Customers need a paid version to exceed the capacity allowed in the free version.
• Use-based limitations: Customers can use the free version for internal use. However, they need the paid version for commercial use.

The freemium model offers the following advantages:

• Facilitated initial adoption: The free version boosts initial adoption.
• Chances of gaining popularity quickly: The free version might show excellent promises, which can make the software product very popular quickly.

This model has the following disadvantages:

• Free users don’t create revenues: You need to quickly acquire enough paid users to support the freemium model. 
• Churn: You might see customer churn among the users of the free product. It’s easy to discard a free product!

3. Zero in on a SaaS pricing strategy that you can follow for your SaaS product

SaaS is popular. Gartner states that SaaS remains the largest market segment in the public cloud space. SaaS companies need the right pricing strategy too.

Follow one of the following pricing strategies if you have a SaaS product:

Cost-plus pricing

This strategy involves accounting for all costs and adding a profit margin to arrive at the price. You need to understand the whole gamut of your costs. Additionally, you need to determine the right profit margin.

This strategy ensures that you cover your costs and make a profit. However, it might not tie the price of your product to the value it delivers.

Competitor-based pricing

The competitor-based pricing strategy involves modeling your pricing structure based on what your competitors do.

Startups launching their first software product don’t have any past sales data to refer to. They can study the pricing structures of their competitors.

This provides a starting point, however, you should focus on the value your software product offers.

Value-based pricing

Value-based pricing is the best option for SaaS companies. It’s also the hardest to implement. You don’t analyze your costs or study your competitors here as in cost-based pricing. Instead, you look for insights from customers.

This strategy has many advantages, e.g.:

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• You correlate your pricing structure to “value” as understood by your customers.
• Since you get insights directly from customers, you can create pricing packages that match their requirements.
• Your profit margin can be higher than your competitors.
• You can revisit your strategy based on relevant insights.

You need to devote significant effort to implementing this strategy, which is a disadvantage. Getting insights from customers can be hard.

4. Review examples of SaaS companies using various SaaS pricing models

You structure your software pricing plans based on your context, e.g.:

• Target market: Your strategy for eCommerce companies will be different from the strategy for social media platforms.
• Monetization requirements: You might want to increase your lifetime value and profit margin from a few strategic features. E.g., you have an advanced feature that provides useful templates to users. You would want higher profits from it.
• Recurring revenue requirements: You might have specific requirements for recurring revenues.

A “one-size-fits-all” solution doesn’t exist. However, you can get ideas from the following examples of companies creating successful pricing structures.

Flat-rate pricing model

Basecamp uses this pricing model well. It knows its target audience, therefore, it can use a simple pricing structure.

Usage-based pricing model, i.e., “pay as you go” model

As we stated earlier, cloud computing giants use the PAYG model effectively. Amazon Web Services (AWS) and Microsoft Azure are good examples. They provide transparency to customers.

Per-user pricing model

Microsoft uses the per-user pricing model effectively. The company has implemented this pricing model for its Microsoft 365 product family.

The active users-based pricing model

Slack is an active user pricing example company and has implemented the model smartly. Clients can add as many users as they want. Slack will charge them for active users only.

Tiered pricing model

Hubspot uses the tiered pricing model well. The company articulates the advantages of different pricing tiers effectively. Another tiered pricing example company is LinkedIn.

The company offers 4 tiers, namely, “Career”, “Business”, “Sales”, and “Hiring”.

Per-feature pricing model

Evernote uses this pricing model. The company offers “Basic”, “Plus”, and “Premium” packages. Each upgrade offers additional features.

Salesforce CRM uses this model too. It has 4 tiers, and each upgrade adds features.

Freemium model

Dropbox uses the freemium model. The company offers a free version. Furthermore, it offers a paid version with more features.   

Planning to Execute a Software Project?

We talked about how to structure a software pricing model. We discussed various pricing strategies and models. Additionally, we reviewed the key decision-making factors.

Do you need help executing your software development project? Read our guide on building a competent software development team.

If you are still looking for experienced software developers, contact DevTeam.Space, and a dedicated account manager will help you.

FAQs on Software Pricing Model