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Developing a SaaS product? You need to understand SaaS pricing models and strategies well. That’ll help you to formulate the right pricing strategy. We at DevTeam.Space can guide you with our considerable software development expertise.
Join us, as we explain smart SaaS pricing models and strategies.
Why choose a smart SaaS pricing strategy and the best pricing model?
The global market for SaaS (Software-as-a-Service) products continues to grow rapidly. A Technavio report estimates that this market will grow by $99.99 billion in the 2021-2025 period. The report projects a CAGR of 11.35% during this period.
SaaS companies can take advantage of this trend in several ways, e.g., product innovation, marketing, etc. One such way is to get the pricing right! SaaS businesses can get the following benefits by getting their pricing strategy right:
- Communicate “value”: They can better communicate the “value” they offer by getting their pricing model and strategy right. Note: “Value” doesn’t refer to functionality only. It refers to the overall benefits to end-users.
- Unlock revenues previously out of bounds: SaaS companies correlating their price to “value” can get the right revenue. They might have missed it earlier.
- Competitive edge: Several SaaS companies decide on pricing models and strategies instinctively. You can get a competitive edge by rationally arriving at the right pricing.
Why do some SaaS companies choose the wrong SaaS pricing strategy?
SaaS businesses often choose the wrong SaaS pricing models and strategies. They do this due to one or more of the following reasons:
- An inability to define “value” from the standpoint of customers: Companies that can’t define what constitutes “value” to customers get the pricing wrong.
- Focus on product development alone: Some companies focus intensely on developing a great product. They don’t think through the pricing strategy enough.
- Prioritizing customer acquisition alone: Several SaaS companies extensively prioritize customer acquisition. They adopt a pricing strategy that helps there. The strategy might lack sound logic.
- “First-of-a-kind” (FOAK) product: A SaaS company that develops a FOAK product doesn’t have prior market benchmarking data for pricing.
- Insufficient market research and analysis: A sound pricing strategy requires plenty of data collection and analysis. Some SaaS businesses don’t undertake such extensive market research and analysis activities.
- Inertia: Some SaaS companies choose pricing models and strategies without enough groundwork. They might realize the limitations later. However, they fear customer churn if they change the pricing strategy. They develop a resistance to change.
The impacts of choosing the wrong SaaS pricing models and strategies
What happens when SaaS companies don’t arrive at rational price points and pricing models? They face one or more of the following challenges:
- Revenues don’t match the value delivered: SaaS businesses might not communicate the value proposition well. They might not have clarity over lifetime value. Their pricing strategy doesn’t match the value delivered, and they earn less revenue.
- Loss of market share to competitors: Competitors might communicate their value well. They might align the pricing strategy to the value delivered. Over time, your customer base and market share are reduced.
- Reduction in customer acquisition: If competitors present more rationalized pricing models, then they get more new customers. Your customer acquisition slows down.
- Lower profits: Diminishing market share and lower revenues result in lower profits.
- Lack of innovation: Lower profits leave fewer funds to undertake product innovation projects.
An overview of key SaaS pricing models
The following are well-known SaaS pricing models:
1. Freemium model
If you adopt the freemium business model, then you need to offer a free version of your product. Note that you aren’t offering just a free trial. You are offering a version that’s always free. On top of it, you offer a paid version of the product.
Your potential customers can use the free product meaningfully. However, you design certain limitations in it carefully. You do that to encourage users to buy the paid version.
These limitations typically belong to the following categories:
- Limited features: The free version offers a limited number of features. The paid version offers significantly more features.
- Limited capacity: Users of the free version face capacity limits, e.g., data storage limits. They need the paid version to use more capacity.
- Limitations on usage: The free version might support internal use only. Organizations need to buy the paid version for commercial use.
The freemium pricing model has the following advantages:
- A boost to initial adoption: The free version eliminates risks for customers, and the initial adoption gets a boost. Note that initial adoption is a key priority area for many SaaS businesses.
- The potential for quick popularity: If your SaaS product has one or two powerful features, the freemium model improves its chances of gaining popularity. The free version of the product accelerates the initial adoption. Subsequently, referrals make the product popular quickly.
This pricing model has the following disadvantages:
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- Considerable pressure to generate revenue quickly: You support several free users. Therefore, you must generate revenues quickly enough. You can’t provide a free product otherwise.
- Higher risk of customer churn: Customers might stop using the free version of your product. They don’t have any risks.
- Dilutes the value proposition: A free version obscures the fact that you provide something of value.
2. Flat-rate pricing
The flat-rate pricing model involves just one price for a product. You can use this simple pricing model for your SaaS product too.
This pricing structure offers the following advantages:
- Simplicity: Potential customers can easily estimate their costs.
- Ease of communicating: Your sales team can communicate this pricing structure very easily.
- Easy to sell: You focus on explaining the value of the product to potential customers. The pricing model is so simple that it doesn’t need any explanations.
This pricing model has the following limitations:
- Confined to certain market segments: Suppose you target SMBs (Small and Medium Businesses) and offer features suited to them. You create a flat-rate pricing plan accordingly. Enterprises need more features, and you don’t have any offering for them.
- Rigidity: Many potential buyers have customized requirements. With a flat-rate pricing model, you can’t cater to them. You need to know your target audience very well if you use this pricing model.
3. “Pay as you go” or usage-based pricing model
The “pay as you go” (PAYG) or usage-based pricing model enjoys significant popularity. The advent of cloud computing made many SaaS companies and software vendors take this model seriously.
The PAYG model correlates the price of a SaaS product to its use. Customers pay a higher price if they use the product more. On the other hand, they pay a low price for lower usage.
Depending on the product, a SaaS company might use different metrics to quantify the usage of the product. A few examples of such metrics are as follows:
- Pageviews, video plays, and impressions;
- The number of transactions executed;
- Data used;
- The number of API calls serviced.
The pros and cons of the “pay as you go” model
You can get the following advantages if you use the PAYG pricing model:
- Transparency about pricing: Your customers get a clear picture of why they pay a certain amount. You provide them with the product usage statistics for this. This fosters transparency.
- Scalability: Customers might have high demands for your product during a busy period. They pay more during this time. The demand might be cyclical, and customers might have a lower demand later. They pay less at that time.
- Lower entry barrier: This pricing model doesn’t require an upfront investment from customers. They pay less if they use the product less. This lowers the entry barrier.
- Compensates for “heavy users”: SaaS companies often contend with “heavy users” that use a lot of resources. A flat-rate pricing model doesn’t compensate enough for them. The PAYG model ensures that the product vendor gets sufficiently compensated.
The PAYG model has the following limitations:
- The lack of alignment between value and price: Do the metrics used for calculating usage align with value? E.g., do customers consider the number of API calls important? Customers might look for business benefits achieved by integrating two software systems. The number of API calls might not constitute “value” for them. Finding the right metrics can be hard!
- The challenges of estimating the revenue: You might not be able to predict the usage in the next quarter. This makes it hard to estimate the revenue.
- Clients find it hard to estimate costs: Clients might not know how much they will use a SaaS product. They find it hard to estimate their costs.
4. Tiered pricing model
You can adopt the tiered pricing model if you want to offer different pricing packages. Each pricing package can provide different bundles of features.
Did you create different buyer personas while conceptualizing your SaaS product? Perhaps you have different target market segments in mind? Customers in different market segments have varying needs. They need different features, and you offer a set of features in each tier.
Offering different pricing tiers provides the following advantages:
- Flexibility: You cater to different market segments with different pricing tiers.
- Better customer acquisition: Some customers only need a few features. A pricing tier with fewer features and a low price helps them. Therefore, customer acquisition improves.
- Improved upselling: Clients using fewer features now might need more features later. You have the next tier ready, therefore, you can upsell.
This pricing model has the following drawbacks:
- Complexities: Potential customers will find your pricing page very complex if you create too many tiers.
- Dilution of the strategic objectives: You can create several pricing tiers to appeal to different market segments. However, are all these your target market segments? Catering to many target market segments might dilute your strategic objectives.
5. Per-user pricing model
SaaS companies can use the per-user pricing model. This model ties the price of a SaaS product to the number of users. Customers that buy the software product for more users need to pay more. They pay a lower price if they buy it for fewer users.
The per-user pricing model has the following plus points:
- Simplicity: Given that the per-user price is constant, the price is directly proportional to the number of users. Customers can understand this model clearly.
- Boosts innovation: SaaS companies know that their revenues increase with the number of users. They try to increase adoption, which drives innovation.
- Predictable revenue stream: You can predict your revenue easily since you know how many users each customer has.
This model has the following disadvantages:
- Risks of foul play: Certain client organizations use questionable business practices. They might share login credentials within their organization. This effectively means free users for them, and you lose revenue.
- A lack of value-vs-pricing alignment: Can the number of users translate to value? Clients want tangible benefits, and this metric might not measure that.
- Limits to adoption: Clients pay a higher price if they use your SaaS product on a larger scale. This can act as a disincentive to adoption.
6. Per-active user pricing model
The per-active use pricing model is a variation of the per-user model. It solves a specific challenge of the per-user pricing model.
Assume that you use the per-user pricing model, and a company bought your SaaS product for X number of users. Only a portion of these users utilizes the product. The customer effectively pays more than it needed to pay.
The per-active user-based pricing model addresses this challenge by charging for active users only. You can see the clear advantage to customers.
However, you have an advantage too. Customers now know that they need to pay for active users only. They can undertake a large-scale adoption of your product since they don’t have risks.
Note: This pricing model doesn’t deliver notable advantages if you have SMB (Small and Medium Businesses) customers. Small businesses and medium-sized companies have budget constraints. They have fewer team members. The difference between “per-user” and “per-active user” isn’t relevant to them.
7. Per-feature pricing model
SaaS providers can offer different pricing packages based on different functionalities and features. Higher-priced packages offer more functionalities and features. Customers opting for the lower-priced packages get fewer functionalities/features.
This pricing model has the following advantages:
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- Clarity over costs and benefits: Customers can clearly see what they are paying for. If they need more functionalities, then they can evaluate the other packages.
- Ease of upselling: Customers can see what they get if they upgrade. This makes upselling easier.
- Accommodates “delivery-heavy” features: Some features in your SaaS product might require heavy amounts of resources. You can put these features in the highest-priced package. This ensures suitable revenue for “delivery-heavy” features.
The limitations of the per-feature pricing model are as follows:
- Hard to balance price vs features: The lowest-price package should have enough useful features. The SaaS product won’t be viable without that. How do you decide which features should go into the highest-priced package? You are offering some useful templates for a service. How do you decide which package should include them? As you can see, implementing the per-feature pricing model can be hard.
- Dissatisfaction among customers: Depending on the nature of your SaaS product, customers might pay significantly for the lowest/medium-priced packages. They still don’t get the features available in the highest-priced package. This might cause dissatisfaction among customers.
Choosing the right SaaS pricing strategy: What are your options?
You now need to create a pricing strategy. Let’s analyze the options when creating a SaaS pricing strategy. These are as follows:
1. Cost-plus pricing
This option involves adding a profit margin after you have calculated your costs. Several SaaS companies use this pricing strategy. They need to take into account all of their costs, e.g.:
- Product design and development costs;
- Operational costs;
- Organizational-level costs.
The cost-plus pricing option offers the following advantages:
- You cover your costs: This option ensures that you cover all your costs and then add a profit margin. Note: You need to know what your costs are.
- Simplicity: You can implement this pricing strategy easily. Once you know the costs, you only need to decide on a profit margin.
This pricing option has the following limitations:
- Price doesn’t align with value: If you only add a profit margin to your costs, then you aren’t accounting for value.
- The possibility of low revenue: For some SaaS products, the per-account costs might be low. Adding a profit margin doesn’t generate enough revenue.
2. Competitor-based pricing
You can use the competitor-based pricing strategy for your SaaS product. This strategy doesn’t involve calculating costs and applying a profit margin. Instead, you study what your competitors do. You set the price points based on what competitors have done for similar products.
What advantages can this pricing strategy offer? It can help startups. Startups don’t have past sales data to fall back on, and they might lack clarity over the value of their product. The price points of your competitors provide you with a benchmark.
This pricing strategy has a limitation though. You haven’t aligned your pricing with the value offered by your product. What if you offer a far superior SaaS product than your competitors? By modeling your pricing after your competitors, you might lose revenue significantly.
3. Value-based pricing
We recommend you implement the value-based pricing strategy for your SaaS product. It’s the most sophisticated strategy, and it’s not easy to implement. This strategy provides sustained value though.
You don’t focus on costs or competitors. Instead, you learn from customers about what price you should charge. Customers pay for your product. They know best what constitutes value for them.
Learn what customers consider important. Understand how much they are willing to pay for it. Solve their problem and price your SaaS product accordingly.
The value-based pricing strategy has the following plus points:
- Value-vs-price alignment: You set price points based on the value of your product.
- High-quality insights: You get insights from customers, who will use your product.
- Healthy profit: You don’t apply a margin over costs or follow competitors. You get the revenue based on the perceived value.
- The room to revisit pricing: The perspective of customers concerning value changes. You can get insights from customers after such a shift. You can then set a different price.
This pricing strategy has a disadvantage. It’s hard to implement. You need to have very meaningful conversations with customers, and you need to analyze plenty of data.
How a SaaS company can create the right pricing plans by using data, metrics, etc.?
How can you, a business leader in a SaaS company, implement the right pricing strategy? We can’t recommend a prescriptive guideline since every SaaS business has its unique characteristics. You can follow these generic steps:
1. Define your problem statement concerning pricing
You need to first define what’s wrong with your current pricing strategy. If you are an existing SaaS company, then you are likely facing these problems already. New SaaS companies might just lack clarity about the pricing strategy.
You need to ask yourselves questions. A few examples are:
- “Does our pricing plan reflect the value we offer?”
- “Are we able to convince new customers from our target market segments? Or, do the complexities in our pricing plan impact new customer onboarding?”
- “We have different pricing tiers, however, do we have relevant add-on features in higher-priced tiers?”
- “Did we cover our customer acquisition cost (CAC) in our pricing plan?”
- “Can we estimate our recurring revenues?”
- “Are our customers overpaying due to our per-seat pricing model?”
- “Do customers have enough incentives to upgrade from our free plan?”
These questions are examples only, and you might have other questions.
2. Analyze the root cause of the problem with the help of data
Analyze the root cause of the problem you are facing concerning the pricing. You need data for this analysis. This data can come from multiple sources, e.g.:
- Your CRM (Customer Relationship Management) system;
- The customer support ticketing system in your organization;
- Customer reviews ;
- Interviews with customers.
Remember that this analysis can be hard. The reasons for this are as follows:
- Critical feedback from customers: You need to hear directly from customers, who might provide critical feedback. Hearing such feedback can be hard.
- Resistance to change: Some stakeholders within your organization might think that they have all the answers. They might dissuade you from approaching customers for feedback.
- Time-consuming processes: You need to devote sufficient time to hearing from customers. You also need time to analyze the feedback.
Note: You can’t depend entirely on analytics reports for this analysis. Gathering feedback from customers might take time, however, you must hear from customers.
3. Modify pricing plans and obtain feedback
Think of this step as a trial. You have understood the problem with your pricing plans, and you now know the root cause. Formulate a revised pricing strategy. Use different pricing models, alternatively, improve upon the current model.
Take feedback from customers. Ask them if the pricing model reflects the value offered by your product. Remember that you need feedback from decision-making stakeholders in the customer organization.
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4. Implement a well-tested solution
By now, you have tried out a few pricing strategies, pricing models, and price points. You have received feedback from relevant customer stakeholders. Implement the solution that you found effective. Remember to follow up with customers after you have implemented a modified pricing model.
Examples of SaaS businesses that structured their pricing pages smartly
You now know about SaaS pricing models and strategies. We talked about how you create/modify your pricing strategy.
A “one-size-fits-all” solution doesn’t exist since different SaaS companies have different requirements. E.g., a SaaS solution to manage social media posts is different from a project management tool.
However, you can review examples of SaaS companies that got their pricing model and strategy right. Check out the following examples:
1. Evernote: Uses the per-feature pricing model smartly
Evernote, the popular app for note-taking and organizing tasks uses the feature-based pricing model very well. The company offers three pricing packages, namely, “Basic”, “Premium”, and “Business”.
These packages offer progressively more features. Each upgrade gives you access to new features. The company has tackled the complexities of this pricing model well. It offers a simple pricing page to customers, and customers can clearly see what each upgrade offers.
2. Slack: Uses the per-active user pricing model effectively
Slack, the popular business communication platform uses the per-active user pricing model. Many enterprises adopted Slack, and they have large teams. They want to use a communication platform uniformly within their organization.
The per-user pricing model will cost them significantly. Slack understands this well. Customers can add as many users to their organization-specific Slack accounts. Slack will charge them per active user only, which mitigates their risks.
3. Hubspot and LinkedIn: Intelligent use of the tiered pricing model
Both Hubspot and LinkedIn use the tiered pricing model smartly. Hubspot articulates the difference between their pricing tiers well. Users can clearly see what they get in different tiers.
LinkedIn has 4 pricing tiers. These are named “Career”, “Business”, “Sales”, and “Hiring”. Customers can clearly see what each tier offers.
4. Dropbox: A fine example of using the freemium model
Dropbox provides one of the most successful examples of implementing the freemium pricing model. This cloud-based file storage service provides a free plan for both personal users and business organizations. The free plan is called the “basic” plan, and it’s always free. It allows 1 user and 2 GB of storage.
Users with limited requirements can certainly use the free plan since it provides enough features. However, users requiring more features can upgrade to the premium plans of Dropbox.
5. Basecamp: An example of using the flat-rate pricing model
Basecamp, the popular project management and team communication software, uses the flat-rate pricing model. It offers one paid plan named “Basecamp Business”. This company mentions the flat rate. It lists all features like templates, storage space, etc. on its pricing page. Basecamp understands its target audience well, and the flat-rate model works well for the company.
6. Microsoft: Uses the per-user pricing model effectively
Microsoft uses the per-user SaaS pricing model for its Microsoft 365 Business plans. The company offers 4 pricing packages in the “Business” category. These are as follows:
- “Microsoft 365 Business Basic”;
- “Microsoft 365 Business Standard”;
- “Microsoft 365 Business Premium”;
- “Microsoft 365 Apps”.
Each of these packages is priced per user. Note that each of the above-mentioned packages offers different sets of features. Therefore, each of them has different price points. Each of them is priced per user though.
We explained the key characteristics of popular SaaS pricing models. We talked about the pros and cons of these pricing options. After explaining various SaaS pricing strategies, we described how to create the right pricing plans.
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FAQs on SaaS Pricing Models
Non-functional requirements (NFRs) like performance, scalability, security, and maintainability are very important for SaaS products. The SaaS product market is competitive. Your SaaS product must deliver both functional requirements and NFRs effectively to make a mark in this market.
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