Choosing the Right SaaS Pricing Model

In this post, we’ll take a look at some of the variables that you should consider when pricing your SaaS product and some of the pricing models that are common in the industry. Hopefully, this will provide you with some insights into how to prepare your own strategy and the ways that it may need tweaking as new information about your customers and your business becomes available.

The importance of pricing

Pricing requirements are harder for SaaS products than they are for products that are sold per unit. With per unit pricing, you know how much it costs to make the product and can easily price higher. Of course, you still must work within the confines of what the market will bear and how you compare to your closest competitor, but the maths behind adjusting and setting your price is more straightforward.

With SaaS products, you can’t know the full value of a customer until you know how long the average customer remains subscribed to your service. The amount of money you make from a customer from the moment they sign up to the moment they churn is the customer’s lifetime value (CLTV). Another important factor that you must consider is how much you spend on sales and marketing to acquire a customer. This is customer acquisition cost (CAC). If your company is to survive, your average cost of acquisition for a customer must be significantly lower than their average lifetime value.

The problem for startups here is clear. You cannot know what the lifetime value for your average customer is because nobody has signed up yet, much less went on to cancel later. The problem goes beyond the startup stage though, and this is where many companies falter. Both the LTV and the CAC averages for your product are going to be in a constant state of flux. A company that never reevaluates pricing is very likely to fail. In fact, a successful SaaS business will not only reevaluate prices regularly but do so continuously.

So if you are just starting out and all you have so far are assumptions about how long your customers will stick around and the number of users that you will have on average, how do you go about setting your pricing? The key here is to think of your initial pricing as nothing more than a starting point. It’s the first step in a long term SaaS pricing strategy. Because of this, you want to keep it as simple as possible. There are a number of benefits to this approach.

• It’s easier to get feedback – With fewer pricing tiers to keep track of, it’s easier to keep the feedback organised. In addition, the initial slow-drip of feedback will be more concentrated rather than spread out over a large number of options.
• It’s more flexible – In the beginning, you might not know exactly which features to differentiate with pricing tiers. Gathering data on which features are of value to your customers and which aren’t will help you know how to make these distinctions and provide better results than trying to guess ahead of time.
• It reduces the friction of iteration – If you start out with a lot of options and then reduce the number of options, your customers are more likely to be upset than if you instead give them more options later on.

The key is that once you’ve put your simple pricing plan into place, you continue to make adjustments to it as you gather feedback from your customers and collect data on the LTV and CAC metrics that we discussed earlier.

The pricing model you choose will in some ways be limited by the type of service you are offering. Regardless of the type of SaaS business you are running, you will have a number of options to choose from when selecting a pricing model. Take a good look at the way your product offering is structured and think about which model makes the most sense for it.

Here are the traditional SaaS pricing models:

• Flat rate – Flat rate pricing means that everybody pays the same amount for the software, and they get everything that the software has to offer. This single price tier makes things very easy to understand but prevents you from optimising your pricing based on customer needs. A flat-rate service may offer a limited-time free trial so that customers can get a feel for the product.
• Tiered – As the name suggests, tiered pricing splits the options into different service tiers. Imagine you have a SaaS business that processes images online in some way. The lowest-priced tier would allow the user to process a small number of images, while the higher-priced tier would give them either a large number of images or an unlimited amount. Because customers can pay for only what they need, you can get more people willing to sign up.
• Freemium – Freemium offerings are often a form of tiered service, so it makes sense to mention them here. In a freemium business model, you are going to allow your customers access to the lowest tier for free. This allows them to get their foot in the door, try your service, and upgrade when their needs exceed the free plan.
• Free trial – This model is often used when SaaS businesses feel that prospective customers won’t see the true value of their product if they were to offer the restricted features version that Freemium does. With a free trial, users get full access to the software for a limited time period, and once the trial has ended they then have the option to purchase a subscription.

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• Usage rate – In this pricing model, customers are charged based on how much of the service that they use. Imagine you own a translation service that offers an API for customers to use in their own products. You might charge them a certain amount per word or per request to process the transaction.
• Per feature – Feature-based pricing is another way to let your users only pay for what they need. In this pricing model, users at the lowest tier of service have access to a limited set of features. Additional features are unlocked until the highest tier is reached and all of the features are available. This can be a good way to ensure that only the high paying customers have access to resource-heavy features.
• Per user – A per user pricing structure can be thought of as similar to a flat rate structure but for products that will be predominantly used by multiple people. For example, a project management platform may be a good candidate for per-user pricing.
• Per active user – Customers may be wary of paying per user if they are unsure how many users will actually take advantage of the platform. In this case, a variant of per-user pricing that only charges for the active users in a given month might be a better model.

You may be tempted to browse through your competition’s pricing pages and try to mimic what they are doing. This is a very easy way to get initial pricing. Not only because the competitor has already done the hard work of building the pricing model, but because you’ll know ahead of time that the market will bear the price.

In the long run though, this pricing strategy simply doesn’t work. You need a way to highlight the things that set you apart from your competition — what creates value and is the key selling point? What are the benefits that your product provides that will solve your prospects pain points? This is how you will build value in your product.

When deciding on a pricing structure, ask yourself what your unique value proposition is. By focusing on what sets you apart from your competitors and building your pricing around that, you will be highlighting the very thing that will help you stand out and close more sales.

Cost-plus pricing is a strategy where you add a markup to your costs. We mentioned earlier how sellers of physical, per-unit items can look at the cost it takes them to make something and add a number to that to ensure that they are making a profit. However, customers don’t care about that. Companies can charge a lot higher over the margin for products that are valued very highly in the market. Likewise, if your product lacks any perceived value, you’ll be lucky to make anything over margin, and your business will fail to grow profitably.

The same is true of SaaS products. In the beginning, you have the costs of development, labour costs, and any monthly bills that your product may rely on. It may be tempting to price at some percentage over that amount, but your customers aren’t going to judge your price points by the operating costs of your company, and this strategy just won’t work long-term.

As your company grows, your operational costs will grow with it. Perhaps you need to hire more support staff or a larger sales force. Tying your product pricing to these ever-changing variables likely will not reflect the market value of your product, and your prices will be changing all the time — this will only infuriate customers and may cause some to churn.

Competitor-based pricing and cost-plus pricing both falter because they neglect the most important aspect of a SaaS product – perceived value. The perceived value of a product is the deciding factor in what people are willing to pay.

In the beginning, you may have no way of knowing what value your customers will place on your product, which is why the traditional models we mentioned earlier are a good starting point to experiment with. After you’ve been operating for a while though, you’ll be able to implement a value-led pricing strategy and set your business up for long-term profitable growth.