A guide to SaaS pricing models
In 2011, Dropbox famously changed its pricing model from a fixed price for a set amount of storage to a tiered pricing model that offered more storage for higher prices. While this change did increase revenue, it also led to confusion among customers and a backlash from some who felt they were being charged too much. In 2016, Dropbox simplified its pricing model and offered a single plan with a fixed price for a set amount of storage.
Choosing the right pricing model for your SaaS business is one of the most important jobs in planning your go-to-market strategy, and can make or break a business.
The right pricing model can help differentiate you from the market, drive acquisition, and increase retention. The wrong pricing model can unwittingly cap your growth and destroy your bottom line.
At its core, a pricing model is simply the way a company charges customers for its product or service. A pricing model is not a pricing strategy. A pricing strategy is how you determine what to charge for your product (e.g cost-plus or competitor-based pricing).
There are plenty of tried and tested options out there, and picking the most effective one for your product depends on a variety of factors:
- How complex your product is
- How many people use it
- How often people use it
- How valuable it is to your customers
- Who you are competing against
- Your product maturity, brand awareness, and positioning
- Your business model and long-term goals
And that’s just to name a few. In this guide, we'll explore the most popular SaaS pricing models available, their pros and cons, and provide some relevant examples to help you choose the right model for your product.
🆓 Freemium pricing
The freemium pricing model is one of the most popular and widely used SaaS pricing models. It involves offering a free version of your product with a limited feature set and giving users the option to upgrade to a paid version to unlock more features. This model works well for products with a broad appeal that want to build a large user base and/or establish brand awareness.
Canva’s freemium model, offered alongside its Pro and Team plans, has played a critical role in helping it generate a reported $1B in revenue in 2021. Their free plan provides ample functionality for budding creators and marketers to create professional-looking, on-brand graphics. Once they’re hooked, they can then move to a paid plan to get access to additional storage, better stock photography and templates, and 24/7 support.
Pros of freemium
- Helps acquire new customers by offering a free entry point
- Allows users to try the product before committing to a paid plan
- Can lead to higher conversion rates and customer loyalty
Cons of freemium
- Free users don’t generate revenue
- It can be difficult to balance the cost of offering a free plan with revenue goals
- Difficulties converting users to a paid plan
👤Per-user pricing
Per-user pricing is based on charging a fee per user or seat. It is typically used by products where the user-to-account ratio is particularly high, such as team collaboration, and project management software.
Slack offers a per-user pricing model where companies pay a monthly fee for each active user on their account. This model allows businesses to scale their usage of Slack as their team grows, while also incentivising them to manage user accounts efficiently.
Pros of pay-per-user pricing
- Offers a straightforward pricing structure that is easy for customers to understand
- Generates revenue based on the number of users which supports scale
- Provides an incentive for companies to manage user accounts effectively to minimise costs
Cons of pay-per-user pricing
- May put off companies with large teams or user bases
- Can be difficult to predict revenue, making it challenging to plan for growth
- May lead to customer dissatisfaction if the number of users fluctuates frequently, resulting in unpredictable costs
🏷️ Flat rate pricing
A flat rate pricing model involves offering a fixed price for all customers regardless of the number of users, usage, or features. It’s the simplest of all the pricing models and is often offered by companies in the early stages of launching their product when their feature set is relatively limited.
Basecamp claims they offer ‘Every feature at one, flat, monthly price’, but they actually offer a tiered model, limited by users, storage, and client access (if you read the fine print). Twitter’s Blue subscription service is probably closer to a pure flat-rate pricing model.
Pros of flat rate pricing
- A straightforward pricing structure that is easy to understand for customers
- Allows for easy budgeting and forecasting for customers since costs remain fixed
- Encourages usage and adoption of the product since there are no added costs for increased usage
Cons of flat rate pricing
- Might not be profitable for companies with low usage or a smaller customer base
- Can limit revenue growth potential as usage increases for high-usage customers
- Difficult to effectively capture the full value of the product for customers who use it heavily
🎂 Tiered pricing
As a product become more complex - more features, multiple customer segments - companies often transition to a tiered pricing model. This allows customers to choose the plan which best suits their needs while charging a premium to customers with a higher cost-to-serve.
A tiered pricing model is often used in conjunction with another pricing model. For instance, a company might offer three pricing tiers including a free tier, and two additional tiers based on usage or the number of users.
Mailchimp is an example of a company with a tiered pricing model, with tiers increasing based on the number of contacts, level of support, and advanced features.
Pros of tiered pricing
- Encourages customer growth and adoption since the pricing scales based on usage
- Provides a cost-effective option for customers who don’t need features of the higher-level plans
- Empowers customers to choose plans that best fit their needs and budgets
Cons of tiered pricing
- Detracts focus from serving your core target customers
- Can be difficult for customers to understand and compare pricing across plans
- Creates additional support, sales, and operational overheads
✅ Feature-based pricing
Feature-based pricing involves charging customers based on the features they use. It is commonly used for products with a large number of features with a high variance of usage amongst its customer base.
Grammarly is a good example of a company that distinguishes its pricing tiers based on features.
Pros of feature-based pricing
- Provides customers with greater flexibility to customise their plans to their specific needs and budgets
- Cost-effective for customers who only need certain features and don’t want to pay for unnecessary ones
- Encourages customer growth and adoption as they can add new features as needed
Cons of feature-based pricing
- Might not be suitable for all types of businesses, especially those that require a comprehensive suite of features
- Can be difficult for customers to estimate their costs upfront
- Can limit revenue potential for SaaS companies, as they aren’t able to capture the full value of their product
⏳ Usage-based pricing
Usage-based pricing involves charging customers based on how much they use the product or service. It is commonly used for products that offer cloud storage or other resources that customers can use as needed.
AWS is an example of a company that offers usage-based pricing. While attractive to start-ups, whose usage is typically low, costs can quickly escalate with some companies now opting to move back out of the cloud to their own infrastructure to tackle the soaring costs.
Pros of usage-based pricing
- Provides customers with cost-effective options since they only pay for the actual usage they incur
- Encourages customer growth and adoption since they can scale their usage up or down as needed
- Allows for greater flexibility in pricing based on different types of usage (i.e. higher pricing for premium features or high-usage customers)
Cons of usage-based pricing
- Can be difficult for customers to estimate their costs upfront, leading to pricing uncertainty and confusion
- Could limit revenue potential for SaaS companies, as they're not able to capture the full value of their product
- May require more complex billing and tracking systems to ensure accurate usage tracking and billing
💎 Value-based pricing
While value-based pricing is a pricing strategy, where the product is priced based on its perceived value to the customer, it can also be used as a pricing model, where the company takes a cut of the value it generates. For instance, time or money saved, or transaction fees on products sold.
Shopify is an example of a SaaS business that uses value-based pricing on top of its subscription model to charge a percentage transaction fee on each purchase.
Pros of value-based pricing
- Aligns pricing with the value customers receives
- Provides an additional revenue stream for the SaaS company, beyond the subscription fee
- Encourages sign-ups as the base cost is often lower as it is off-set
Cons of value-based pricing
- Can be difficult to accurately measure the value generated by some products, leading to pricing inconsistencies and customer dissatisfaction
- Can put off customers at the high end, leading them to search for competitors that charge a flat fee or even develop their own solutions
- Can be complex to communicate to customers, especially if the pricing model is based on multiple variables
Summary
SaaS businesses have several pricing models available to them, and choosing the right one is critical to success. Each model has its own pluses and minuses depending on factors such as product complexity, customer usage, competition, and long-term business goals. The freemium model is ideal for broad-appeal products looking to build a large user base, while per-user pricing is more suited to products with high user-to-account ratios. Flat-rate pricing is the simplest of all models, while tiered pricing is often used in conjunction with other pricing models to provide flexibility and choice to the customer. Regardless of which method you end up choosing, make sure you allocate a decent amount time to making the decision, and as you would with any other decision of your product, balance the needs of your customers with your business objectives.
