Most SaaS founders misprice their offerings when they are starting out. The dynamics of the market and customer offer uptake are likely to affect your pricing during the first few months of operation. When starting out, what pricing model should you adopt? Should you go for a linear scaling pricing or a plan model?
Pricing can be tricky for any SaaS company. Unlike other types of businesses, subscription-based businesses depend on the revenues generated by customers at every defined billing cycle. Companies therefore have to adopt effective pricing models that will see them acquire a large number of users at a low cost per acquisition (CPA) than their lifetime value (LTV).
Experimenting with pricing helps SaaS businesses to understand their markets and know who to price their offers. Most startups opt for two pricing models: linear scaling pricing and plan pricing.
1. Linear Scaling Pricing Model
In a linear scaling pricing model, customers who bring more business are charged less. Let’s take an example of a SaaS business providing managed hosting services. The business may charge monthly fees as follows:
- 1 server= $18 per server
- 10+ servers= $14 per server
- 50+ servers= $9 per server
On the surface, the pricing model appears to align price with customer success i.e. bigger customers pay more money so they are entitled to a lower price per server. The model offers low-cost entry options, which the SaaS business hopes to scale up on.
The benefits of a linear scaling pricing model include:
- Increased sign up rate: This can be mainly attributed to the lower price point.
- Lower churn rate: Customers stay longer since they are only paying for what they need.
- Customer segmentation: You can identify large customers based on uptake of your service.
- Large customer base: You can reach both hobbyists customers and business customers.
With a linear scaling price model, you may get a large number of signups due to the low cost of entry and therefore experience improved margins due to scale.
However, you should also consider other costs you will incur such as customer support. You might need a large support team to handle all the customers, and this can mean digging more into your revenues for their payroll.
Scaling your price linearly when customer value expands is can lead to losses in the long run. The rule of thumb is you should price according to value, not according to cost.
2. Tiered Pricing Model
A different pricing model you can consider is the tier-segmented model, which can be segmented by usage of service offers.
The advantages of this model include:
- Eliminate trivial decisions: When you name your plans correctly, customers have an easy decision on the plan to go for based on how they perceive themselves (e.g. small business, enterprise, etc.)
- Predictable pricing: You are assured to get the same amount of revenue from a customer regardless of the extent that your service will be used.
- Fewer decisions: You do not need capacity planning to determine how the uptake of your service is going to be affected when a customer’s needs increase.
- Better alignment with business goals: Instead of focusing on the extent of service uptake by your customers, you will be concentrating on the revenues generated.
Experimenting with pricing will help you find the right footing for your SaaS company. If you are too cheap, you will leave money on the table and inhibit your ability to acquire new customers. On the other hand, if you are too expensive, you may be scaring away your potential customers.
Please share your ideas and comments below.