Very FEW businesses get pricing right the first time. After developing your app, you have to decide how to price it. Price too high and you risk locking out potential customers. Price too low and you risk losing out on revenues. How do you determine the right price for your service?
The “right” price is subjective. For SaaS founders, this is even trickier since they are selling services and not product which have fixed costs. How do you price the thousands of lines of code running your app plus the support you will offer?
When launching, most founders shoot themselves on the foot by pricing too low. Perhaps it’s due to fear on whether customers will really pay a high price for their service. Pricing experiments therefore become necessary to understand the perceived value that customers attach to your service.
Two common pricing strategies you can experiment with are pay for usage and value based plans.
Pay for Usage Plans
With a pay for usage plan, users pay for the amount of service they consume. This model makes sense because the more the customers consume, the more they pay. The model is great because:
- Users feel they are paying a fair price i.e. the more they consume, the more they pay.
- It is easy to compete against lower-priced competitors.
- Higher sign-up rate because of the lower price point.
- Best for services targeting hobbyists or single users.
While pay per usage looks like a good plan, its flaws start to be experienced as the number of users grows. Usually, hobbyists have larger support requirements and this can stretch your resources. Hobby businesses are usually one-person operations and if the users are not knowledgeable about the service you offer, they can increase your support costs.
For instance, if you are offering VPS servers, incorrect configurations can lead to frequent downtimes and take a toll on your support. When support suffers, the word going round will be that you do not care about your customers.
Before opting for a pay for usage plan, consider carefully your service and the technical expertise that a customer may require to use it. This post by Patrick McKenzie goes in-depth on how pay as you go pricing is a flawed pricing model. The Hacker News comments are also very helpful.
Value Based Pricing
With value based price plans, you offer users a number of packages that are defined by the value provided. For example, you may have a three price package costing $99, $129 and $199.
Unlike the pay for usage plan, the plans here are distinguished by the value that users get rather than what they choose to consume. Usually, the lower price plan offers primary features, followed by the medium plan while the upper plan offers all the primary and advanced features.
The advantages of value based pricing for customers include:
- Choose value based on needs. Users can select “Silver”, “Gold” or “Platinum” plans based on the value offered and their needs.
- Constant price. Unlike pay for usage prices that can go up and down during the billing cycle based on user activity, value based plans offer predictable pricing. Users know that no matter how much they use the service, they will pay a fixed amount.
For SaaS businesses, value based pricing also weeds out customers who may not be serious with the services. Moreover, offering additional value such as expedited set up and phone support makes users appreciate the higher price plans. This means more revenue for the company.
What about Freemium?
Freemium might seem like a viable option to include in your pricing plan. However, there are many things you should consider, even if your customers are giving something in return, before including a freemium model. I recommend you read Lincoln Murphy’s timely whitepaper, “The Reality of Freemium in SaaS” to understand issues you will have to consider.
Before you offer a freemium plan, I suggest that you first price your service and test to see whether customers will pay for it. In most instances, users will peg a price on your service based on the price of your competitors. If you are charging higher, justify it with your unique value proposition (UVP) or something else.
Testing Your Pricing
Ultimately, you will have to test out prices to find the optimum amount users are willing to pay for your service. A 1-2 months A/B test will be enough to determine what price will be right.
As we wrap up, I will suggest you also read Neil Davidson’s Don’t Roll the Dice to understand more on pricing SaaS products.