A definitive guide to SaaS Pricing Models - Types, Examples and top metrics to track

In this guide, we will talk about the different types of SaaS pricing models, the metrics to track the performance of your pricing model and how to think about pricing before finalising a pricing model. With this guide, you’ll gain better clarity about what's,how's and the why's of pricing models.


Why choosing the right pricing model is important?


According to Gartner, SaaS businesses are the largest segment of the cloud market and are slated to grow exponentially in the coming years. And when it comes to SaaS, here’s the problem - What many fail to understand is that, your work doesn’t get over after building a great product. Building your product is just the first step.

A lot of SaaS companies spend all their blood and sweat in building a great product and then throw it in the market hoping to hear the sweet sound of “cha-ching” almost immediately.

The secret sauce to building a successful product boils down to an often overlooked factor - Pricing. Knowing…..

  • How to position your product?
  • How much value does it offer?
  • Who is your ideal customer?
  • Which pricing model complements your target market?

…..are some of the most crucial questions that should be answered with full clarity before deciding a pricing model.

Companies often ignore the above and start celebrating their “Eureka” moment immediately after building the product.

A great product coupled with a great pricing plan is a force to be reckoned with.

Pricing plays an integral part in helping you monetize your customers and keep your business in good health. It shouldn’t be overlooked and formulated with wishful thinking or weak statistical data.

So, how to choose the right pricing model for your product? Before answering that question, we must learn about the different types of SaaS Pricing models.

We’ll discuss about choosing the right pricing model later in the guide.

Now, let’s start with the pricing models,

Types of SaaS Pricing Models

Flat rate pricing model:

In flat rate pricing, the product is offered with a set of features at a predetermined price. There are no pricing options or features to choose from. The method is basically based on the “one size fits all” pricing strategy and you charge your customers the same amount monthly/annually regardless of how many users or their usage is.

Example: Basecamp is a real-time communication tool that helps teams stay on the same page. Their core value is simplicity and inorder to synchronize with their values they’ve incorporated a flat-rate pricing for their product, which is thereby easier to understand and doesn’t confuse your customer by giving too many options.

Advantages of a flat rate pricing:

  • Simple & easy to comprehend.
  • Forecasting revenue is far more easier and accurate as there’s no complication or varying price points to account for.
  • Helps you communicate and sell easily and focus your marketing and sales on a single, clearly-defined pricing offer.
  • For a new and lean SaaS Product, following the flat price model might help gain customers faster thanks to a simple pricing structure which might cut down the decision making time.

Disadvantages of flat-rate pricing:

  • Ironically, the one size fits all strategy won’t work for all customers. Appealing to businesses that require custom plans is impossible which discourages them from considering your product.
  • By incorporating flat rate pricing you don’t give your customers any choice which might make them feel crippled when making a decision to buy your product. Flat rate pricing might signal a “take it or leave it” approach denying that psychological satisfaction.
  • As there is no option to upgrade plans, you completely lose out on any upselling opportunities.
  • If you’re scaling, acquiring users from new markets will be difficult as you’re pricing is optimized for a specific niche in the market.

Tiered Pricing Model:

Tiered pricing model is based on the tiered pricing strategy when it comes to the real world pricing scenario. Both terms are used interchangeably, leading to a potential confusion. This post spells the difference between the two. In the tiered pricing model different versions of the product is offered at varied prices. These can be based on features, number of users or usage and is decided by the business based on the product they have to offer. Usually 2 to 5 tiers are created and your customers are allowed to choose from the same based on their needs. Using this pricing model you can upsell to your customers incrementally which can include features as they scale. The pricing tiers should be carefully constructed with an appropriate strategy failing which your customer will end up getting confused.

Example: Hubspot is a developer and marketer of software products which are used for inbound marketing and sales activities. They’ve priced their plans useful in such a way that new marketers to professional teams can use their product as they scale.

Advantages of tiered pricing model:

  • It appeals to different customers from beginners to advanced, thereby increase your market share and revenue potential.
  • Gives your customers the power of choice, so that they can pick and choose the plan that works for them..
  • Opportunity to upsell to your existing customers that’ll improve your existing MRR without any marketing spend.

Disadvantages of tiered pricing model:

  • The tiers should be carefully thought out and constructed based on the customers you’re targeting. A lot of tiers can be confusing whereas lesser number of poorly constructed tiers doesn’t really help you reap the benefits of the tiered model.
  • Every tier increases the complexity of your customers’ decision making process.

Learn all about Tiered Pricing

Usage based pricing model:

Usage based pricing model is also touted as the “pay as you go” model. In this pricing model, the customer is charged based on their usage of the product. If they use more, they’re charged more and if they use less they’re charged less. The usage can be charged based on a variety of factors such as number of Emails being sent, per API, per call, per transaction etc., There are few variants of usage based SaaS models, some are purely usage based and some have a base subscription fee and then will be charged according to usage.

Example: Chargebee is a subscription billing platform which charges the customer by directly syncing the price charged for the pricing tier with revenue. If your revenue increases you will be charged more. This ensures that customers can afford the product and the price being paid is justified.

Advantages of usage based pricing model:

  • Customers might often perceive this pricing model to be the fairest among all because the pricing is directly proportional to their usage. If they use more they’re charged more. It’s more transparent and there are no hidden fees whatsoever.
  • The pricing is designed in such a way that it is easily adaptable according to fluctuations in your customers business.

Disadvantages of usage based pricing model:

  • Since, you charge your users based on their usage, the value of your product doesn’t really stand out and dims in comparison.
  • You cannot charge the customer based on their organisation size and you might lose a revenue in the same process. For instance, you might end up charging your enterprise customers less because they use less and a startup will be charged more if they use more. In this case, you might miss out on revenue which will be generated by your enterprise customers.
  • Predicting revenue can be difficult as your revenue is based on your customer’s usage of your product which cannot be measured accurately.

Per user based pricing

Pretty self explanatory, per user based pricing model allows businesses to charge based on the number of individuals using the product. In this model, the revenue scales along with the adoption of the product by the users in the company. Every account is charged which makes it easier to predict revenue.

Example: Canva is an online graphic tool website which has easy-to-use features and functionality that helps people create a multitude of engaging content. They charge their users on a per user basis for using the product.

Advantages of per user pricing model:

  • Per user pricing model is easier to understand for your customers because it’s easier for them to calculate how much they’ll pay based on the headcount using the product.
  • All users are given complete access to the product with no shady upsells for more features.
  • This model helps people adopt your product quickly across the organization.

Disadvantages of per user pricing model:

  • Sometimes, due to cost cutting measures the organizations may limit the number of users using the product.
  • Login abuse can become a trend - multiple individuals using a single account.
  • Pricing does not reflect the value of your product which might lead the users not realizing the same. This can hinder your brand growth in the long term.

Per feature pricing:

The product is priced based on the features and functionality which is offered to your customers. The more features the more your customers pay and vice versa. The pricing tiers are separated based on the functionality available for each tier. In feature based pricing your customers scale along with the product as they expand. They might need new solutions to the problems they might face during growth and hence upgrade to the next level. In per feature pricing model you’re tying the price directly to the value offered by you to your customers.

Example: Quickbooks is a small business book-keeping software that helps manage and account for sales and transactions. They price their product based on the functionality. For instance, their starter plan helps you track income, expenses, sales, sales tax and so on, as you upgrade you can manage bills, users and track the time taken and so on. The rates they charge increases incrementally with the features they offer in each tier.

Advantages of per feature pricing model:

  • Allows your customers to pay only for what they need and what is in their functional scope.
  • Saves money as they need not pay for unnecessary featuress that might not be useful for them at their current stage of growth.

Disadvantages of per feature pricing model:

  • It is difficult to get it right because it's impossible to tell which customer needs which features.
  • Some add-on features might not be welcomed by the customer as they might not find its usage and restrict themselves from purchasing upgraded versions.

Freemium Pricing Model:

Freemium is a widely adopted pricing model which allows businesses to lure users to signup for a free but limited version of your product. The idea is to hook users to your product and nudge them later to upgrade for the paid version. In Freemium, certain features are offered for free and a paid upgrade is available when they want to access more functionality the product has to offer. In the Freemium model you usually keep your potential customers in the free product incubator and target sales and marketing campaigns exclusively for them so that they can upgrade.

Example: Drift, a conversational marketing and sales technology company offers its solutions in a free trial version thereby letting their freemium versions act as a lead-generation tool.

Advantages of Freemium model:

  • Low Customer Acquisition Cost (CAC) as the product drives adoption faster and cheaper compared to other models
  • Monetize free plan by introducing ads alongside nudging users to upgrade to a paid plan.
  • Acts as a front door which lets your customers by allowing them to try out the product for free.
  • The free version is an ideal testing ground to experiment new features without upsetting your revenue generating engine.

Disadvantages of Freemium model:

  • Statistically speaking, less than 10% of free users convert into paying customers. There’s always the unnecessary burden on your limited resources which is used to serve free users more than your paid customers.
  • Decreases the value of the product in the eyes of the customer. When someone pays for a product, the way they see the product is completely different and they might not abandon using the product on a whim, which isn’t applicable to Freemium models.
  • Increased burden on your operational resources mainly caused by free users.

Per Active User Pricing Model:

In a per activer user pricing model, you charge your subscribers only based on how active they’re, in other words you only charge the users who use the product. Teams can enroll as many users as possible to buy the product but they will be charged only based on the ones who use them. This means that no money is spent on vacant places.

Example: Slack, is a cloud based instant messaging platform, that enables people in the organization to collaborate effectively. They’re famous for using this pricing model, as they charge their users based on how many people actively use the product.

Advantages of per active user pricing model:

  • No money is wasted on inactive users, only the active ones have to pay.
  • Enterprise customers can buy the product for their teams and they will be charged based on the people using the product, thereby reducing the risk of adoption across the organization.

Disadvantages of per active user pricing model:

  • Doesn’t work well with small business because they’ve small teams and everyone will find application in the product.
  • Some customers might not use the product at all even though they’ve access.
  • Multiple logins through one account in order to reduce costs can take a toll on your revenue health.

Given so many options of pricing models, you might get confused as to which one is the best suited for your business. But, pricing models shouldn’t really belong by choosing based on what your competitors have done or what articles you read to find out the best pricing model. A pricing model is unique to every business, whatever competitor data or guides you get online should only be your knowledge base giving you a small level of hindsight

How to choose the right pricing model for your SaaS business?

To choose a pricing model, you’re supposed to think from the shoes of your customers and base your decision on the data generated. Here is a blog on how you should go about thinking when your developing your own pricing model for the business. Given below are some points which will help you set stage before you jump into choosing a pricing model.

  • Know your LTV/CAC ratio when choosing a pricing model. It helps to determine if the model is really going to keep your business in good health.
  • Pricing isn’t a single department decision. It’s a decision which should be jointly made by Marketing, Sales, Product and Management. They help you position, pack, manage and target your audience effectively.
  • Develop buyer personas from the data available. Do a thorough research on who your customers are and which segment of the people you’re speaking with. This will help you position your product more effectively, based on what they need.
  • Come up with differentiated tiers after having a clear idea of your buyer personas. Knowing how to differentiate what a startup will want from an enterprise will help you pack and sell your features at different price points helping you sell effectively.
  • Arrive at your pricing model from data inputs by your existing customers and prospective customers. Learn to ask what they want from your product because your customers are the people usingthe product. What is a better way than to ask them what they want rather than making random guesses, which might end up going downhill.

How to track & analyse your Pricing model?

The work doesn’t end for you after deciding on a pricing model. In order to find out the profitability and usability, you need metrics in place which will help you track and analyze how well your pricing model is being received by your customers. Here are the methods on how to analyze your pricing model:

LTV/CAC ratio:

While creating your pricing model, it is important to look at the LTV (Life-time value) and CAC (customer acquisition costs) ratio.

Why? This ratio helps you arrive at a profitable business model. The ratio between these two parameters should always be greater than 1, so that you don’t lose money on every customer you get. A lower LTV/CAC ratio shows how long it takes for your customer to payback, which could result in a potential loss for your business. Many companies ignore the importance of the ratio and step into the zone of losing money in their business with every new customer.

Gross MRR churn ratio:

Gross MRR churn is the percentage of revenue lost due to the cancellation of the license for the product or due to downgrades. It estimates the total loss to the company in terms of percentage and is calculated by dividing total MRR churn (for the month) and total MRR (for the month) and multiplying the resultant answer by 100 to obtain the percentage.

Gross MRR churn = total MRR churn/ total MRR x 100

For enterprise companies the idea Gross MRR churn should be around 1% and for small businesses around 2-2.5%. If your gross MRR churn ratio is greater than 5%, it means that you’re losing a substantial part of revenue due to cancellation and downgrades.

Expansion MRR:

Expansion MRR is the ratio which tells us about the revenue generated through add-ons, upsells and cross-sells. It is given in terms of percentage. It shows if you can deliver and add more value to your customer such that you can monetize the monetize the value. It is calculated by subtracting total expansion MRR at the beginning of the month from the total expansion at the end of the month, divided by the total MRR at the beginning of the month and multiplying the resultant by 100.

Expansion MRR = Total expansion MRR at the end of the month-total expansion MRR at the beginning of the month/total expansion MRR at the beginning of the month x 100

Total expansion MRR shows how already existing customers generate more revenue and value to your product, thereby generating more demand. An increased MRR ratio shows sustainable growth since it reduces the new CAC cost, but at the same time generates increased revenue and leading to a good business health.

Upgrade MRR:

Upgrade MRR is similar to expansion MRR, but it mostly concentrates only on upgrades and is applicable to subscription based businesses. When a customer upgrades from one of the existing plans to a higher plan for the need for more functionality and features, then it is called as the upgrade MRR. It is calculated by subtracting the cost of the higher plan with the cost of the existing plan.

Upgrade MRR = Cost of the upgraded/higher plan - Cost of the existing/lower plan

Upgrade MRR shows how many customers are upgrading to a higher plan to opt for advanced functionalities. Adding new features to the product, you encourage your customers to upgrade. If this value doesn’t increase it shows that you’re offering high value for a low price, thereby helping you reassess your pricing strategy.

Conclusion:

Taking all the information and going back and forth questioning your pricing strategies and plans is the right way to begin with before arriving at a model. Here are a few key takeaways:

  • Pricing isn’t something you set one time and forget. It should be revised as the product ages.
  • Pricing should scale along with your product and should convey the value of your product.
  • Your plans should resonate synchronously with how your product is packaged and based on your buyers.

With the above given information, it’ll help you gain some insight into the pricing world and arriving at the best pricing strategy and plan for your business.