Developing the right pricing is critical if you’re trying to build a profitable SaaS company. To be successful, you need a pricing strategy that appeals to your customers and captures the full value of your product or service. Narrowing in on the ideal product pricing for your SaaS is challenging, and getting it wrong can result in unnecessary revenue leakage.
Your prices should attract new customers and help reduce the churn rate of existing customers. But at the same time, you don’t want to run the risk of setting prices too low.
To strike the ideal balance, you don’t just need the right prices—you also need the right pricing model. To guide you in the right direction, this guide looks at the difference between pricing strategies and models and then provides ten of the most common pricing models and how to use them.
Defining pricing strategy vs pricing model
When you research different pricing options, you will often hear the phrases pricing strategy and pricing model. These phrases overlap—they both help you find a price point that will maximize the lifetime value (LTV) of your customers. But there’s a key distinction between these concepts:
Pricing Strategy: Your business develops a pricing strategy internally based on its goals, the competition, and the expectations of potential customers. Your pricing strategy influences which pricing model(s) you select, and it also helps you determine the best price point for your products or services.
Pricing Model: This refers to the format or template you use for your prices. The pricing model is externally facing. Although you may use different price points, the same model applies to all of your products and services. You may charge a different price for a new product, for example, but you will use the same model as you do for your other products.
Your pricing strategy will affect the pricing model and the price points that you select. Your strategy will outline the metrics you want to hit, and then, your pricing model will help to ensure you hit those metrics.
For example, the most common SaaS pricing strategy is a subscription-based pricing model. This gives customers the perceived value of constant access to your software at a predictable set price every month. At the same time, it provides a higher-than-average gross margin. KeyBanc reports that while the total gross margin of SaaS companies was 73% over the last two years, and the median subscription gross margin was 77 to 80%.
The 10 most common pricing models
To hone in on the right strategy, you need to consider a wide range of questions. What do your customers want? What is the competition doing? What prices can the market bear? What prices do you need for growth? You can’t just focus on a dollar amount alone. There are all kinds of different ways to price a product, and if you want to be as profitable as possible, you need to understand the different types of pricing models.
This pricing model starts with the cost of developing and maintaining your SaaS, and then it adds on a certain margin. For instance, if it costs $20 to make a widget and you want a 20% profit margin, you would charge $25. To put it another way, you would mark up production costs by 25%. This is also called markup pricing.
This pricing model isn’t ideal for SaaS companies as their products tend to provide significantly more value than the cost of producing them. Businesses that sell physical products tend to use cost-plus pricing the most.
With competitive pricing, you don’t consider the cost of production or consumer demand. Instead, you base your prices around the competition’s prices. You may select prices that are the same or lower than the competition, or you may price your offerings slightly higher in exchange for offering more value or better features.
Competitive pricing works best in highly saturated industries where consumers have a lot of choices between similar products.
Penetration pricing is when you start with a low price to attract customers, even if it initially loses your business money. Businesses pick this pricing model when they want to disrupt the current marketplace and take as many customers as possible from the competition. This option can be especially effective for startups, but it’s not sustainable.
Ultimately, once you build your customer base, you will likely need to raise prices to stay profitable. If you want to explore this option, you need to keep that caveat in mind while building your pricing models and profit projections.
Penetration pricing can work for nearly any industry, and it’s most appealing to businesses that are just getting started or are trying to break into a new market.
Your target market doesn’t necessarily want the lowest prices. Most often, they want value, and they’re willing to pay a high price for it. Premium pricing relies on the rule that the best price isn’t always the lowest price. It taps into the idea that solving a very specific problem better than anyone else allows you to charge a higher price.
SaaS businesses that use premium pricing often leverage their unique selling points to charge higher prices. This pricing model is very common in mid to late-stage SaaS companies who have achieved product market fit and have a competitively differentiated product offering.
In some cases, the most competitive price is $0. Offering free trials or basic versions of your product lets customers test out your offerings. Freemium pricing shows your customers what you can do for them, and it builds trust. Offering a free version also creates awareness of your product in the marketplace—this approach is most common among product-led SaaS companies.
Although it may seem counterintuitive, freemium pricing can greatly help to grow your market share and enhance your profitability. For instance, SaaS companies that offer a robust free product often recover their customer acquisition costs in about 75% of the time that it takes companies that don't offer free trials.
Freemium pricing also allows SaaS companies to build out their initial user base before executing cross-sell and upsell tactics. SaaS companies often use this strategy, but businesses across all kinds of industries often give up freebies as a marketing hook or in exchange for new customers as well.
Flat-rate pricing is a set price for access to your SaaS product. Customers pay a certain price for your service plus set amounts for any add-ons. The price itself is often influenced by the cost of providing the service, but it’s even more closely tied to the value of the service.
For example, business professionals such as attorneys and accountants often charge flat rates for different types of services, but SaaS companies that provide streaming services or different types of software providers also use flat rates on a subscription basis.
What is your customer willing to pay? How much value do they place on the service you are providing? Answering these questions is the most important part of a value-based pricing strategy. With this pricing model, you base your price on the value of your product to your customers, not on your production costs.
This requires you to study your target market very closely. You must get to know them to determine exactly how much they’re willing to pay. Businesses that use this pricing model could often choose to charge more, but they build loyalty by charging rates that align with their customer’s desires and expectations. The challenge of value-based pricing is that you have to be very in tune with your customers, and you must stay aware of changes in the marketplace.
This pricing model is ideal for a SaaS business that is tuned in to the needs of its customer base and is able to generate a significant ROI for their users.
The tiered pricing model uses different price points for different features or subscription levels. This allows you to provide unique offerings at different price points based on the needs of your target customers. It also builds inherent opportunities to upsell over time.
A new customer will often start on the lowest tier. This could even be a freemium offering. Then, once they need more functionality or a different set of features, they can just jump up a level. Your offerings take customers through various stages of the customer lifecycle.
SaaS companies often use tier pricing when creating their subscription pricing, but you also see this pricing model from companies that offer food delivery, cable TV services, and consumer goods.
This pricing model charges based on the number of users. Customers pay a set fee for every person that’s going to access the product. When determining the fee, businesses take into account cost, value, competition, and many of the other concepts discussed above.
Consumers like this model because they only have to pay for what they need. If they only have one active user, they pay a lot lower price than if they have multiple users. Businesses gravitate toward this model because it’s easier to calculate the target price. It’s also easier to make revenue predictions when compared to usage-based pricing.
Per-user pricing is very popular with software companies, but it’s also found at amusement parks, movies, and throughout the entertainment industry.
With usage-based pricing, the price depends on how much the customer consumes. The more they use or consume, the more they will pay. Customers often prefer this pricing model because it's linked directly to the value they’re receiving in return.
However, there are two main challenges with this pricing model. Ray Rike sums them up as:
Forecast management: “How does the vendor accurately predict the usage?”
Customer reaction to overuse: "When [the user] exceeds their projected usage levels and has not adequately budgeted for the actual usage levels."
If you adopt this model, you have to consider both of those elements as well as all of the other dynamic market factors that affect demand. Many software companies use this model, and it’s long been the standard for utility companies.
Considerations when selecting a pricing model
With so many pricing options, it can be hard to even know where to start. Ultimately, there is no one-size-fits-all solution. The best pricing strategy varies based on your business model and goals.
A small business providing consultancy services to a handful of clients, for example, may have a vastly different pricing structure than a manufacturer who sells millions of products to millions of people. Similarly, SaaS companies need to use a different pricing structure than companies that focus on tangible products or traditional services.
You also have to take into account your target market and look at what the competition is doing. In particular, you should consider the following in your decision-making process.
Buyer persona: Who is going to buy your product? What do they want? What are they willing to pay? Ideally, your product should solve a problem for your target buyer, and it should have a price point that appeals to their desire for value, luxury, or other intangibles.
Competitor pricing: Even if you don’t use a competitive pricing model, you should research your competitors’ prices. Then, look behind cost and think about the elements that differentiate you from the competition.
Messaging: Your messaging shapes how your customers interpret your prices, and it can be even more important than the actual price itself. According to Bryan Belanger, "Any consternation on these types of [pricing] changes is largely due to the rollout messaging, not the actual changes."
Should you choose a basic markup strategy for your products? Should you choose a flat rate for your services? Should you embrace tiered pricing for your SaaS pricing models? Choosing the right template can be challenging.
You need to look at the competition and think about what your target market expects, but then, in some cases, you may want to disrupt expectations or offer something better than the current trend. To strike the right balance, you need a partner that allows you to offer various pricing models based on your needs.
Pricing models in summary
There are all kinds of different pricing models. Some are closely based on your production costs, the prices your competition use, or the value perceived by your customer base. Others are tied to objectives. For instance, penetration pricing helps you break into a market, while the freemium pricing model helps you build your customer base by proving value early on in the user relationship.
There are also different ways to assess prices based on how people access your products and services. You may charge a flat rate, a per-user rate, or a rate based on usage. You may also charge different prices for different tiers or levels of features or services.
To hone in on the optimal prices, you need to develop a pricing strategy based on your business goals. Then, you need to select a pricing model that supports your strategy, and you need to identify metrics that allow you to assess if you have reached your goals.
This process requires you to assess multiple elements both inside and outside your business. Then, of course, you have to reassess, adapt, and fine-tune constantly. On top of all that, you need to develop a brand image that supports your pricing model and develop messaging to bring it all together.
That can be a lot, but we’re here to help. At Maxio, we bring order to financial chaos. We help you offer your customers an optimal pricing model at price points that are just right. We can also help you automate your billing, subscription management, collections, and reporting.
We provide financial operations solutions for SaaS companies so that they can focus on what's important—scaling their business. To provide the best services possible to our clients, we always stay up to date on the latest trends and best practices in this space.
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