SaaS Business

SaaS Pricing Models: The Rundown

October 10, 2019

Buying products today is easier than ever thanks to software-as-a-service (SaaS) – but if you're a SaaS business, what pricing models should you be looking out for and emulating to ensure the best change of success for your company?

SaaS companies normally use a subscription model where customers pay for the service over a set period and as a result, receive a particular service for as long as they're paying the fee. 

Originally used by the publishing industry for sales of magazines and newspapers, the SaaS subscription model is now used effectively in a large number of business sectors as a means of offering subscription services to users.

These might include utilities – the model is effectively used by mobile phone and internet providers, as an example – as well as in day to day situations such as a gym membership, app subscription or Netflix subscription.

Netflix operates on a simple SaaS pricing model

As a subscription-based lifestyle becomes increasingly more popular, customers increasingly choose to pay for monthly subscriptions to lifestyle items such as beauty products and nutritional products such as meal plans and diet supplements.

As far as range and variety are concerned, we're only just starting to see the potential of the SaaS model.

As a buyer, there are both advantages and disadvantages to SaaS and there are multiple ways that businesses choose to apply their particular breed of SaaS pricing model.

Understanding the most profitable ways of applying the model is an important step to running a successful SaaS business – to do this effectively, it’s well worth observing how other successful companies choose to apply the model.

We will look more specifically into successful examples of how SaaS is used effectively in business plans further down this article. 

Advantages of a SaaS subscription model

From a business perspective, a SaaS subscription model gives unparalleled peace of mind with regards to a steady flow of income – you know how many people have subscribed to which plan and therefore have an understanding of exactly how much money you are expecting to bring in each month.

In a good business, this is also true for changes to revenue – run a SaaS business for long enough, and you'll develop a strong sense of how many people you're expecting to join and leave it in a given month.

If you're selling physical goods rather than digital services It also makes inventory much easier to manage, and if you provide a service where you have to send products out to customers, you always know exactly how much and how many are going to be leaving your site in any one week, month or year.

In technology, we many SaaS businesses are being built, SaaS and cloud are almost interchangeable nowadays – and so a key selling point for the SaaS model is that the service, whatever it may be, is hosted on a web-server and then made available to customers over the internet.

This ease of access means that it can be accessed from wherever the customer may be, assuming they have an active internet connection. Generally, the application or service is managed and controlled from a single, central location – sole responsibility for the service is on the provider, this includes the care of the software itself, hardware and any security processes that may need to be put in place. This makes upgrades, enhancements, bug fixes etc much easier and faster.

From a customer’s perspective, the process is also advantageous.

As the software application has already been specifically installed and configured to the business’ requirements, if you as a customer decide to purchase a subscription, in whatever form, you are simply required to register and provide basic pieces of information (such as your name, contact details, and bank account details) before you can get going with using the service.

As it’s such an easy process, it won’t be long before you’re up and away and the customer isn’t expected to invest large amounts of money on the software – if it doesn’t work for you, depending on the subscription choice you went with, then you are able to cancel and invest elsewhere.

On the flipside, if you invest in a service that works well for you, there are likely opportunities for you to upgrade your subscription directly through the SaaS seller. 

What is a pricing model?

When we talk about pricing models in this article, we're talking about a structure in which prices are set within a market for a specific service.

Models usually vary based on the supply and demand of the service in the market and the reputation of the company, and for a SaaS business, your pricing model will be at its core.

It sets the structure for how you will generate revenue and the future growth and expansion of the company – with the wrong pricing model framework, your growth will be limited, as well as your ability to attract customers.

Aside from different pricing models, there are also different pricing strategies to consider – your pricing model ma well leverage a pricing strategy as an advantage for users or a pricing differentiator.

Some of the most popular pricing strategies include…

Captive pricing

Captive pricing derives its name from offering a free or captivating offer, and then increasing your pricing based on adding additional products or features to your original offering. An example of this would be software company Adobe, as the company offers versions of their old software for free but encourages users to purchase new software by enticing them with new features.

Penetration pricing

This strategy is often used in new or emerging markets and involves a company deliberately lowering their prices to penetrate a new market. Over time the company will then offer upgrades with increased prices to their existing customer base.

Luxury pricing

Sometimes referred to as the prestige pricing strategy, luxury pricing involves a company purposely offering high, fixed pricing to convey a sense of luxury and quality. This strategy is often used in niche markets that have the capital to favor quality over price. 

The iPhone is an example of a blended luxury and promotional pricing model.

Promotional pricing

Promotional pricing is often used by companies such as Apple who begin by offering their products or services at a premium price but then reduce, or skim, their prices when they bring another product or service to market. For example, the price of an iPhone dramatically decreases when a new iPhone model is released. This strategy is popular as it attracts more premium businesses when the price is high and eventually caters to smaller or more budget-bound businesses.

Cost-plus pricing

Many SaaS companies adopt cost-plus pricing as a starting point of their sales strategy. The strategy involves calculating the overall expenditure to create, design and produce the product or service and adding a target profit margin to create a price for a product. However, businesses opting to use this strategy must take into account competitor pricing and ensure they are not being too optimistic with their target profit margin.

How should I price my SaaS service? 

Pricing plans are probably one of the most important factors when building your SaaS business – yet there is often a lack of understanding of how important pricing your service effectively is. If you overcharge for your service, you will see a lack of growth and interest in your services whilst undercharging means you’ll cripple yourself and your business development. 

The simplest way to sell a SaaS service is through flat-rate pricing.

Flat-rate pricing involves offering a single product for a single price. The flat-rate pricing model is renowned for being quite similar to a software license – but has the added benefit of being paid for on a monthly basis, making it much more appealing to the customer.

Not a particularly over-popular choice generally speaking, as far as pricing models are concerned, a good example of where the practice is effectively used is CartHook or, where a single price-plan is offered. Everyone is offered exactly the same service and pays exactly the same monthly price for this service. 

Advantages of the pricing model include it being much easier to sell – you’re able to focus all of your attention on marketing the product in its best light, highlighting a clear-defined and definitive product to your customers.

A flat rate price also makes it much easier for the customer to understand – they will be able to see exactly what they’re getting for their money and won’t have to spend time deciphering the benefits of a particular price-plan.

Many startups use a tiered pricing model

At the same time, flat-rate pricing models can be detrimental to your business – having a single price means you have one single opportunity to attract a new customer – if for whatever reason the price and what you are offering doesn’t meet their requirements, they will likely move their business elsewhere. 

What is a tiered SaaS pricing model?

Tiered pricing models are arguably the most effective models for SaaS businesses – and it’s fair to say that they are used by the vast majority of companies.

Tiered pricing allows businesses to offer multiple pricing packages to their clientele, giving them a choice of both features and price plans that adhere entirely to their needs. Most companies offer at least three packages to choose from, each with different features that separate one package from the next. 

Each pricing tier is specifically designed around the needs of the potential customer – it targets customers based on their budget and their specific product needs.

The customer who wants to have all of the benefits of subscribing will naturally pay more in terms of a monthly subscription fee whilst the customer who wants the basics will naturally pay a smaller subscription fee.

One of the benefits of offering tiered SaaS models is that it allows you to promote your services and appeal to as many different potential customers as possible. With a single price plan, you only have one opportunity to attract and secure custom – this is not the case as far as tiered pricing is concerned. You are able to specifically tailor your package options to appeal to as many customers as you deem appropriate. 

Understanding your customer base is important – and no customer is the same as the next. Whilst some customers would be more than willing to pay $25 a month for a particular service, others may be less inclined to do so – having a single price for your service not only out-prices those who don’t want to pay $25 a month, it also undercharges those who have a much more significant budget and are willing to pay for additional features.

Giving your customers the opportunity to weigh up the benefits of each package and work out where they fall on the spectrum also gives them a route to be upsold – if your customer finds that their current package isn’t working for them anymore, then there is an opportunity for them to upgrade their service to the next price point if they need to.

What other SaaS pricing models are available on the market?

Pay per use pricing model

This is a model adopted by many companies who operate through recurring billing platforms. The model works by varying its price depending on how many people are using the service. In simple terms, if a user uses more of a service, they will pay more.

Although this is a very common pricing model, it has its flaws – a pay per user model makes calculating revenue and customer costs more difficult. On the other hand, other businesses find the ability to scale and correlate price and use extremely helpful. 

User-based (or seat-based) pricing model

Many businesses favor a user-based pricing model for its simplicity. As the name suggests, the model works by increasing its cost every time another user (in large organizations, a user is often termed a 'seat') is added to it.

For example, if a company uses physical licensing software and they add another employee, in a user-based pricing model, the price will increase. This model is popular because its simplicity makes calculating monthly costs easy.

Pay per active user model

To address some of the limitations raised about the above user-based pricing model, some SaaS businesses instead opt for a pay per active user model. With a pay per active user model businesses can sign up as many employees as possible but will only be charged if an employee actually uses the platform. 

Pay per feature pricing 

The pay per feature model contains a pricing tier that either increases or decreases depending on the features a user wishes to use. For example, SaaS that comes in a pricing structure of basic, premium and deluxe can be seen to be presented as a pay per feature model.

This model can be quite successful as it encourages the user to upgrade their current usage. However, this price model can also be considered quite risky as it is hard to determine exactly what features users are willing to pay extra for.

Freemium SaaS model

A Freemium SaaS model, made popular by use from companies such as Dropbox and Evernote, involves offering free usage of a product or platform at an entry-level, that can be upgraded for a specific price. Upgrades are often required if a user wishes to improve their features and usage capabilities.

Many businesses have begun offering this pricing model as the free service attracts users. However, this can also be considered a business limitation as some users will work to keep within the free price range and avoid paying for the service.

Create your own pricing model

A create your own pricing model can be seen to address some of the concerns raised with featured based pricing models. Instead of selecting which pricing tier is most suited to them, with a create your own pricing model a user selects which features they wish to have and customize their own package. The price will then be calculated based on what features they have chosen.

This pricing model is often favored by start-ups of small businesses that do not have the standard needs of larger businesses. However, it may lead to extremely complex pricing models, such as those seen in organizations such as Intercom.

Free SaaS with alternative revenues

One pricing model some businesses consider is offering a free service, and instead, selling advertising space on their website and platform. For example, Wave Accounting offers free small business accounting software but runs advertisements on its webpage for relevant accounting products and services.

This may not be the most financially lucrative pricing model but it helps build customer interest and loyalty. Businesses can also start to offer users an ad-free service if they wish, similar to a freemium or pay per feature pricing model.

Which pricing model is right for my business?

As indicated above, there is no one-size-fits-all solution or answer to the question of which pricing model is correct for your SaaS business. Before you decide what pricing model to use it is important you establish what industries you are trying to attract and your market position. For example, some important thing to consider include…

• How many customers do you wish to attract? For example, if you are targeting a niche target market a pay per user model may not be the most financially beneficial model for you.

• How long is the lifespan of your product/service? If your service is only required to be used once by most businesses offering a freemium pricing model would limit your chances of financial growth as if your customers are not returning to pay for your service, you won't receive an incoming cash flow.

• Are you targeting individuals, SMEs or large businesses? Pricing structures such as pay per user or pay per active user would only be beneficial for large companies.

• Are there potential layers to your service? Models such as the pay per feature model are only a realistic option for businesses that have multiple features and layers of service to offer.

• How many competitors do you have? If you are entering a fairly saturated market offering a freemium service may help bring new customers to you and help you make a mark in a potentially crowded industry.