Did you know that the average SaaS founder spends just six hours defining the company’s pricing model? Despite it being one of the main drivers of revenue1. Founders often choose pricing just by looking at their competitors and then call it a day. But figuring out your startup’s pricing model is an intricate process that requires just as much consideration as your product roadmap, target audience, and marketing strategy.
Still not convinced? Patrick Campbell, CEO of ProfitWell, shared that pricing is “four times as efficient in improving revenue as acquisition and two times as efficient as improving retention.”2 Selecting a pricing model shouldn’t be a one-and-done task. Revisiting your pricing strategy several times a year will allow you to optimize or overhaul it to grow your recurring revenue. A one percent improvement in price optimization can boost profits by over 11 percent on average3.
So, how do you determine the monetization model for your SaaS business? To get you started, we’ve outlined the best SaaS pricing models to help grow your recurring revenue along with the pros and cons of each.
1. Freemium Pricing Model
Over the past decade, freemium – a combination of “free” and “premium” – has become an increasingly popular pricing model among online businesses and app developers. The freemium pricing model gives people a taste of your product. By lowering the barrier to entry, customers can try out basic features and then upgrade to the paid version when they want all the features.
Your free version can be ad-supported, too, making you money without charging customers. Free features also attract prospects without expensive marketing and sales campaigns.
According to Harvard Business Review, freemium is more successful than 30-day free trials or other limited-time offers because customers have grown wary of difficult cancellation processes and find unlimited free access more compelling. While the freemium model draws in a big crowd, the average conversion rate typically falls between 2-5%4.
Example of the Freemium Pricing Model
Spotify uses a freemium revenue model that offers a basic, ad-supported service for free and an unlimited premium service for a subscription fee. Spotify attracts new signups with its free version where customers can enjoy music but can’t download or listen to it ad-free.
In 2021, Spotify generated €9.66 billion. Of this revenue, 87.5 percent (or €8.46 billion) came from premium memberships, while over 12.5 percent (or €1.2 billion) came from ad-supported members5. The primary goal of its ad-supported model is to enhance Spotify’s adoption and create a funnel that leads free users into the premium subscription.
Pros of the Freemium Pricing Model
- Low customer acquisition costs
- Lower barrier to entry
- Faster product adoption
- An ad-supported model can generate revenue from free users.
- It’s a good playground for experimenting with new features.
- Free features are a potent marketing tool.
Cons of the Freemium Pricing Model
- Conversion rates from free to paying customers are very low.
- Free users still require customer support without paying for services.
- High churn rates
- You need lots of customers to generate sustainable revenue.
2. Usage-Based Pricing Model
The usage-based pricing model allows your customer to start using your product or service at a low cost and increase their commitment as their needs grow. Since the threshold to entry is low, your software might appeal to freelancers, contractors, small businesses, and other startups – as well as larger companies with bigger budgets.
It’s easy to monetize a customer over time because the price is directly tied to the value they receive. And since you aren’t limiting the number of users who can access the software, customers can find new use cases for the product, which leads to more long-term success and higher lifetime value.
Example of the Usage-Based Pricing Model
HubSpot is a great example of the usage-based pricing model. For the first five years in business, Hubspot offered three subscription packages that ranged in price. Customer churn was high, and the company struggled to expand its revenue.
In 2011, they deployed usage-based pricing. Now, customers proportionally increase their spending with HubSpot as they generate more leads through its software. This change in pricing strategy caused a jump in HubSpot’s net revenue retention rate from 70 percent (in 2011) to nearly 100 percent (in 2014)6.
Pros of the Usage-Based Pricing Model
- Easily Acquire low-usage customers and grow with their needs
- Opens a wider range of audiences.
- Better flexibility means lower churn.
- You charge heavy users appropriately for the services they’re using.
Cons of the Usage-Based Pricing Model
- Complicated to set up this pricing model correctly
- Longer sales cycle if customers are unsure about their usage requirements
- You’re forcing your customers to do the math, so you risk losing them.
- Expenses and revenue fluctuate monthly, so it’s harder to predict revenue.
3. Per-User Pricing Model
The per-user, or per-seat, pricing model allows customers to pay for each person that uses the software. Pacific Crest’s survey found that per-user pricing was the most popular pricing model used by SaaS companies7.
Why is it so popular? Because it’s simple for both the customer and the SaaS company. It’s easy to understand and implement: A user pays a fixed monthly price, and if you add a second user, the cost doubles, and so on. The per-user cost usually includes all the features, and your customers only have to decide on the total number of users.
Example of the Per-User Pricing Model
Adobe offers apps like Photoshop, Illustrator, and InDesign on a per-license basis. One license will allow one user to access apps in the Adobe Creative Suite.
In fact, before SaaS business models became popular, Adobe led the pack by making a then-radical pivot from boxed-licensed software to a monthly subscription model in 20138. Product pricing went from a one-time cost (of $1,300 to $2,600) to a monthly subscription (ranging from $9.99 to $79.99) for all the apps in the Creative Cloud. Instead of paying a huge upfront amount, creatives could afford to pay for a single license at a lower monthly subscription fee.
Pros of the Per-User Pricing Model
- One of the simplest, most-direct pricing models
- Easy to manage and predict revenue
- Revenue scales with product adoption.
- All customers get access to all the product features.
Cons of the Per-User Pricing Model
- It limits adoption, as you provide a reason to avoid adding new users to the tool.
- Susceptible to high churn rate, because customers don’t want to pay for unnecessary users
- Incentivizes customers to cheat the system by having multiple users log in through the same account.
4. Flat-Rate Pricing Model
This one-size-fits-all pricing model eliminates any billing confusion: You charge all customers the same amount regardless of usage, users, or features. One of the most strategic ways to implement flat-rate billing is to apply it when you’re targeting one buyer persona or a niche demographic. If you serve multiple target audiences, you won’t be able to please everyone with a flat price.
Example of the Flat-Rate Pricing Model
YouTube charges a monthly flat fee of $11.99 for YouTube Premium, offering ad-free access to its content. However, they offer discounts for specific audiences, such as students and families. These limited discounts target audiences that can’t afford the basic flat rate now but will ultimately grow out of their current situation (younger children and students, for example).
Pros of the Flat-Rate Pricing Model
- Clear value offering, simple to understand
- More accurate revenue projections
- Easier to market as you’re only conveying one price point
Cons of the Flat-Rate Pricing Model
- Off-putting to customers who want custom options
- Lack of choice may lead to fewer customers.
- No opportunities to upsell
- Scaling is harder because your flat rate price will only appeal to a specific market.
5. Tiered Pricing Model
The tiered pricing model is one of the most common billing models used by SaaS companies. Each tier or plan comes at a fixed monthly price. It brings flexibility to your software’s offering, allowing customers to level up as they need it. The most significant advantage of tiered pricing is your ability to upsell customers from one tier to the next.
Example of the Tiered Pricing Model
Netflix has a well-known tiered pricing model that charges on the number of devices subscribers use to stream its content. But the streaming giant is also notorious for price rises that either result in huge subscriber losses or big hikes in revenue.
One of their wins: In 2017, Netflix raised the prices of its monthly plans by 10 percent. Unexpectedly, this did not stunt subscriber growth and ended up being a huge success. Netflix added 2 million new subscribers in the US and 6.4 million overseas. Both new and existing customers had no problem accepting the price increase, lifting Netflix’s revenue by 35%9.
Customers respond better to price increases when they have options. In Netflix’s case, they increased the price of the Standard Plan but kept their Basic plan the same. A budget-conscious person could downgrade if they couldn’t afford the price increase of their current plan.
Pros of the Tiered Pricing Model
- Scale with customers as they grow.
- Easier to increase revenue through upselling to a higher tier
- Meet the needs and budgets of different customer personas.
- Each tier can appeal to a different target audience.
Cons of the Tiered Pricing Model
- Users may pick the wrong tier resulting in a high churn rate.
- Customers feel confused by too many tiers and options.
- Risk of adding too many features just to fill each tier
6. Feature-Based Pricing Model
Feature-based pricing allows you to price your services and products based on varying levels of functionality. While used often in the SaaS industry, this pricing model is also prevalent in everyday life, as we logically pay a higher price for more functionality (think laptops, gym memberships, and courses). You tie the price directly to the value you offer customers.
As mentioned before, you might pair feature-based and tiered pricing , where each tier opens more features at a higher cost. Customers scale along with your product as they expand, needing new solutions to their problems during growth stages.
Example of the Feature-Based Pricing Model
Wix, the popular website builder, is a great example of feature-based pricing. Wix offers seven tiers (four for individual use, three for business use), each with unique features.
Customers receive more features at every level, including a website domain, storage space, a professional logo, and customer care. For example, a novice freelance writer only needs the basic website plan. But as their writing business grows, they’ll want to access more professional features.
Pros of the Feature-Based Pricing Model
- Upselling is more natural as there is a clear benefit in upgrading.
- Customers can use basic features as a trial without investing a lot of money.
- Easy-to-understand pricing
- Ideal for hybrid pricing strategies
Cons of the Feature-Based Pricing Model
- Challenging to divide features into tiers while incentivizing upgrades
- Customers may resent that they don’t have access to important features despite paying a monthly fee.
- Companies may build redundant features just to offer more functionality in each tier.
Choosing the Right SaaS Pricing Model for Your Startup
One of the exciting opportunities of SaaS is that you can stand out in the market by thinking differently about pricing. And you don’t have to pick just one of the above options – many SaaS companies blend pricing strategies to best serve their customers and increase their recurring revenue.
Look at Canva, the online graphic design tool. Canva combines three different pricing models: feature-based, freemium, and tiered pricing. The tiers of its feature-based model solve additional graphic design challenges for its customers. Canva’s first tier is free to use, while the pro plans give you access to premium stock photos, templates, brand kits, cloud storage, and more editing options. As its customers’ needs expand, they upgrade to the next tier to take full advantage of Canva’s software.
Now, it’s time to get creative with your SaaS pricing model!
The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before entering into any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.