How do you set your subscription pricing?
You might look at your competitors’ prices and set yours similarly. Perhaps you’re working out your costs and adding a little margin. Maybe you’re just going with your gut.
All these approaches can work — but all of them leave money on the table. The most profitable pricing strategies put customer value front and center, are driven by data, and match your customers’ purchasing and usage habits. And they’re certainly not pulled out of thin air.
This article will show how you can maximize monetization and retention for your recurring revenue business. It’ll walk through why subscription is so hard, outline a few common strategies and subscription models for setting your pricing, and explain why value-based pricing should be your only pricing model of choice.
What is subscription pricing?
Subscription pricing is different than pricing for traditional products. Instead of paying upfront, customers pay recurring amounts on a regular schedule (usually monthly) in exchange for access to your product.
Since payments are small and spread out over time, subscription businesses need to optimize their pricing for both revenue and retention.
What companies get wrong about subscription pricing
Deciding how much to charge your customers shouldn’t be taken lightly, and yet many companies simply don’t give it enough thought. In fact, companies spend an average of only ten hours each year on their pricing.
This happens for a number of reasons, such as pressure to acquire new customers instead of optimizing the value of those they already have, a lack of knowledge on how to price, failure to invest in collecting customer data, and many more.
But even if you spend double that amount of time on your pricing strategy, if you’re not also avoiding the following mistakes, you could be charging less than you should.
Basing pricing on instinct or “gut feel” over data
When you’re just starting out, you might look to competitors’ pricing strategies— or worse, you might just guess — where your subscription pricing should start. But as you begin quantifying your ideal customers, you’ll understand what they truly value in your product, and what they’re willing to pay for it.
Data needs to be at the heart of every pricing decision you make. Failing to base your subscription pricing on hard data could lead you to overprice or underprice your product or services.
Updating pricing = higher revenue
Price points that work well in the early days of your subscription business often end up underpricing your product over time. As your product or service improves over time, you should vary your pricing to track the value you provide. Failing to revisit your pricing regularly can only hurt your bottom line.
The data backs this up: Companies who regularly revisit and update their pricing every six months see nearly double the average revenue per user (ARPU) gain over those who update their pricing only once a year or longer.
4 types of subscription pricing models
Each of the four common pricing models for subscription companies scales according to different factors. And each works best in different situations.
Choosing the right model can make or break your subscription business.
1. Fixed / flat-rate pricing model
Fixed pricing stays simple: a single product, a fixed set of features, and a fixed price per month.
Basecamp offers flat-rate pricing on their project management software.
Flat-rate pricing is easier to communicate and easier to sell. Adding valuable features? Raise your rate. Additional products? The fixed price goes on top of your base fixed rate.
But while flat-rate subscription pricing might be easy for potential customers to understand, it often means leaving money on the table. Keeping prices low means missing out on additional revenue from larger companies; and vice-versa, smaller companies might be priced out of higher-cost tools.
2. Tiered pricing model
Tiered pricing allows companies to offer multiple packages with different features and product combinations available at different price points. The number of packages can vary, but most subscription companies offer two or three tiers.
Sprout Social’s tiered pricing model offers different combinations of features across their three packages.
Social media management tool Sprout Social designs their tiers around the needs of different customers, whether they’re professionals who need “essential tools” or companies looking for advanced tools “at scale.” By catering to multiple buyer personas at multiple price points, Sprout Social is able to maximize how much revenue they can extract from each different customer, while also providing an easy upsell opportunity as companies outgrow each tier.
Beyond two or three options, however, things start to go downhill—offering too many choices leads to indecision and lower sales. It’s easy to try appealing to many customer types with varying budgets by adding more and more tiers, leading to lack of decision and lost sales.
3. Per unit/user model
Per-user pricing is the go-to model for the majority of subscription companies. Pricing scales evenly along with the number of users — the more users, the more you can charge.
Buffer prices each tier of their social media management tool by the number of users.
Per-user pricing is easy for potential buyers to understand, simplifying the sales process. It also makes forecasting revenue straightforward, since revenue scales in direct proportion to the number of users.
Charging for each new user does have downsides, though. It doesn’t reflect the true value your product provides — more seats doesn’t necessarily make the product more valuable for users. Charging per seat can also lead to users sharing logins across teams, cutting into your potential revenue.
4. Usage model
Usage-based pricing is somewhat less common among SaaS businesses— it’s mainly used by telecommunications companies and IT services. Users are charged based on how much of a product or service they consume: download 4GB of data in a month, for example, and you’ll be charged for exactly 4GB. Download 5GB next month, and you’ll be charged more.
Data enrichment tool Clearbit charges based on the number of API requests each month.
Tying pricing to usage makes it easier for small companies to get started with your product while avoiding the high upfront fees charged by some subscription companies. On the other end of the scale, it also accounts for additional costs incurred by heavy users, charging them fairly based on the extra time and resources they’re consuming. Charging based on usage does, however, make it much harder to predict revenue, since billing can vary dramatically each month.
What to consider when choosing a pricing model
Different situations call for different pricing models. Ask yourself these questions when choosing a pricing model for your recurring revenue business:
- What are your fixed and variable costs? Work out how much it costs you to deliver the base value to the customer. This includes all your operating costs like payroll and benefits, office space, hosting fees, software and tools, merchant fees, and taxes. Next, add in any variable costs, like advertising fees, travel, contract labor, and other miscellaneous services.
The proportion of fixed versus variable costs should also guide your pricing model decision. For example, if you’re charging all customers a fixed price, yet they use resources that fluctuate significantly across different users, you may want to have a usage model for your subscription pricing.
- Who are your customers? Are your customers using your software for business or leisure? Do they prefer paying up-front or spreading payments over time? Do they value simplicity or choice when making product decisions? How much are they willing and able to spend on your product? Match each tier’s pricing and feature set to your primary customer segments, instead of simply choosing tiers based on which features you want to include.
- How does your competition price their products? This should NEVER be the only pricing strategy you use, but it’s important to know your playing field. Your customers will benchmark your own pricing model against your competitors — but there’s no way of knowing the effectiveness of your competitors’ chosen model.
3 popular pricing strategies
Your subscription pricing model provides the framework for how you’ll charge customers for your product — but it doesn’t cover how much you’ll actually be charging. For that, you’ll need to define a pricing strategy.
To help you come up with your own subscription pricing strategy, below are three common strategies subscription companies use to define their pricing: cost-plus pricing, competitor-based pricing, and value-based pricing. You’ll see why value-based pricing is the strategy you should use in your own recurring revenue business.
Cost-plus pricing is the most simple approach to setting your prices. Sum up all the fixed and variable costs of doing business, add a percentage margin (around 20%), and set that as the price for your product.
This strategy requires very little market research — assuming you have a handle on your costs, it’s easy to work out your price. You’re also guaranteed that you’ll be covering your costs.
Cost-plus pricing definitely isn’t a home run, though. Think of pricing like a dartboard — you might be aiming for the bull’s-eye, but cost-plus pricing still means you’re hitting all across the board.
Cost-plus pricing is a good starting point for subscription pricing, but there’s still plenty of room for improvement.
That’s because basing your pricing on cost ignores the perceived value of your product, and how much customers are willing to pay. Customers don’t care about your costs — they care about how much value you can provide.
It’s good to understand your costs to help define your absolute lower bound for pricing — but cost-plus pricing is virtually never the right strategy.
Competitor-based pricing involves looking at the prices set by competing businesses in the same sector, raising prices or perhaps discounting a little to account for the value of your product, and then adopting those prices for your own business.
This can be a reasonable approach for companies starting out with a new product, or moving into a new industry. You’re unsure of the initial value your product provides, and you don’t want to completely miss your target, so you look at what everyone else is doing.
Competitor-based subscription pricing can get you pretty close, but you’ll still forever be undercharging.
It’s a simple approach, and one that can get you pretty close — but it also means your following their pricing strategy, not yours. You’re no doubt offering a better product that provides more value to your customers — but tying your pricing to your competition means you’re unable to realize that extra value in your pricing. You’ll find yourself forever undercharging customers who are willing and able to pay more.
Instead of looking inward to your own company costs, or laterally toward your competitor’s pricing, value-based pricing looks outward towards the people who ultimately decide the right price for your product: your customers.
Value-based pricing strategies utilize customer data on the overall value of your product, as well as breakdowns of the relative value of individual features, to set your pricing. This means getting out of the office, and doing the hard work of asking customers what they’ll actually pay for your product. Tying price to value also incentivizes you to provide more value by developing new features and improving your service.
Value-based pricing is the undeniable king of subscription strategies, getting you closest to optimal pricing.
The downside? All this research takes time. You need to be dedicated to finding out more about your customers and your product to properly understand the value you provide. The end result, though, is a price that’s much closer to the truth, and a price that maximizes your chances of profitability and sustainability.
Even after you’ve chosen a subscription pricing model and a strategy for setting your prices, there’s still room to enhance your pricing.
- If you’re using a tiered pricing model, make sure your offerings match your users’ needs, not your own. Many companies only offer two tiers: cheap and useless, or expensive and overpowered, neither of which is remotely valuable to buyers.
- If your resources are being drained, try a usage model. But remember that it’s more convenient for you, not for your customer.
- Upsell and cross-sell when needed. It doesn’t have to be automated, too. If your customers seem to be hitting a wall in their basic plan, send them a personal email or chat to show them your premium offerings may hold up better.
- Always choose value-based pricing. If you’re still setting your pricing based on your competitors or your costs, your product will be completely off-value from where it needs to be.
Almost every recurring revenue business can benefit from pricing around value. By finding out what’s important to your customers, aligning that to value metrics, and building your pricing around those metrics, you can maximize monetization and retention, while creating better and more competitive products for your customers.
The most common subscription pricing models, and the only one you should be using
PS. Don’t treat freemium as a pricing model. It’s a lead generation model, and it usually does more harm than to good in terms of extracting maximum value. It can be good at the beginning, to gain traction and scale, but further down the line it limits your potential.