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Every SaaS business must to decide how to charge for the service. Pricing plans are some of the most difficult decisions to make. Equally important to the price is determining the point at which the customer pays – the conversion point.

There are a few different models that seem to work: up front payment, freemium, limited free trials, money back guarantee. Picking the right one depends on a number of different factors. Below is a table that summarizes what I’ve seen work at various companies.

Pricing Model Value Proposition Product Complexity End User is Buyer Avg Seat Value
Freemium Increases with time Simple Yes or No Low
Limited Free Trial Increases with time Complex Yes Low/Medium
Up Front Payment Immediate Simple Yes High
Money Back Guarantee Immediate Complex Yes High

Freemium

Freemium is a strategy for products whose value proposition is simply conveyed and whose value increases with time. Evernote’s value compounds with the data the user enters into the database. Expensify’s utility increases with the number of expense reporters on the system.

Freemium businesses must target markets with very large user bases because the conversion to paid rates vary between 2 to 4%. To drive $50M in annual revenue at that conversion rate and $100/year subscription, you would need 17M users.

Sometimes, the end users are buyers (typically in consumer services). Other times (for enterprise customers), end users are sales prequalifiiers. Given enough users of a product in an organization, the enterprise can be upsold to a company wide license. Freemium distribution enables a company to acquire those users inexpensively.

Limited Free Trial

The main difference between freemium and trial products is product complexity: trial products are more complex and need time for the user to gain a deeper understanding of the value. CRM tools like Salesforce and 37Signal’s HighRise both use limited trials. The goal with these marketing mechanisms is to drive customers to explore the product for a brief period of time and then force a conversion. Allow too much time to pass and the customer will forget the value proposition. LFT is also present in gamiing. In a shift away from freemium, Zynga moved in this direction with several of their more sophisticated games, requiring users to pay to advance in the game.

These kinds of products tend to require significant user behavior change so these products must market a promise and then use the conversion to paid event to enforce that behavior change (carrot + stick).  Because of the behavior change, these products are marketed to decision makers who select the software for their teams: product managers, tech leads and heads of sales. Many of the tests I’ve seen have indicated shorter trial periods are better: 7 days is better than 14 days is better than 30 days.

Up Front Payment

To pursue up front payment, you need an established brand with a clear value proposition and you sell the product to the end-user. Adobe’s Creative Suite is a canonical example. Customers know what the software can do and if they need it, customers will pay for it. The same is true for AutoCad, MS Office, and operating systems. Most of these products are high cost per seat products. Because they are well-known in the market, they command a price premium.

Money Back Guarantee

For products lacking an established brand, but offering an immediate value proposition and charging a high average seat value, there is no better solution than the money back guarantee. It mitigates the customers commitment phobia but establishes a billing relationship at the outset. This pricing strategy requires contact with a sales or account management team which implies a higher cost of sales. Ideally, higher conversion rates mitigate these costs. In other words, the up front commitment is a sales pre-qualifier. Your sales team will have fewer, higher quality leads. Plus, your sales team will have direct product feedback to share with product.  Oracle offers this for many of their products as do Eloqua.

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13 thoughts on “Your Startup’s Pricing Strategy

  1. @Tom: Excellent piece. Pricing Plans are indeed incredibly difficult. I really liked how you emphasized Conversion Point as well. Realizing the two are distinct entities are crucial to clarity of purpose.

    Another pricing plan could be called “Free to Play”. The idea being no cost to entry with X amount of free tokens. Then payments for every x amount of tokens thereafter.

    But maybe that already fits into the “Freemium” dichotomy. Thoughts?

  2. I’ve been toying with the idea of letting our customers pick their own price, aka the RadioHead pricing model. What are you thought on that model and how does that figure into your table?

    • That is one I hadn’t considered. Priceline and eBay are examples. But I think they would fit into the up front cost model.

      It seems to me there is a category of market places which have fixed fees despite variable prices and then companies. Are there other examples where such models exist?

    • @Chris: That’s actually a really good idea. I’d give it a shot and see what happens. We’ve done this in the past and, at the very least, you’ll gain some valuable insight into the behavior of your product’s core customer. The hardest part will be committing to a specific time period so you can get the data you need.

      I’ve also seen the Pay What You Want strategy executed by the folks at The Humble Indie Bundle with tremendous results. Definitely give it some thought.

      • I honestly don’t know of any SaaS based companies doing this. It seems to me, you do this for a period of time to drive some engagement, lower barriers while realizing some revenue. But at the very least it removes the questions about pricing being too high or too low and sort of plays the role of customer development as far as pricing goes. I’m still on the fence about it myself.

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