The ultimate guide to SaaS pricing

In this guide, I'm going to help you understand everything you need to know about different SaaS pricing models and strategies, and how to determine the right one for your business. Whether you're just starting out or looking to optimize your current pricing model, this guide will provide you with the information and tools needed to succeed in the 2023 SaaS market.

What Are SaaS Pricing Models?

When it comes to SaaS pricing, it can sometimes feel like you're stuck between a rock and a hard place. On one hand, you need to charge enough to cover your costs and make a profit. On the other hand, you don't want to price yourself out of the market and lose potential customers. The good news is that there are several SaaS pricing models available to help identify the right pricing model for your business.

The three primary models are:

Cost Based Pricing: A methodology that is based on the cost of developing, designing, and selling a software product. The price of a SaaS product is determined by adding a percentage of the creation and selling costs to the selling price to make a profit.

Market Based Pricing: A methodology when the price of a SaaS product is set according to current market prices for the same or similar SaaS products.

Value Based Pricing: A methodology setting prices primarily based on a consumer's perceived value of a SaaS product or service. Value-based pricing is more customer-focused, meaning SaaS companies base their pricing on how much they think customers will pay.

The key to identifying the right price strategy for your SaaS is to understand the different models and how they can benefit your business. Every business is different and what works for one may not work as well for another.

Today we’ll be giving you the key concepts of the top SaaS pricing models.

Importance Of Saas Pricing—Why Does It Matter?

As a business owner, understanding the implications of SaaS pricing is essential for success. From revenue generation to customer retention, SaaS pricing affects every aspect of running a business. With the right strategies, businesses can leverage SaaS pricing to maximize profits and increase customer loyalty.

Here are three ways SaaS pricing affects your business.

Revenue Generation & Competitive Advantage

One of the primary benefits of SaaS pricing is its ability to generate revenue. By offering subscription-based services, businesses can generate predictable income streams that can be used to fund additional initiatives or projects.

Statistically, SaaS businesses have a much higher recurring revenue rate than traditional software companies, making it an incredibly attractive option for entrepreneurs looking to maximize their profits.

Product Positioning & Profit Margins

Another benefit of SaaS pricing is its ability to position products in the market. This means that businesses can strategically structure their pricing plans to attract the right customers while simultaneously maximizing their profit margins. Businesses can increase profits—without sacrificing customer satisfaction—by offering different tiers of service and charging a premium for advanced features or services.

Customer Acquisition & Retention

Finally, SaaS pricing can be leveraged for customer acquisition and retention purposes.

The best way to acquire new customers is by offering attractive pricing plans and promotional offers. For example, businesses can offer discounts for long-term commitments or bundle services together to attract customers.

Slack is a great example of a SaaS product that leverages pricing for customer retention. Slack offers a free plan and has premium plans offering additional features and more storage space.

Seven Pricing Dimensions for SaaS Companies

The range of SaaS solutions available to businesses today can be incredibly powerful.

Not only do they make operations more streamlined and efficient, but they also have the potential to help drive growth. To get the most out of them, you've got to select the right fit—and that means getting the pricing model right.

There are seven distinct SaaS pricing dimensions (aka variables), each of which has advantages and drawbacks. A dimension is a secondary consideration to be made when deciding how to price your product. It’s similar to the way some products at the grocery store are sold by the individual item (ie. one avocado) and others are sold by weight (potatoes per lb).

Finding the right pricing dimensions for your SaaS depends on your use cases and customers, so it’s important to understand the details of each model before making a decision.

Let’s dive into them:

Flat-Rate Pricing

What Is flat-rate pricing? In a flat-rate pricing model, customers pay a set amount for access to a given service or product on an ongoing basis.

This could be anything from monthly or yearly subscriptions to ad hoc charges for additional features. This pricing type's main benefit is that it allows businesses to monetize their services quickly and easily.

When writing about their pricing strategy, the founder and CTO of Basecamp wrote: “The problem with per-seat pricing is that it by definition makes your biggest customers your best customers. With money comes influence, if not outright power. And from that flows decisions about what and who to spend time on.”

Examples of Software Using This Model

Many software companies use a flat-rate model for their services, including Adobe Creative Cloud, Dropbox Pro, Slack Plus, and Microsoft Office 365.

These services typically offer basic features at no additional cost, while premium features such as additional storage space or advanced analytics come for an extra fee.

It allows businesses to tailor their subscription packages according to their needs and budgets.

According to one research by Salesforce in 2019, 66% of consumers prefer subscription models over traditional ownership models when purchasing software products due to their affordability and convenience.

This suggests that there is high demand for SaaS products with flat-rate pricing models as people are more likely to pay for them on an ongoing basis than one large upfront fee.

Pros & Cons Of Flat Rate Pricing For SaaS Companies

Pros:

• Quick access to cash flow through recurring customer payments
• Predictable costs for customers, builds trust between them and the business

Cons:

• Customers may only pay once but expect unlimited access leading to losses for companies
• Customers not getting full value from subscriptions and churning out, resulting in loss of revenue income

Pay As You Go or Usage Based

One of the most common pricing models used by SaaS companies is the pay-as-you-go or usage-based model. In this model, customers are charged based on their usage of the software. This could include the number of users, the number of transactions, the amount of storage used, or any other metric that is relevant to the software.

Examples of Saas Companies Using this Model

Examples of SaaS companies that use the pay-as-you-go model include:

• Amazon Web Services (AWS): Customers pay for the amount of storage, computing power, and bandwidth they use.
• Salesforce: Customers pay for the number of users and the amount of storage they use.
• Zoom: Customers pay for the number of meeting minutes they use.

Rates for these services vary depending on the specific usage and plan chosen, but they can range from a few cents to several dollars per user per month.

Pros and Cons of the Pay-As-You-Go Model

Pros:

• Flexibility: Customers can adjust their usage and costs based on their changing needs.
• Predictable costs: Customers can easily calculate and budget for their monthly or annual costs.
• Low risk: Customers can start with a small investment and scale up as their business grows.

Cons:

• Complex billing: Customers may find it difficult to understand and manage their usage and costs.
• Higher costs at scale: As usage increases, costs can also increase significantly.
• Limited features: Some features may only be available at higher usage tiers, which could limit the functionality of the software for some customers.

Tiered-Based

The tiered-based pricing model is a type of pricing strategy that divides customers into different groups, or tiers, based on their usage or needs. Each tier is associated with a different price point.

One of the key advantages of tiered-based pricing is that it allows SaaS companies to segment their market and target different types of customers with different pricing options.

This can help to increase revenue and profitability, as customers are willing to pay more for additional features or higher levels of service.

Examples of Tiered-Based SaaS Product Companies

Examples of SaaS companies that use tiered pricing include:

• Mailchimp: Offers a free plan for small businesses and basic features, and three different paid plans with increasing features and capabilities.
• Dropbox: Offers a free plan with limited storage, and three different paid plans with increasing storage and advanced features.
• HubSpot: Offers a free plan for basic features, and four different paid plans with increasing features and capabilities.

The pricing of these services varies depending on the specific plan and usage. For example, Dropbox offers a basic plan with 2GB of storage for free, and a plus plan with 2 TB of storage for $9.99 per user per month.

Pros and Cons

Pros:

• Tailor packages to suit multiple buyer personas
• Maximize revenue generated from different types of customers
• Direct route to the next price point when customer outgrows current package

Cons:

• Too many choices may lead to an abandoned sale
• Appealing to too many needs can lead to a lack of focus
• Uncompensated usage beyond allocation in top tier users

User-Based Pricing (Non-Active Users)

User-based pricing is a model in which the price of a service is determined by the number of users that will be using the service. This model is particularly useful for companies that have a large number of users, as it allows them to ensure that they are paying for only the number of users they need.

Examples

• Slack: Slack is a popular communication tool that charges customers based on the number of users that will be accessing the service. The company offers different pricing plans, including a free plan for small teams, and paid plans for larger teams.
• Trello: Trello is a project management tool that also uses a user-based pricing model. The company offers different pricing plans, including a free plan for small teams and paid plans for larger teams.

Pros and Cons

Pros:

• Allows companies to scale their service as their user base grows
• Allows companies to offer different levels of service to different users
• Encourages users to upgrade to more advanced service plans

Cons:

• Difficult to keep track of who is using the service and how many users are active at any given time
• Can lead to billing errors
• Can create an unnecessary financial burden for the company with non-active users

Active Users-Bases Pricing

The active user-based pricing model works by charging customers for each user that is actively using the software. This means that companies will be charged for each user who signs up for their account and uses it at least once in a given period. The amount that companies are charged typically depends on the features they are using and how many users they have accessing those features.

For example, Company A has 10 employees who use a certain SaaS product regularly and two additional employees who only use it occasionally. Company A would pay for all 12 users, not just the 10 regular ones—and depending on their agreement with their SaaS provider, they might also be charged extra for those two occasional users.

Examples of Active Users-Bases Pricing

Dropbox, Asana, Zendesk, and Salesforce are all examples of providers who have adopted active user-based pricing models. As a part of their pricing plans, these companies charge customers for each user actively using their software in a given period.
These are just some of the many companies that use this pricing model.

Pros & Cons

Pros:

• Flexibility in budgeting for software needs
• Ability to add or remove users without long-term contracts and upfront costs

Cons:

• Possibility of paying more than necessary with too many inactive users
• Necessity of tracking active users to maximize savings

Features-Based Pricing

The features-based pricing model is a popular option for SaaS applications. This type of pricing model focuses on providing customers with bundles of features at different price points, allowing them to pay only for the features they need most and customize their plans accordingly.

Examples of Featured Based Pricing

For example, a SaaS application might offer three tiers of plan options: basic, pro, and enterprise. The basic plan could include core functionality such as an online store and basic analytics software, while the professional plan could offer more sophisticated tracking tools and customer support chat integrated into the platform. The enterprise tier would then provide additional advanced features such as automated workflows, data mining capabilities and other sophisticated customizations.

Each level would come with its own associated cost. For instance, the basic package may cost $10/month, while the professional package costs $20/month, and the enterprise package could cost $50/month or more. Customers can select the appropriate plan based on their needs and budget in order to get access to only what they need without having to pay for more than they require.

Examples of this kind of pricing model include: Adobe Creative Cloud and Hubspot. You would see different plans for various levels of features, such as the Photography Plan or All Apps Plan. The more features you need, the higher price you would have to pay.

Pros & Cons of Features-Based Pricing Model

Pros:

• Allows customers to customize packages based on their needs
• Easy to understand consumers
• Flexible to scale up as business expands

Cons:

• Can be challenging to price different feature bundles accurately
• May be difficult for consumers to compare prices across products
• Can lead to “Feature Creep” where too many unrelated features are incentivized

Freemium Pricing Model

The freemium pricing model is a pricing strategy that allows customers to access a basic version of a service for free, with the option to upgrade to a paid version for additional features and services. This model is particularly useful for companies that want to attract a large number of customers and build a customer base.

Examples Of Freemium Model

• Canva: You can use Canva for free or you can sign up for additional features and benefits that go beyond the free version of the product and app.
• Spotify: Spotify offers a free version of its music streaming service, with the option to upgrade to a paid version for additional features and services such as ad-free listening and offline playback.
• LinkedIn: LinkedIn offers a free version of its professional networking service, with the option to upgrade to a paid version for additional features and services such as advanced search and messaging capabilities.

Pros and Cons:

Pros:

• Attracts a large number of customers
• Builds a customer base
• Increases brand awareness

Cons:

• Can be difficult to convert free users to paid users
• Can lead to decreased revenue if free users do not upgrade
• Can lead to decreased revenue if free users do not upgrade

SaaS Pricing Strategies Most Commonly Followed

Understanding the pricing models is essential, but it's also important to know the strategies behind them. After all, effective execution starts with proper planning.

In this section, we'll dive into the strategies that drive these pricing models and how they can be implemented to optimize your SaaS pricing and drive growth for your business.

Penetration Pricing Strategy

This pricing strategy is often used by businesses to quickly gain market share by setting a low initial price for a product or service. The idea is that once a significant portion of the market is captured, the price can be increased. This strategy is particularly effective for new businesses entering a crowded market, as it allows them to quickly establish a foothold with a low-priced offering. However, it can be difficult to raise prices later on without losing customers.

Captive Pricing Strategy

Captive pricing strategy is used to make it difficult for customers to switch to a competitor's offering. This can be achieved through proprietary technology, exclusive distribution agreements, or other means. This strategy is used by companies that have a unique product or service that is not easily replicated by competitors. It is especially useful in cases where switching costs are high for the customer.

Skimming Pricing Strategy

Skimming pricing strategy involves setting a high initial price for a product or service, and then gradually lowering the price over time. This is often used when a product or service is new and there is a high level of demand. The high initial price allows the business to generate a large profit early on, while the gradual price decrease can help to maintain demand as the product or service becomes more widely available.

Prestige Pricing Strategy

Prestige pricing strategy involves setting a high price for a product or service in order to create an image of exclusivity or luxury. This can be used to differentiate a product or service from competitors and appeal to a certain type of customer. This strategy is often used by high-end luxury brands and can be effective in generating a sense of prestige and exclusivity.

Bundle Pricing Strategy

Bundle pricing strategy involves offering a group of products or services at a discounted price when purchased together. This can be used to increase sales and customer loyalty. Bundle pricing is often used by retailers and service providers to offer customers a deal that is too good to pass up.

Freemium Pricing Strategy

Freemium pricing strategy involves offering a basic version of a product or service for free, with the option to upgrade to a paid version with additional features or services. This can be used to attract a large user base and generate revenue from a small percentage of users who upgrade. This strategy is particularly effective for software and app development companies, as it allows them to provide a taste of their product to a large user base at no cost.

Value-Based Pricing Strategy

Value-based pricing strategy involves setting the price for a product or service based on the perceived value that it offers to customers. This can be used to appeal to customers who are willing to pay more for a higher-quality or more useful product or service. This strategy is particularly effective for businesses that can demonstrate the value of their product or service through research or testimonials.

Cost-Plus Pricing Strategy

Cost-plus pricing strategy involves setting the price for a product or service by adding a markup to the cost of production. This can be used to ensure that the business is generating a profit on each sale. This strategy is often used by manufacturers and wholesalers, as it is a simple and straightforward way to ensure profitability.

Pricing Strategy examples

• Penetration Pricing: Slack
• Captive Pricing: Apple (with proprietary technology such as iOS)
• Skimming Pricing: Tesla (with their new car models)
• Prestige Pricing: Louis Vuitton
• Bundle Pricing: Amazon (with their subscription service, Amazon Prime)
• Freemium Pricing: Spotify (with their free version and premium version)
• Value-Based Pricing: Patagonia (with their high-quality outdoor clothing and gear)
• Cost-Plus Pricing: Wholesale distributors such as Costco

Psychological Tactics to Successfully Price your SaaS Products

SaaS companies are always looking for ways to optimize their pricing strategy to maximize revenue. Fortunately, psychological tactics can give you an advantage when pricing your product. These tactics are based on human behavior and can help influence customers’ decisions when purchasing your product or service. Let’s look at some of the most effective psychological tactics used in SaaS pricing.

Anchoring with a Free Trial

One of the most commonly used psychological tactics in SaaS pricing is anchoring with a free trial. By offering a free trial of your product or service, customers will likely view the full version as cheaper than if they had not experienced the free version first.

This anchoring can be very effective in getting people interested in your product or service and making them feel like they are getting a good deal when they purchase the full version.

We spoke to Bill Wilson of PriceToProfit about one of the strategies called Good-Better-Best pricing and how it dominates B2B SaaS pricing. This is what he shared:

Create packages built around your target personas and the problems you solve But psychological effects also play a huge role. Utilizing the psychology of choice, this strategy leverages two key principles to drive conversions:

1. Single Option Aversion. Avoid presenting just one option. Prospects are hesitant to make a purchase without comparable options. By offering "Good," "Better," or "Best” options, prospects will feel more confident in making a decision.
2. Extremeness Aversion. The core principle behind the Good-Better-Best strategy is the Goldilocks effect. This principle states that prospects will tend to disregard the extreme options and instead choose the middle option. "Best" serves as a high anchor, "Good" keeps them grounded on the low end, but "Better" is the sweet spot, just like the porridge in Goldilocks.

The Good-Better-Best pricing strategy can help eliminate hesitancy, fulfill the prospect’s need for comparison and guide them to the package you want most for them to buy.

When asked why this strategy could help Wilson said:

“Ultimately you want to change the conversation in your prospect's mind from: "Am I going to buy from you?” to "What am I going to buy from you?" 

Decoy Pricing

Another tactic used by many SaaS companies is decoy pricing. Decoy pricing involves offering multiple different versions of the same product at different prices. Two of the products are so closely priced with so much additional value that the one that is slightly more expensive tends to be perceived as a no-brainer decision for the customer.

For example, if you were selling a subscription-based software, you could offer two packages—one for $20/month and one for $35/month—and make sure that there is something exclusive about the higher-priced package that makes it appear worth spending more money on. This tactic encourages people to spend more money on the higher-priced option because it appears more valuable than the cheaper option.

Price Ending

Price ending is another common psychological tactic used in SaaS pricing strategies.

This tactic involves setting prices that end in “9” or “99” instead of round numbers such as “50” or “100” (e.g., $49 instead of $50). The idea behind this tactic is that customers perceive these prices as lower than they are because they perceive it is a dollar less (e.g., $49 versus $50). Studies have shown that price ending can effectively encourage customers to purchase products or services at slightly higher prices than they would normally pay for round numbers such as fifty dollars ($50).

These are just some examples of psychological tactics many successful SaaS companies use today when setting their prices for products and services.

Other popular psychological tactics that can influence pricing include:

• Loss Aversion
• Scarcity
• Social Proof
• Justification Pricing
• Inertia Pricing
• Familiarity Pricing
• Reciprocity Pricing
• Anchoring With A Free Trial

Key Metrics That Will Help Guide Your Pricing

You now understand how to use psychological tactics when planning your pricing strategy.

The next step is to understand the metrics that need to be considered to ensure it all works out. It's also important to track and analyze key metrics associated with your business to ensure that the pricing model you choose is =working effectively. Keep in mind the following key metrics as you iterate and build on your SaaS pricing strategy:

LTV/CAC Ratio

The idea of an LTV/CAC ratio compares the lifetime value (LTV) of a customer to the cost of acquiring that customer (CAC). A high LTV/CAC ratio indicates that your pricing model is sustainable and profitable and a low ratio will give you an indication that you may want to make some adjustments to the way you’re operating and running your business.

Gross MRR Churn Ratio

The Gross MRR Churn Ratio is a formula that measures the percentage of monthly recurring revenue (MRR) that is lost due to customers canceling their subscriptions. A low gross MRR churn ratio indicates that your pricing model is retaining customers effectively.

Expansion MRR

Another metric measured in SaaS pricing model analysis is the additional revenue generated—or the expansion MRR—from existing customers who upgrade to a higher-priced package or add additional services or features. A high expansion MRR indicates that your pricing model is effectively upselling to existing customers.

Upgrade MRR

Finally, the upgrade MRR metric measures the revenue generated from customers who upgrade to a higher-priced package. A high upgrade MRR indicates that your pricing model is effectively encouraging customers to upgrade.

Factors to Consider when Setting SaaS Pricing

Setting the right price for your SaaS product is essential to ensure that you are both profitable and competitive.

There are several factors to consider when it comes to pricing, so it’s important to understand these factors and how they can impact your pricing model.

Let's review some of the key pricing factors for SaaS products and provide tips for setting effective prices.

Target Market Analysis

Before you set a price, it’s important to understand who your target market is and what they are looking for. This will help you determine the value of your product and the price point most likely to attract customers.

It’s also important to research the competition to understand the current market prices and what customers expect.

Cost of Goods Sold

When setting a price, it’s important to consider your cost of goods sold (COGS). This includes everything from materials and labor costs associated with producing the product and any other costs related to running your business, such as rent or utilities.

Knowing your COGS will help you determine a fair price that covers your expenses while leaving room for profit margins.

Sales and Marketing Expenses

In addition to COGS, you must factor in sales and marketing expenses when setting a price.
These costs include advertising fees, sales staff salaries, website maintenance fees, etc.
Knowing these expenses can help you determine how much money needs to be made from each sale for your business model to be successful.

Development Costs

Finally, when setting a price, you must consider any development costs associated with creating and maintaining your product or service. This includes software licensing fees, server costs, hosting fees, etc. These costs can quickly add up, so they must be factored into your pricing model to make sure you can profit on each sale.

5 Best Practices for SaaS Pricing Strategies

As the industry grows, businesses must have an effective pricing strategy to compete and remain profitable. Here are the five best practices for creating and optimizing your SaaS pricing strategy.

Test Different Pricing Models

One of the most important aspects of creating a successful pricing plan is testing different models and seeing which works best for your business. A few common strategies include charging a flat fee, offering tiered plans, or using pay-as-you-go subscriptions.

It’s also important to consider how other companies in your field are pricing their services, so you know what competitive rates look like in the market. It may be helpful to test different options on small subsets of customers before introducing them across the board.

Communicate Value To Customers

Your customers should understand why they should pay for your services and how much value they get from them. Ensure this message is communicated clearly throughout all customer communications, including emails, website messaging, sales calls, etc.

This will help increase customer loyalty and engagement with your product or service.

Be Transparent About Pricing Changes

Customers need to be aware of any changes to the prices of your services so they can make informed decisions about whether they want to stay with you or switch providers. Be sure to provide ample notice before any changes take effect so customers can adjust accordingly.
If possible, offer existing customers discounted rates compared to new ones as an incentive to stay with you during increased prices or decreased features/services offered.

Discounts And Promotions

Offering discounts and promotions can be a great way to attract new customers and retain existing ones who may be considering switching providers due to increased prices or decreased features/services offered by your company.

When offering discounts, make sure that they are tailored specifically towards certain customer segments, such as students or small businesses who may not be able to afford full-price services but still need access to quality products/services provided by your company to remain viable competitors in their respective fields/industries.

Continuously Review and Optimize Pricing

You must continuously review and optimize your pricing structure to keep up with changing market conditions and customer needs/preferences. This will help you maximize profit potential while still providing quality products/services at competitive rates within your industry sector.

Final Verdict: Pricing Depends On The SaaS

And with that, you now know exactly how you price your SaaS.

A solid pricing plan is the foundation for a thriving SaaS business. With the right approach and strategy, you can unlock the full potential of your product or service and stand out in the competitive SaaS market.

By determining the value of your offering, researching the market and your competitors, and utilizing the seven strategically-minded techniques outlined in this guide, you can craft a pricing plan that truly resonates with your target audience.

Furthermore, it's essential to understand the different pricing models and how they can be tailored to fit the unique needs of your business.

Get creative with monetization tactics, stay on top of industry trends, and you'll be well on your way to crafting a pricing plan that drives revenue and keeps customers coming back for more.