Saas space is growing with more and more businesses and products moving to Saas. Another trend that has become wide spread leading even the #1 brand Apple to reconsider its strategy is the subscription pricing.

The pros of subscription pricing have been highlighted in many articles but some prominent ones are:

1. Lower barrier to entry: Makes the product more affordable for users. Also helps user use the product before they commit to it. This is why it is important to not only price it right that it lowers the barrier to entry for new users but also as a business, it makes sense to invest in habit forming features that increases the stickiness and engagement.
2. Leverage switching cost: As users use the product, they add their footprints to the software such as files uploaded, historical data etc. Users find it costly to switch the product. In absence of anything else the cost of taking a decision to switch is sometimes enough for users to not think about switching.
3. Better Cash flow management : More predictable cash flow leads to better business planning avoiding any uncertainty. A consistent and reliable revenue infuse confidence in investors, employees, and partners.

Does it mean everyone should switch to subscription model? Of course not. Some reasons to not switch to the model are:

1. Churn: Customers may stop using the product much before you could achieve the breakeven cost. If the marginal cost to service a user is zero, it would not matter. But in long run, subscription pricing will only be successful if the product delivers the true value and keep users engaged.
2. Risk of non payment: Since collection happens at regular interval, chances of non payment goes up.
3. Longer breakeven cycle: Some startups may find it difficult to justify to their investors the long time duration to get breakeven.

However, there is an additional dimension that adds to the complexity. Should we have one price for all customers? As we know not all customers are equal. This is why price discrimination helps understand willingness to pay (WTP) for different customer segments and if priced right capture a significant portion of the value created. This is why ‘packaging’ in subscription becomes important.

An example of software pricing and packaging can be seen from Hubspot pricing tiers

Few observations from the above pricing and packaging are:

1. As can be seen from the pricing tier, it is really easy to see what additional value a user can get from moving from one tier to the other.
2. Simplicity by avoiding too many tiers: Objective should be to remove any friction in decision making. In trying to price discriminate, it is easy to end up creating too many price tiers. This is why Good-Better-Best pricing works.
3. Higher tiers have ‘Talk to sales’ CTA. This allows Hubspot not only to explain the value proposition but also understand what users actually wants. This can be used later on to inform the packaging.

Some companies also toss in Freemium model for users to try for free and then pay to unlock additional features. However, freemium model only works if the packages are built so that freemium delivers actual value to the user. For example, Apple offers 5GB of iCloud free, which is a decent storage for most users. As I kept adding photos, however, I needed more storage. This is the idea of a freemium model to etch out a well defined ‘migration plan’ to move a free user to paying user. This also requires that subsequent tiers should also have a clear and established value proposition.

Few additional notes for pricing and packaging:

1. Identify packaging before identifying price. Tackling both at the same time could be tricky. In that sense let value drive the pricing.
2. Right price tier that balances business surplus and customer surplus
3. A/B test to understand the price elasticity of demand
4. No vanity features to create false tiers. Include features only if they add value to the customers
5. Price and package around your north star metric — Pricing done in vacuum leads to cross functional team blaming each other. If the objective is acquisition try penetration pricing, if the goal is profitability try skimming. It is easier to go lower in pricing than to go higher. Also pricing lower can act as an acquisition strategy but only if the product has enough habit forming or engaging hooks.
6. Use user psychology to inform the pricing strategy: Have you ever wondered why most pricing tiers are arranged from Free to the most expensive? It is because arranging the other way leads to lower conversion as most of the users read from left to right. Putting the most expensive plan on the left gives an impression to the users that the product us already too expensive. One more such psychology trick is putting monthly and annual plan next to each other and showing annual plan in monthly fee i.e. pay $25 instead of $30 per month when switching to annual plan. This allows users to see the saving they can get by buying the annual plan instead of taking a monthly plan. Another example is using status quo bias that increases the cost of switching the default or recommended tier to maximize the value captured. An example from Mailchimp is shown below where Mailchimp recommends Standard plan rather than Essentials or free. It takes effort for users to switch from default option so keep it as second highest tier that your product has.

And finally, Pricing is not set in stone, it is in motion — Keep iterating and identifying the changes. Run A/B test and keep incorporating the learning in the product, price, and packaging.

Read our latest article on monetization strategy here