In this guide, we explore three SaaS pricing models: fixed subscription, consumption, and hybrid. You'll delve into the significance of pricing, examine the advantages and disadvantages of each model, and understand when to apply them.
Pricing is proven to be a critical growth lever for scaling businesses.
According to McKinsey, pricing transformations can generate margin improvements of up to 7% in as little as 3 months, and sustain those improvements into the long term. Get pricing right, and you stand a much better chance of gaining loyal users and growing market share. Get it wrong, and you risk leaving money on the table, losing deals, and being left behind by competitors.
Adapting pricing models at regular intervals can help accelerate the scaleup growth trajectory, and put your business on the path to profitability. Businesses that update their pricing at least once every 6 months see nearly twice the Average Revenue Per User gain of those who update it less regularly.
But knowing when to evaluate pricing models and how to adapt them can be challenging. In the early days of a startup, the priority is acquiring customers at any price. As businesses scale, building out processes and infrastructure to manage pricing strategically is critical – but often overlooked. Research shows that some businesses only spend six hours on their pricing strategy across their entire lifetime.
Pricing isn’t a ‘set it and forget it’ activity: as the product evolves and expands, and as the business enters new markets and targets new segments, pricing should be updated accordingly. Finding the optimal model depends on product type, market, organizational structure, business goals and more. In this guide, we’ll weigh up three of the most common pricing models, explaining how they work, why businesses might choose to use them, and how they drive growth.
Pricing is the main tool you have to align customers, the value of your product or service, and your goals. At least one person in your company should be obsessing over it.Ariela Bitran Rich, Director of Pricing Strategy at Chargebee
There are a number of ways in which SaaS businesses might choose to package and price their products. Different combinations can help reach different audiences, with different needs and use cases.
Increasingly, businesses are getting creative with the way they consider pricing – but to get you started, below are some of the most common, market-tested pricing models.
Historically, fixed subscription pricing has been the go-to model for SaaS businesses.
Fixed subscriptions are usually tiered. Vendors offer a small range of ‘good, better, best’ options, each at a different price point and delivering different features and functionality.
Customers can choose the package that best suits their needs, and subscribe for access to the product over a defined duration. Customers may pay for several licences in their subscription: the price is usually per seat or location. Customers pay the same set price for the subscription at regular intervals (monthly, annually), irrespective of how much of the product they use, or how often they use it.
In order to drive growth with a fixed subscription model, vendors need to add new customers. The only way to drive revenue is to sell the product to more people, as opposed to encouraging more usage within the same customer base.
There are three key metrics vendors should track to understand whether their fixed subscription model is helping them scale:
Fixed subscription pricing works well if the product delivers value through individual usage – those that help sales reps or designers work more efficiently or be more productive, for instance. It is not a good fit for products where the value is generated via systems, such as ecommerce or data infrastructure.
Per seat pricing can increase if functionality is added, and total revenue can grow if your customers are growing their headcount. Likewise, if you charge a subscription based on locations, revenue can grow with added functionality, or locations being added by your customers.Todd Gardner, Managing Director of SaaS Advisors
Consumption pricing has become more popular in recent years, as businesses have looked for ways to add and create value through their pricing model.
There are several different ways to set up and manage consumption models, including credit systems (e.g. 1 credit = 10 API calls), pre-payment limits and pay-as-you-go usage.
However it’s structured, the core of any consumption model is that rather than paying a fixed price for a product based on the capacity they predict they will need, customers only pay for what they actually consume. Though payment intervals remain regular, the amount customers pay can vary from period to period.
There are two ways vendors can drive growth with a consumption pricing model. One is to add new customers (as with fixed subscription models), the other is to expand within their existing customers by encouraging them to use the product more.
One of the major benefits of consumption pricing is that it allows for frictionless expansion.
Customer usage and revenues may start small, but can expand automatically and exponentially without the need for deal renegotiation. This frictionless growth is particularly profitable for vendors because there are no sales and marketing expenses. Consumption pricing models are therefore a popular choice among vendors seeking to grow revenue and minimize costs.
Frictionless growth doesn’t mean sales and marketing teams can be entirely hands-off. When leveraging consumption pricing as part of a Product Led Growth strategy, sales teams will need to be trained at the outset to ensure they have a strong technical understanding of the product, and can drive adoption. Marketing will also have to build a Product Led Growth go-to-market strategy, and while this makes it easier for customers to grow their own value further down the line, all teams will need to be aligned to Customer Success to help customers thrive and ensure ongoing frictionless growth.
Metrics tracking can be somewhat more complicated for consumption pricing models. Vendors should look to measure:
Consumption pricing is best when other value metrics aren’t available. It’s typically used by businesses whose solutions sit lower in the stack, for instance computing and storage, but is also seen in middleware and applications in growing numbers. Customers understand that those services are valuable and expensive, but they’re utilities, not value-drivers. For consumption pricing models to work well, usage needs to be both trackable, and predicted to grow. There’s more detail on evaluating usage-based pricing in our blog Is Usage-based pricing right for my business.
Consumption pricing makes sense for vendors pursuing Product Led Growth strategies. Consumption models enable them to remove barriers to entry, with free or low-cost trials, and expand usage and revenue from there without having to negotiate a deal.
We typically see use usage or consumption based pricing models if/when: a) consumption is trackable, b) consumption metric is expected to grow, c) down-trade risk is low, d) market acceptance is high, e) there is a clear link to value, f) there is a clear link to cost / other methods have too material a risk of not recovering cost.
To effectively implement a usage-based pricing model, companies need to think about the different activities required across the business. This includes the impact on the sales organizational structure and specifically the importance of a Customer Success function, sales incentivization, KPI tracking, refreshed sales collateral as well developing a new tracking and billing capability.Avi Sethi, Senior Director at Simon-Kucher & Partners
Hybrid pricing is essentially a combination of subscription and consumption pricing models. Usually, vendors will sell a subscription package with overlaid consumption elements, such as overages or usage-based add-ons.
For this reason, hybrid pricing is sometimes referred to as ‘usage-based subscriptions’. Some companies are testing usage-based pricing elements, some have ‘largely’ usage-based pricing models, and over a third offer usage-based subscriptions.
One way to think about hybrid pricing is as a very sophisticated tiering system. Because there are so many different ways to dice up, repackage and price different elements of the product, vendors can offer a custom ‘tier’ to suit nearly every market segment.
Hybrid models are a great way of having your cake and eating it. Businesses can stick with the ‘good, better, best’ subscription model, and start layering in usage elements, typically around allowances or bundles. They either allow you to monetize additionally outside core recurring revenue, or use usage to move people up and down a sophisticated set of subscription tiers.Marek Rubasinski, VP, Business Development & Partnerships at m3ter
Hybrid pricing models can drive growth in a number of different ways, depending on the different elements vendors choose to leverage, and how they work together. Hybrid models may depend on new customers, expansion within the customer base, or both, and can also open up new revenue streams by enabling vendors to target new markets or segments.
Hybrid pricing models enable vendors to monetize outside of their core product and diversify revenue streams. They offer stability and scalability: subscription elements ensure ongoing financial security, while consumption elements leave headroom for unlimited growth. The recent pivot in the SaaS funding landscape from ‘growth at all costs’ to efficient growth – where top- and bottom-line growth are balanced – means hybrid pricing models are becoming more popular.
As businesses scale and start to serve bigger customers, it’s wise to put processes in place that allow for ongoing adaptation of pricing models.
Startups can afford to wait until later in their growth journey to refine their pricing model. Rigorous pricing strategies are a lesser priority than winning early customers and understanding product market fit. Keeping pricing simple in the early days means the widest possible market can access the product, giving businesses the opportunity to gather feedback and understand product value. These insights inform the growth strategy and in turn, the pricing strategy.Andreas Panayiotou, Director, Pricing & Monetization at Notion Capital
So, when is the right time to get strategic about pricing? There are a few indicators that businesses should assess and adapt:
Pricing transformations are whole-business transformations. They’re not just technology processes, but also operational and cultural processes – and they don’t happen overnight. A considerable amount of operational change management is required, as well as input and collaboration from several core teams.
If you want to move to a new model, the whole revenue model changes. The decision has to come from the very top, as it changes the monetization plan. It won’t happen overnight, and it has to be designed as a solution. Transitioning existing customers to the new plan is a particularly complex balancing act. Nobody wants to lose a customer over a pricing model, so businesses need to work out how best to how to protect them and their revenues.Shah Choudhury, Senior Manager, Pricing Strategy at Salesforce
For SaaS leaders, pricing transformations offer an opportunity to get creative and take control of growth, even in uncertain economic conditions. A thoroughly considered (and regularly reviewed) pricing strategy can open up new revenue streams, and create headroom for ongoing scale in competitive markets.
It’s critical to understand the spectrum of different pricing models, and how they connect to business growth. With an informed strategy in place, growth businesses can start to build out the teams, processes and tooling to support it.
m3ter can help.