SaaS Pricing - How to Stay Ahead of the Curve

By Shemer Steinlauf
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Recently I took part in a think tank for a SaaS product group that was struggling with pricing issues. The issue at hand was that the product team was having a hard time getting users to opt for what they identified as the best offering out of three possible package tiers for their users. 

The product’s standard tier package was originally priced at a fixed cost of $10/mo plus additional usage based costs. Further on down the road, they added a lower tier with limited features. The usage cost for the lower tier was set at almost a fifth of the standard tier price.

With time, as user needs to scale grew, a third premium tier package offering was added. This time, for technical reasons, the price was set at a monthly fixed price of $700. Not an unusually high price but in comparison to the two other packages, this was presented as 70(!) times the original standard tier offering. The new premium package offered robustness for high system load, and while the two other tiers did deliver, it was agreed that the new offering was the best offering for the users.   

The problem: given the three choices, users were opting for the lower tier package and the standard, while the premium tier was seldom used even though it in fact was a much better offer with better features at a great value for money. 

Before reviewing how to untangle this issue, let's review the things you need to consider when approaching pricing of SaaS products.

Evaluating different pricing models 

Here are the 4 most common pricing models: 

  1. Flat rate - paying a fixed price for all the product features. Typically, this will be monthly or annually based. This model is simple and is rarely used as it doesn't give much room to capture a broad customer base. Simply put, it’s an offer they can refuse.

    pricing offer

  2. Pay as you go - a usage based pricing tier. This pricing model has its appeal to customers. They can moderate their payment according to their growth, and the fact that they can scale down and cut costs if they hit a rough patch can be a good selling point. On the other hand, this pricing model might cause a headache when trying to forecast your company's revenue, as any bump on the road for your customers directly affects your earnings. Plus, your engineering team will also find this challenging as they will need to have a robust scaling strategy that can grow and shrink to cut your infrastructure costs (remember, your customers do not pay for what they do not use).

    The best and most successful examples for this model would be the big cloud providers - Amazon web services and Microsoft Azure. They are big enough to use the competitive nature of this model and still stay profitable.

  3. Flat rate + Pay as you go - This fine combination of the two models above consists of a fixed flat rate (e.g. $10/mo), in addition to a payment based on usage (e.g. 100 emails = $5, 1000 emails = $15. etc.). I like it because it creates a predictable safety net to the pay as you go model.
       
  4. Tiered - Usually averaged at 3.5 offerings (that constitute a combination of all of the above), in this model, we want to appeal to a broader audience and have a safety net in the form of a mid-price in case our premium price deters users. 

    On the con side, the tier model planning is the most complex as it does not only consist of your cost plus profit. It entails strategy, psychology, and understanding of elements of game theory. It’s important to decide what features should be included in each tier and how to price it correctly. The SaaS product team understood that they were not playing this game correctly. Let’s now break down what went wrong and learn from it.

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A Pro Tip about Frog Boiling: It's not uncommon to also add a basic or even free tier that will constitute a honey trap to convert potential users into future paying users. Christopher Penn from the legendary podcast "Marketing Over Coffee" talks about a "frog boiling" method in which companies create incremental declines to their free offering over time. Through this method companies offer a free package and then degrade the license to a point it's not worth having. That way the free package keeps getting less and less effective and the pay now button (and ads) get bigger and brighter. The message: "here's the paid alternative if you want to do better" will ring loud and clear to these users. If such companies just flipped the switch overnight they would be pushed back - the trick is to keep turning the dial down a little bit at a time.

The core elements to consider when building your offering

  • What model is most suitable for your product. When possible I always advocate for the tier model but don’t force a model in cases where there’s no justification. The SaaS product team realized their usage of the tier offerings at the early stage where there were only two offerings was actually leading people to opt for an offering they didn’t want them to choose. At that early stage of the product, a valid alternative solution would have been to offer one winning flat rate + pay as you go model.
     
  • The alternatives out there. How are your competitors packaging and pricing their offerings? What is your USP and how can you stand out and make your offering appealing? Even if you’re aiming to be perceived as more expensive than your competition, make sure to make that a conscious decision (and keep in mind, no matter what you do, you’re always part of a competitive landscape and choosing to pay you is always on account of not paying someone else).
     
  • The value of the product. It’s a given that the bottom line price can make or break the conversion of demand into a sale. You want to help the prospect make the right choice and select the best most relevant product for him. In a world of numbers, "bottom line" pricing is considered an art form, where there is no ultimate right or wrongs but it is the difference between making and breaking it. 

    "Pricing is actually pretty simple...customers will not pay literally a penny more than the true value of the product." - Ron Johnson

    Although this is an over simplified statement (I would add that customers will not pay a penny more than the perceived value of the product), it does convey one truth - we have a job to convey the value of the product to the customer and help the customer feel that the price is fair and reflects that value – it’s important to keep that in mind when choosing a pricing offering. Ask yourself - is there a correlation between the price you are charging and the value you’re offering? Make sure to do your market research.

    The SaaS product team was offering great value and their current pricing offerings were not reflecting that. This made users opt for packages that were not optimal for them. Consider this, people think they’re rational but they’re not. Decide what tier you want to aim for and structure your pricing in a way that will help them choose.



                                                            The Decoy Effect

    When the team decided to add more expensive offerings, users were able to choose amongst 3 premium packages priced at $700, $1,400, and $2,800. Based on our newly introduced pricing perspective, would you take the cheap $10 offering for your high-performance system?

 

  • Your list of features. This goes hand in hand with the value of the product. Simply put, longer is better. Here’s how to go about this:

    1. Make a list of everything you can offer. Write down everything you know and everything you can think of.

    2. Get specific. Don’t overlook differences such as limited vs. full warranty – each should be a separate item.

    apples and oranges

    3. List the features you’d like to offer to your best value tier and then add or subtract to the other offers. Consider the perceived value to your users and work that into your structure. Make sure to be as quantitative as possible. The SaaS product team was offering shared computer resources for the standard tier and a dedicated resource for the premium tier. Most users would ask, “I know that dedicated is better than shared, but is it $700 better?” The solution was to add another feature to the list. While the first feature was still stating shared/dedicated resources per tier, the second feature detailed how much compute power will be dedicated to the user. That sort of quantitative information is such that the user can assign a value to and rationalize it.

    4. Make sure the length of each tier’s list correlates with the perceived value (premium should be longer than basic etc). The SaaS product team’s lists of features were all the same length, that’s confusing for the user.

How to present your offering 

In the traditional world, we have display counters, sales reps, and cashiers - the customer is already inside your store and we have time to complete the sale, and maybe even upsell. SaaS doesn’t have that luxury, the point of sale is usually limited to one page, so you really need to plan how to display your products. Here are a few tips:
 

  • Carefully choose your copy. “Best for small business that are aiming high”, “For people on the go with no excessive time”, “Ideal for beginners”. Help the users help themselves by understanding what best suits their needs. Clarify what each tier/ model is best suited for (i.e “recommended for development”, “recommended for low throughput systems” etc). Consider that the easiest decision is made when one knows that “people like me” selected this offering.
  • Draw the eye. For this purpose, make sure to schedule a meeting with the bearded heavy glasses flowery shirt and flip flops dude from the designer studio. Get his help figuring out how to make your selected offer pop. Big, colorful, “best value” flags are a good place to start, but can you take this to the next level?
    Your goal is to draw the weight of the page towards the selection you’re aiming for.

    mailchimp pricing

                MailChimp calls you a lamb if you select the free tier. 

Final thoughts 

Pricing is an art and as such we do not know what will make our users decide one price over the other. When approaching your SaaS pricing it’s important to take into consideration:

  • the most suitable model for the product
  • conveying a clear value
  • the alternatives out there
  • applying best practices that will influence the user to opt for the price they are aiming for

Now go make them an offer they can't refuse.

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About Shemer Steinlauf

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Shemer is an an Azure development technical adviser at Microsoft. He's currently studying for his Masters in design innovation and entrepreneurship at the College of Management Academic Studies

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