Pricing is complicated. You have to consider the financial impacts, the psychology, packaging, naming, and more. It’s so complicated there are companies that charge an arm and a leg for their expertise. The result? Many folks (me included) go the DIY route using the wisdom of the internet to figure things out. If you’re one of those folks, hopefully this summary of my research and thoughts helps!
Before we go into more detail, I want to clarify that I’m not an expert on pricing. I’ve been involved in pricing projects at three companies (Shopify, Superside, and Freshbooks). But those experiences made me realize how little I know. Please don’t blindly follow this advice.
Three Simple Guidelines
I’m the type of person that operates on guidelines and principles. I use principles to navigate through complicated problems. So here are my three simple guidelines for pricing:
- Revenue is directly proportional to value – You should make more money as your customer gets more value.
- Value > Price - You shouldn’t charge more for your product than the customer feels like they are getting value. But you should aim to get as close as possible to the perceived value without going over.
- Price > Cost - You should always charge more for your product than it costs you to deliver your product otherwise you won’t be in business for long. (Note: for subscriptions products this is using LTV not your monthly price)
Value could be money earned (Optimizely, Shopify), efficiency improvements (Asana, Slack), enjoyment (video games, Netflix), and more.
How to use value to price your plans
To do price your product you need to have a clear idea of the value your product provides to your customer. You want to set up your pricing so your customer pays more or upgrades as they get more value. You’ll end up with a fuzzy approximation for value, but it’s almost impossible to find an accurate metric for value.
In the case of Shopify, the value to the customer is the money they make selling online. As a result, the plans are set up so you go with a higher plan as you make more money with Shopify. See my breakdown below for more details on the pricing.
Types of Plans
We’ll use email marketing companies as an example for each of these types of plans. For email marketing, the metric they use to represent value is emails sent or number of subscribers.
Flat Tier + Overage (3-part tariff)
This type of plan consists of a flat fee that includes a certain level of usage, everything after that point you pay overage on. Think of your cellphone plan, most likely it’s a 3-part tariff. One study based on a telecom company found “Customers who switched to a three-part tariff increased their usage by 15.1%, while customers who remained on a two-part tariff increased their usage by 0.9%.” (source)
Flat Fee + Usage (2-part tariff)
For this type of plan, the customer pays a flat “access” fee and usage is pay as you go. Using ConvertKit as an example, you pay $29 to get access to the platform and less than 1000 subscribers. After that you pay depending on the number of subscribers you have.
Pay as you go
You only pay for what you use. For an email marketing tool, the pricing would mean you pay per email sent or subscriber to your email list. AWS is one of the best examples of this approach, for each of the services you only pay what you use.
This approach doesn’t price based on usage. Instead, the packages are setup based on features. You should choose features that correspond to the value the customer is getting. For example, features for a large organization should only be available at the top tiers.
The Pricing Wall
The pricing wall is when you are happily using a product and paying for it, when a small change to your situation results in a massive price increase. The best example of this is Atlassian’s cloud plans:
The price jumps from $10 for the first 10 users to $77 with the addition of one more user. It kind of feels like this:
Note, I don’t have any data on the impact of this wall except for my own personal feelings about it. It sucks.
Charging per User
This is the most common usage metric for SaaS companies. A customer pays for each user accessing the product. For a lot of companies (like Slack, Google Suite, etc) it makes sense, but don’t immediately assume it applies to your company. Make sure that number of users is the best proxy metric for value.
Useful Snippets of Knowledge
If 10% to 20% of your prospects tell you you’re too expensive, and 10% to 20% don’t even blink when you mention the price, you’re in the golden middle.
Andy’s first step was to list the problems that he wanted his new pricing model to solve for his business. Two were top of mind: lumpy revenue and the commoditization
Keep testing to find the optimal price — another rule of thumb is to keep raising prices after each sale until you start to get pushback from about 20% of the prospects you speak to.
Using more than one dimension for your pricing (for example a set of features + a value metric) is a great way to maximize your revenue by targeting several different customer segments.
According to Madhavan, if 70% of your customers are in the entry-level tier, your business will not survive. The demarcation between pricing buckets is not successful. The bronze tier offers too much value. The goal is to achieve 70% of customers in silver and gold tier.
There are only two kinds of subscription pricing: consumption and capability. Consumption pricing means charging by the seat, the API call or the CPU cycle. Capability pricing means charging by new features and functionality. Subscription companies should choose one or the other.