Every SaaS business must to decide how to charge for the service. Pricing plans are some of the most difficult decisions to make. Equally important to the price is determining the point at which the customer pays – the conversion point.
There are a five different models that I’ve experienced: up front payment, freemium, limited free trials, money back guarantee. Picking the right one depends on a number of different factors. Below is a table that summarizes these five approaches.
|Pricing Model||User Value||Product Complexity||End User Buys||Avg Seat $|
|Freemium||Increases with time||Simple||Yes or No||Low|
|Limited Free Trial||Increases with time||Complex||Yes||Low/Medium|
|Up Front Payment||Immediate||Simple||Yes||High|
|Money Back Guarantee||Immediate||Complex||Yes||High|
Freemium is a strategy for products whose value proposition is simply conveyed and whose value increases with time. Evernote’s value compounds with the data the user enters into the database. Expensify’s utility increases with the number of expense reporters on the system.
Freemium businesses must target markets with very large user bases because the conversion to paid rates vary between 2 to 4%. To drive $50M in annual revenue at that conversion rate and $100/year subscription, you would need 17M users.
Sometimes, the end users are buyers (typically in consumer services). Other times (for enterprise customers), end users are sales prequalifiiers who create a groundswell within an organization to convert to paid. Given enough users of a product in an organization, the enterprise can be upsold to a company wide license. Freemium distribution enables a company to acquire those users inexpensively.
Limited Free Trial
The main difference between freemium and trial products is product complexity: trial products are more complex and need time for the user to gain a deeper understanding of the value. CRM tools like Salesforce and 37Signal’s HighRise both use limited trials. The goal with these marketing mechanisms is to drive customers to explore the product for a brief period of time and then force a conversion. Allow too much time to pass and the customer will forget the value proposition.
These kinds of products tend to require significant user behavior change so these products must market a promise and then use the conversion to paid event to enforce that behavior change (carrot + stick). Because of the behavior change, these products are marketed to decision makers who select the software for their teams: product managers, tech leads and heads of sales. Many of the tests I’ve seen have indicated shorter trial periods are better: 7 days is better than 14 days is better than 30 days.
Up Front Payment
To pursue up front payment, you need an established brand with a clear value proposition and you sell the product to the end-user. Adobe’s Creative Suite is a canonical example. Customers know what the software can do and if they need it, customers will pay for it. The same is true for AutoCad, MS Office, and operating systems. Most of these products are high cost per seat products. Because they are well-known in the market, they command a price premium.
Money Back Guarantee
For products lacking an established brand, but offering an immediate value proposition and charging a high average seat value, there is no better solution than the money back guarantee. It mitigates the customers commitment phobia but establishes a billing relationship at the outset. This pricing strategy requires contact with a sales or account management team which implies a higher cost of sales. Ideally, higher conversion rates mitigate these costs. In other words, the up front commitment is a sales pre-qualifier. Your sales team will have fewer, higher quality leads. Plus, your sales team will have direct product feedback to share with the product team. Oracle offers this for many of their products as do Eloqua.
While each product and target market have some unique attributes, consider the time to value, complexity of the product, product complexity and your sales model (freemium vs sales) when you do price your startup’s product.
*Originally posted on Tom’s blog, here.