Effective Pricing Strategies for Subscription-Based Businesses
Understanding the Importance of Pricing Strategies for Subscription-Based Businesses
Choosing the right pricing strategy for a high-technology company is critical amidst a fiercely competitive market. The subscription-based business model creates a natural path for recurring revenue, but the risk of customers evaluating competitors remains. To ensure continued business growth, high-tech companies must ensure pricing remains competitive and offers benefits to customers for their loyalty.
A subscription model allows the client to reap the benefits of lower costs while the provider can often ensure revenue through longer-tailed contracts. It’s always critical for companies to stay vigilant of the customer experience and competitor offerings.
Subscription businesses experienced a surge of more than 300% from 2012 to 2018, according to the Harvard Business Review, when the SaaS model grew, firms took advantage of the low hiring and compensation costs while customers reaped the lower cost benefits. Since then, we saw the ‘SaaS crash’ when demand slowed during the COVID-19 pandemic, and offerings must now add more subscription offerings to product lines to best meet customers where they are. (https://hbr.org/2023/04/the-rebirth-of-software-as-a-service)
These models provide many benefits to customers to encourage loyalty and lock in renewals. A study from Forbes shows it costs five times more to acquire a new customer than to retain an existing customer (https://www.forbes.com/sites/forbesbusinesscouncil/2022/12/12/customer-retention-versus-customer-acquisition/?sh=603197421c7d), reinforcing how important it is to retain customers via subscription models.
Consistency Across Global Markets
Global markets can pose challenges to a subscription-based pricing model as companies work to maximize profits in every market. Competitive pressures and economic conditions can vary by geography, and companies can’t always keep costs the same when delivering in different markets. However, consistent pricing maintains a brand reputation. Many global companies expect the same pricing but have the ability to source their services from many different locations or companies.
Maximizing Revenue
While you want to maximize your profit, customer retention is one of the keys to ensure you can focus on growth. Remember that it costs five times more for new customer acquisition! Balancing customer acquisition and retention is key to maximizing revenue. Ultimately, you must find the right pricing balance for your own profit and satisfy your customers. Choosing the right subscription-based model for your business and your clients is the best way to accomplish this.
Effective Pricing Strategies for Subscription-Based Businesses
Flat Rate Pricing
A flat rate pricing model provides the most simplicity. The pricing model remains the same for all of your customers regardless of usage or any other factors.
This pricing model works best for customers with a single product with plenty of brand equity. There isn’t room to negotiate with this model, which can keep brand equity intact, but could be a lost opportunity for those customers seeking a bargain.
PRO:
- Works best for customers with a single product with plenty of brand equity
- Steady pricing keeps brand equity intact
CON:
- Limited customized provides no room to negotiate
- Businesses who don’t utilize all features can pay for unneeded features
EXAMPLES: Your favorite podcasting technology that has a set rate for everyone looking to leverage it is a key example. The technology Basecamp is another example, which is a communication tool, with flat rate pricing where everyone pays the same flat rate.
Segmentation and Tiered Pricing
One of the most popular models is value-based pricing through tiered pricing. Price differentiation is important in the tiers offered, and it often allows for customer segmentation based on unique needs.
Typically, companies with high fixed costs benefit from leveraging segmented pricing as it provides an optimal platform for upselling and cross-selling opportunities. While it can be beneficial, it’s not always the best fit for every customer.
PRO:
- Customers benefit with higher control based on budget and their needs
- The seller has more opportunity to tap into different markets at different price points
CON:
- Can lead to more abandoned decisions as it can spur indecision in customers
- Forecasting revenue is more difficult given customers have more choices
EXAMPLE: Typically a tax software company offers tiered pricing where one can select the right level of service and features based on pricing.
Free Trials and Freemium Models
Free trials are a great tool for customers to try the product or service first. Freemium models serve as a customer acquisition strategy to hook new customers. It helps lower any risk for them. Converting free users to paid subscribers is the ultimate goal, so the trial experience is key in the customer journey. The spotlight is on conversion rate optimization, where the focus is on encouraging customers to upgrade.
PRO:
- Increases the user base quickly without risking prospects
- Reduces sales friction as selling becomes an easy and risk free process
- The free version creates opportunities for upselling premium features
CON:
- Can devalue your product’s services while introducing complexity in feature differentiation
- Costs add up to support free users
- Adoption rate directly influences revenue, which can add significant time to generate income
EXAMPLE: Many analytics dashboard services will offer a freemium pricing model for prospects to try the software, determine if it works for them, and ultimately upgrade. Trello is an example where there is a freemium tier with opportunity to upsell.
Dynamic & Demand-Based Pricing
Dynamic pricing adjusts prices based on market demand. A dynamic pricing model can be an incredible tool to retain customers or attract those who may have fluctuating usage. Data-driven pricing strategies attract customers who may need to learn what they need.
While demand-based pricing strategies can pose challenges for revenue management, a baseline of data can be collected in a short time to understand typical usage patterns.
PRO:
- Customers with variable usage benefit from the flexibility
- High perceived value from customers who pay for exactly what is leveraged and no wasted money
- High level of trust given pricing transparency
CON:
- Difficulty for provider to predict revenue accurately without visibility into the usage or variability in plans
EXAMPLE: Amazon Web Services (AWS) is a well known provider of variable usage pricing.
Value-Based Pricing
Value-based pricing is a model relying on customers’ perceived value of a service. You’re charging your customers for the value offered. Value pricing hinges on you setting the right price point as you’ll lose customers if you overcharge, but undercharging can cost you big revenue. Determining the right value is the key.
PRO:
- Focused on value and reflects the perceived value to the customer, allowing company to maximize profits
- Provides flexibility to software feature changes or improvements without requiring an overhaul of pricing structure
- Provides revenue stability as price is tied to value rather than usage or number of customers
CON:
- Requires a deep understanding of customer needs and the value they place on features
- Perceived value is subjective
- Effective value-based pricing relies on accurate customer data
- Higher risk of underpricing or overpricing
EXAMPLE: Adobe is a key name leveraging value-based pricing.
Markup or Cost-Plus Pricing
Markup pricing, or often called cost-plus pricing, is a pricing strategy based on the cost and markup added.
While common in retail, a markup pricing strategy is not the best for SaaS typically as the value of products can be much higher than the cost of production.
PRO:
- Simple to use while allowing for quick adjustments where needed
- Leads to consistent profit margins
- Not tied to competitors’ pricing, giving flexibility to adjust price as needed
CON:
- Does not reflect customer value
- No guarantee it will be as profitable as sales can easily be overestimated
- Limited flexibility to quickly respond to market changes in pricing
EXAMPLE: A markup pricing strategy is well known in retail companies.
Competitive Pricing
Competitive pricing is a well-known strategy for new SaaS companies as it establishes its price based on a benchmark for similar SaaS products. Competitive pricing strategies leverage the existing market data to determine the price for their service or product.
PRO:
- Risk is mitigated as a model is likely already proven and accepted in the market as industry norms
- Offers benefits for newcomers in the space as it can attract cost-conscious customers
CON:
- Lose out on valuable data behind the decisions competitors made in pricing
- Likely not sustainable for a long period of time as it can lead to lower profit margins
- Unique features or capabilities can be undervalued
EXAMPLE: Hulu is an example of competitive pricing as they priced similar to Netflix as they entered the space. They based their pricing off what they saw a Netflix subscriber was willing to pay.
Per-User Pricing
Per user pricing allows customers to pay based on the number of users. User pricing is typically sold by the number of licenses needed.
PRO:
- Simple to implement and forecast revenue
- Benefits are offered as purchasing in bulk for businesses looking to scale
CON:
- Buyers can be incentivized to limit the number of users to save in cost, limiting overall user engagement and adoption
- Organizations who don’t fully utilize the software will have to pay for unused licenses
EXAMPLE: Salesforce often offers user licensing pricing where customers pay based on the number of users.
Sustainable Growth: Iterating and Optimizing Pricing Strategies Over Time
While setting the right pricing strategy is important, it’s never a set-it-and-forget-it approach. You must continue optimizing pricing strategies as the market and customer preferences evolve. Optimizing pricing is the key to sustainable growth.
Conclusion: Implement the Right Pricing Strategy for Your Subscription-Based Business
The right SaaS pricing model and strategy combination is critical to success. You must understand your customers to ultimately know what they’re willing to pay and what competitors are charging as alternatives. Leveraging data is the key to understanding the best pricing strategy.
While it’s never a set it and forget it approach, you’ll need to keep an eye on the market and ensure you’re optimizing pricing just as competitors optimize theirs. More than anything, focus on providing value to your customers and harness all the data at your fingertips to drive your decisions. If you need help organizing or interpreting your data to get closer to your optimal pricing model or strategy, we can help!
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