SaaS pricing strategies
As a SaaS startup team, you’ll have to choose a pricing model for your product at some point. This decision is crucial as it shapes the future of your brand, your marketing and your business.
When we started our pricing strategy research we were choosing between freemium and free trial as these are the models our competitors use. We were surprised to find out there are actually tens of different monetization strategies a startup can choose from.
Let’s quickly cover the most popular SaaS pricing models, so you have all the ammunition you need to make the right decision for your team.
Free with ads
If you frequent YouTube or have seen pop-up ads in your free mobile game, then you’re already familiar with the “free with ads” model.
You should be careful with the amount of ads you display within your app as people get easily annoyed and tend to seek out the ads-free alternative. E.g. I’m really getting tired of the ads in Skype. It turns out, I’m not alone:
When choosing this pricing model for your SaaS startup, make sure you can promote your product well enough to produce plenty of visitors. You’ll need lots of traffic in order to effectively monetize the ads. Even if your app goes viral, bear in mind that virality won’t last forever. In order to sustain this model, you’ll have to constantly come up with new ideas and build new apps to maintain your cash flow.
Whether you tried to catch ‘em all or not, we all saw the Pokémon GO game become a global obsession in 2016. But look what happened to it within just a couple of months. Even though we are talking about a game, and not a SaaS, the following graph shows how even the hottest trends can quickly lose momentum. The hype surrounding the world’s most popular products can fade in the blink of an eye.
In a free trial financial model, you are letting customers use the full version of the product for a brief period, usually for 7, 15 or 30 days.
Personally, I like free trials. Lots of marketing software comes as free trial (E.g. Ahrefs, Intercom). If your free trial user converts into a paying customer – that’s perfect. If not – that’s great too. First, because you don’t have to spend your time, effort and resources dealing with a non-paying client like you would in a freemium financial model. Secondly, you have your lead’s email which is a powerful weapon in your hands, letting you convert a potential client into a satisfied paying customer later.
Freemium pricing model. Pros and cons
Freemium services offer a light version of the product with basic, often limited functionality that you give away forever and at no charge. How does freemium work? If your customers are interested in the full version of the product or getting additional features, they’d have to upgrade to a paid package. Just like there are many marketing products with free trial pricing, there is also a big bunch of freemium fans. Marketing tools like Screaming Frog, Similar Web, and Buffer are all using freemium.
It sounds good, doesn’t it – you attract lots of customers, collect their feedback, they are spreading the word about your product…
But how will you convert freemium users into paying customers? You should keep in mind that the average freemium conversion rate for a SaaS company is as low as 1-2%. Therefore you’ll need to attract a high volume of free users to stay profitable.
Let’s say your monthly fee is $50 and your need at least $10K to break even and continue running your business. Simple math tells us that you’ll need a minimum of 200 paying clients, which means you must attract from 10K to 20K free users in order to convert enough of that group into income generators.
And we are not even talking about profit here!
Additionally, these 20K free users require lots of resources such as customer support, storage space and so on.
Finally, don’t forget to prioritize the feedback you receive from the paying customers. Your freemium users’ wish list may guide your product in a wrong direction. Don’t sacrifice profitability by leaving your real source of income unattended to care for the much larger group of free users.
There are also a few types of freemium pricing models; let’s take a look at the most popular variants:
This pricing model is very much like traditional freemium. The app is free, but you can get some features (often not indispensable) for extra money. Viber and Duolingo are great examples of this model. They are both free, yet Viber sells stickers and you can buy lingots from the Duolingo app. Popular games like World of Tanks, Dota, and Overwatch also use this strategy letting their users make in-game purchases.
Choosing this SaaS pricing model is justified when:
- You can afford to attract and support tons of free users.
- You can develop a high loyalty toward your product within your audience (e.g. I really appreciate the great job Duolingo team does with their product – it gives me a great opportunity to learn Spanish for free, so I tend to buy lingots out of my high loyalty towards them).
Free with paid services
This is a business model where you give away your software for free and sell additional services or upgrades – customize it according to the clients’ needs, add features, provide extra support.
It’s a hard-to-scale pricing model as you are basically selling your services, not a product.
This model would work well with a demanding enterprise sector where companies need a fully-customized product or extra hours from your support team.
We tend to think of a SaaS product as a project that requires significant effort from your development team in the beginning. With time, we think, it’ll become less of a strain. Well, with free-with-paid-services pricing model it’s the opposite. You will require even more resources to develop custom features for each and every customer.
There could be some combinations as well. For example, you could use ads in your freemium product and once the user switches to the paid plan, the ads could be removed and additional features could be added. I was thinking of Skype again, but then realized even if you make paid phone calls, you still see the annoying ads.
You can also combine freemium and free trial. A good example is another marketing tool, Buzzsumo – they give you a free 14-day trial to test their premium features and then you can switch to a paid plan. If you don’t switch, you will still be able to use their tool, but only as a limited app version.
Freemium vs Free trial
If you are choosing between freemium and free trial, these are the questions you have to ask yourself. They’ll help you come up with the right decision:
- If you choose freemium, will your free clients bring a proper value to your business?
Maybe your freemium clients provide you with valuable feedback or help generate word-of-mouth. They should bring you a benefit of some kind. If they don’t, you simply shouldn’t go after freemium.
- How big is your market? Do you have a B2B or B2C market?
If you are choosing a B2B pricing strategy, you should consider the size of your market. There is no point in choosing freemium if you have a niche B2B product. As mentioned above, freemium requires a large number of users, and with a narrow industry you just won’t get that many customers. Freemium works well for large B2C or B2B markets. But when it comes to narrowing the niche down it’s best to go with a free trial.
- Have you got a financial backup to support a freemium model?
Handling millions of users could be quite challenging for your pocket. You have to do the math right before making a decision on your pricing strategy.
- Does your product deliver value right away or over time?
If the value is being delivered right away, free trial is the best solution. If the value that a product delivers increases over time, then freemium could be a good choice for you. E.g. for a business messenger like we are building, teams experience a cumulative benefit from the searchable files and saved messages they’ve stored in our cloud over time.
Pay to get started
As you know, everything old is new again. So this is a relatively new—yet actually very old— pricing model where customers don’t get anything for free. I first got to know this model after subscribing to a beta test at https://www.getcompass.co/. Compass is a service showing you the ads run by your competitors in Facebook and LinkedIn.
What was interesting about them—and what really surprised me—was their paid beta test. First I thought, “Seriously? You really want me to pay for a beta test of your product?”
But then I took a closer look and even asked their founder to go deeper, explaining his approach and this is how he went about it:
We want to ensure that our customers are qualified – they truly have an urgent need which they’re willing to spend money to solve. Steve Blank pushes this framework and it has been used by a lot of startups in the Valley. Moreover, our pricing is a fraction of the value our customers are getting – so if paying anything at all is a deal-breaker for them, they’re not the right customer to co-design our product with, because it signals that solving the problem is not of much value to them.
I really liked this answer and it made me rethink the whole pricing policy that we initially planned for our Chanty business messenger. As I said before, we were going to make our product a freemium. We needed about 100 teams to use our paid version to break even and continue running the company. 100 paid teams meant at least 10K free teams which is between 100K to 1M forever-free customers. Handling 1M non-paid customers sounds a bit intense for a bootstrapped startup like we are.
We thought we’d start off with a freemium, see how it goes and then most likely change it to a free trial with time. We hope to receive several benefits from our freemium users during an early stage. First off, they’re testing out our UX. Secondly, we hope for a word-of-mouth effect.
Messengers are considered to be a software with a high virality. Having 100 emails of beta users could result in a couple of thousand emails to their teammates that would join them in the business messenger chat. This increases our chances for word-of-mouth if we make sure our product is really good.
- Some of the most popular pricing models for SaaS startups are free trial, freemium, free with ads or the freemium versions: free with paid services and in-app purchase.
- There is also a “pay-to-get-started” pricing model where nothing is free. If you are confident your product is about to change the world and holds an impeccable value, go for this model.
- When choosing between free trial and freemium, think about the size of the market you are entering and your funding abilities, as well as what benefit you could potentially receive from your freemium users.
We’ll keep you updated and share everything we learn on our journey to a great SaaS product. Let us know what affected your decision when choosing a pricing model for your startup? We look forward to your comments.
Also published on Medium.