Determining the right monetization strategy is by far the most important issue for every SaaS business. You can have all the traction in the world — acquire, activate, and retain hundreds of users, but until your startup earns money, you are doing charity work, not running a business. To make your startup truly profitable you need an effective pricing strategy.
How to choose a pricing strategy
It’s not easy to choose the right pricing strategy for a SaaS product. The decision will affect and shape your brand, your marketing, and your business.
Moreover, just coming up with a pricing page once isn’t enough. Your product improves with time, your business team grows, and so your pricing can’t stay outdated. The pricing page will show better performance if you constantly experiment, test, and optimize.
Jordan T. McBride, a SaaS pricing expert, claims that a company should update its pricing page every six months. The article also stated that companies usually spend only up to six hours choosing their pricing strategy and coming up with a pricing plan. Then they typically stick to this plan for years without revisiting it or making any changes.
At Chanty, we spent several weeks researching so we could make the right decision on our own pricing strategy. Today I am going to share everything we’ve learned to help you make your choice.
Freemium isn’t free
In order to even talk about pricing for SaaS products, we need to address one of the most popular strategies used today. The freemium model.
The word itself is a combination of free and premium. Different sources define freemium as a business model or a pricing strategy. The tech-savvy millennials (me being one of them) are already familiar with the “shareware” concept that was turned into freemium. To put it simply, SaaS freemium pricing gives you the ability to use the lite version of the product for free with the option of upgrading to a paid plan with extra features.
Even if you are just starting to consider building a SaaS startup, you’ve probably used products with either freemium pricing or a free trial. The battle between these two models is the most prominent in the SaaS world. However, your pricing options go far beyond these.
6 questions to ask when determining a pricing strategy
To develop a pricing strategy, you’ll need to walk through the same steps you took when creating your business plan. This will help you consider every operational and external factor to arrive at the best initial pricing strategy for your business.
So, before you dive into specific pricing models you should first ask yourself the following questions.
1. What is the pricing strategy of your competitors?
Unless you are inventing a new market with your product, there are companies out there that your product will compete with. They have already gone a long way and probably tested lots of different concepts and pricing strategies. It’s fair to think that you can repeat what your competitors are doing and succeed as well.
However, there’s one thing you should pay particular attention to — the competitor size and funding. If you are a bootstrapped DIY solopreneur, you should estimate your chances and think twice before choosing your VC-funded, 200-employees-strong competitor’s pricing strategy.
My advice? Take a look at the successful market players that are equal to your company in size and potential. Additionally, pay attention to how long they’ve been in business and if their pricing strategy has changed over time.
Chanty, for example, directly competes with the likes of Slack. We quickly realized that the market we were entering is built for virality. In order to have any chance of succeeding, business owners in this niche need a mass of free users to spread the word about their app. Therefore, a large number of our competitors (both big and small) either go with a freemium or free trial model, giving us an obvious starting point.
2. What is the market size?
The size of the market you are entering is important. You can’t just look at the entire market and think that’s how many customers are available to you.
You’ll need to consider how much of the market you’ll actually attract, and what portion you’ll then be able to convert. Depending on how narrow or broad your target market ends up being, some pricing models simply won’t be effective. Similar to how your competitors approach pricing, this can be a simple way to narrow down your viable options.
3. How is the value of your product delivered?
Are you able to convey the value of your product instantly? Or is it a bit more complicated and needs to be experienced to understand the benefit? Your answer to this question can help you decide if a free version or trial model should be included in your pricing strategy.
For example, marketing software usually has a clear, easy-to-understand value; that’s why products like Ahrefs and Semrush don’t have freemium options. Instead, they require either a small intro fee or provide variations of the tool to test out.
Productivity software on the other hand, like Slack or Outpost, is much more difficult to sell the benefit. The positive results customers receive out of it grows with time and therefore a free element may be more necessary.
4. Can free users bring you value?
According to a law of equivalent exchange, when you are giving away something, you have to receive something back. With a freemium app, if you are giving away the software for free, there should be some kind of immaterial return — a word-of-mouth recommendation, email address, valuable feedback, or a chance to convert into a paying customer in the future.
If non-paying customers clearly don’t bring you much value, you shouldn’t consider freemium as an option.
5. How is your startup funded?
Bootstrapped startups can rarely afford to play a freemium business game due to the high cost per additional (free) customer and the low conversion rate from freemium into premium. Moreover, it’s important for a solopreneur to start earning money with the product as soon as possible to keep the business up and running.
However, if you’ve done the simple math and it seems like your pocket (or your VC funding) is large enough to support all the freemiums—go for it.
6. Is your product unique?
If it is, plus the product value is clear, you should definitely go with the premium option. Inventing a new market with a product has its advantages. It’s much easier to get customers to pay for an app when they have no other options — e.g. no other competitors around with freemium or free trial.
Choosing the pay-to-get-started approach will also help you to validate the business idea. The first paying customers will be the best proof that the issue your product solves is important enough and worth paying for.
7 Common startup pricing strategies
Now that you’ve walked through your business and validated your options it’s time to actually develop your pricing strategy. Let’s take a look and see what works best for your business.
Let’s dive a bit deeper into the freemium pricing model. More than likely, you see the potential value of it as an option, but that doesn’t mean you should revolve your pricing structure around it.
Although some companies optimize their pricing well enough to receive more than 4 percent conversion rate from freemium into premium, the majority of SaaS products are lucky to achieve a rate as low as 1 percent.
By the way, we are talking about the high-quality products that work and add value, not some buggy minimum viable products (MVPs) that a large number of startups come up with after several weeks of work. Conversion rates for underdeveloped products are likely to be much lower.
“The easiest way to get 1 million people paying is to get 1 billion people using.”
Just think of the resources that attaining 1 billion users might require—the time and effort of your team to support all these users, the cloud space to keep their data. That said, I’d highlight that it’s easier for big companies with deep pockets to run a freemium product.
Here’s how to determine if freemium is right for you
- Figure out how many paying customers you need to run the company. If you charge every user $50 and spend $10K to pay the business bills, you need at least 200 customers to break even.
- Multiply that number by 100 if the conversion rate you are expecting is closer to 1 percent for the minimum number of free users you’ll have to support. In our example, it’s 20K non-paying customers.
- Think of how much storage space every user of your product might need, as well as an average support time your freemium customers will require per month. It’s critical to understand the metrics in terms of dollars per additional user, as you’ll have to spend this amount to serve thousands of your non-paying customers.
Is freemium a good long-term strategy?
There is another downside of this strategy you could run into:
Freemium is so popular that many SaaS startup owners consider this pricing option and regret this choice afterward. I talked to Adam Hempenstall, founder and CEO at BetterProposals, who has been using freemium for three years for his SaaS product:
“Honestly, I think it was a mistake. What it did do to start with was remove price as an issue so we could focus on getting the product right and usability right. Initially, I think this was a good idea.
The issue going forward is as you try to narrow down on your user base, you find that free users give you different feedback, have different requirements, and generally don’t value the service like paying users do.
I suspect we’ll get rid of the freemium model at some point soon as there’s no real benefit. You’re not going to go viral Dropbox style, so having a freemium model doesn’t really work. I would suggest doing it until you get to 100 active users—iron out any bugs and issues, then switch it off and charge any new people.”
Your non-paying customers don’t value the product as much as paying users do. They have different needs, so their feedback will differ. Many startups make the mistake of focusing on the feedback from non-paying users and end up making a product for those who have never spent a penny on their product. What you really should do is to make your premium customers a priority — listen to what they say, what they want, and develop the product according to their needs.
As you can see, there are a lot of things to consider around using the freemium pricing model. If it’s got so many pitfalls, why so many companies keep using it? Let’s take a look at the benefits now:
- Freemium customers could be a great source of virality. Let’s face it—everyone likes free stuff. It’s easier to attract users at no charge. Once your customers get used to the product and develop trust and loyalty toward your business, they will become your advocates and spread the word.
- Freemium customers are likely to convert into paying customers. If the value of the premium product version is clear, the customers who developed trust in and loyalty to the company could become paying customers with time.
Another friend of mine, multipreneur, and CEO at Ritekit Saul Fleischman has actually found the freemium model beneficial for some of his SaaS products:
“With forever free users, they blog about us, and we get to market to them. We do on-site notifications, newsletters, and actually, some of them actually convert after even a long time as free users.”
Having that much said about freemium pricing in its conventional form, let’s move on to other pricing strategies.
2. Free with in-app purchase
This type of freemium is quite popular with computer games as well as mobile apps we come across daily. The name is self-explanatory — you offer an app for free and charge for in-app purchases and add-ons to provide users with a better experience or bring extra value. A paid sticker on Viber or an extra weapon in World of Tanks could be a great example of an in-app purchase.
Sales are usually physiologically motivated, like computer games addiction, high loyalty toward a company (I used to buy lingots at Duolingo just because I appreciate the great work they’ve done with the app), or an impeccable value of the add-on.
3. Free with ads
We run into this kind of software services every day — Google, Youtube, Instagram, and so on. They attract millions of customers and monetize by displaying in-app advertisements. It’s mostly popular with B2C markets. If your SaaS targets consumers, your app went viral, and you plan to have a mass of users visiting, this might be a good monetization strategy to consider.
4. $1 freemium
When I came across this approach for the first time, I thought it was brilliant — instead of giving away the app for free, you charge customers $1 for the lite product version. It’s not much, yet it’s not free. This approach removes the physiological barrier one might have while using a product at no charge. The hardest thing, they say, is to get someone to pay $1 if you previously received the same value for free.
This strategy was adopted by Zendesk. However, they’ve changed their tactics with time and you can see the price for their basic version had gone up to $5 per user which looks like a regular free trial now. My wild guess is that the number of starter plans was growing rapidly so they had to raise the bar. I’m still waiting for an official answer from their representatives as this option seems very attractive to me.
5. Free trial
If you are not familiar with pricing models, it’s likely you are confusing free trial and freemium. Some people think having a “free” component in a product makes it freemium. That’s wrong. The difference between a free trial and freemium is indeed striking.
In a free trial, you offer the premium version of your product for free for a certain period of time (usually seven, 15, or 30 days). Once the trial is over, the customer has an option to continue using the app by upgrading to a paid plan or to stop using the product and migrate to your competitor.
By offering a free trial you are basically telling your customers that there are no strings attached and they are not obliged to pay unless they like the software. Your task is to do your best to push free users down the funnel and convert them into paying customers during their free trial.
Well-known SaaS companies constantly experiment with their pricing pages and test different tactics. Freemium is often combined with a free trial as well as with ads. Think of the various mobile apps where they show you half-screen ads with an option to pay for using it ads-free, or freemium marketing products that offer a free trial of their premium product.
LinkedIn, for instance, is a jack of all trades when it comes to monetization. It offers a freemium of their social network to everyone, has a premium plan as well as a free trial of this plan, plus it also monetizes on the ads. Skype could also be considered as an example of this combined monetization approach; it is making money both by featuring ads and offering add-ons like landline or mobile calls.
There’s nothing free in this pricing option—no trial period, no lite product version. It’s pretty simple: users have to pay to get started. Some companies go even further, requesting an upfront payment at their beta stage. I was surprised to come across a beta app I had to pay for. However, after a short chat with Rand Owens, the CEO, and founder of Compass who has applied this strategy to his startup, I started thinking of it as a good idea:
“We want to ensure that our customers are qualified—they have an urgent need which they’re willing to spend money to solve. Our product pricing is a fraction of the value our customers are getting.
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 isn’t of much value to them.”
Pricing strategy is an evolving process
Choosing a pricing strategy should be a well-thought-through decision. Our research has shown that a freemium path results in serious responsibility — you and your team would have to spend plenty of time, effort, and resources to support thousands of non-paying users. At the same time, going down the route of a free trial or premium strategy may not result in as much exposure as your product could’ve had with freemium.
Only you can make the tough choice. The good news is, your decision doesn’t have to be final. In the world of lean startups, you can iterate and experiment trying new and different approaches, looking for the perfect one for your business.
The ultimate goal of experimenting with the pricing is to convert as many users as possible into paying customers. If you still don’t think your pricing page requires more than six hours of your attention, consider that even the slightest change in conversion rate could result in thousands of dollars in lost sales.
Editors’ note: This article was originally published in 2017 and updated for 2020.