Starting a company requires to build a pricing model that is both suitable for your current needs and scalable enough to generate revenue. Pricing models are evolving as fast as new products are emerging on the market.
Around 2010, the subscription model became famous because it was a true revolution: high upfront fees were no longer the norm, companies started to provide software as a service, for which customers paid a monthly fee. In recent years, as competition was increasing, some actors like AWS initiated a new revolution: pay-as-you-go (i.e. only for what you use).
It’s not easy to determine exactly what your pricing model should be, and switching from one to another incurs high costs for engineering and business teams. Updating a billing engine is a long process, and painful one if your billing system is homemade. To help you make your decision, we’ve listed here the most famous pricing models, with their advantages and drawbacks.
Subscription-based pricing model
This model emerged about 10 years ago with the SaaS fame. With this model, your customers pay a fixed fee on a monthly/yearly basis to use your product.
This pricing is fairly simple. You choose a plan, and you can upgrade (or downgrade) if you need access to more features, also called entitlement rights. In most cases, customers can choose to pay monthly or yearly.
1. Skip the decision fatigue for customers
Decision to buy your product is pretty easy. Customers often select the first plan and upgrade if they need to access more features.
2. More transparency
A grid of plans is easy to read and your customers know exactly what they will have to pay at the end of the billing period. No surprise.
3. More predictability
Your customers can predict how much your tool will cost them, which makes it easy to allocate a budget.
1. The slow path to upselling
Your customers only upgrade when they need a new feature. However, you don’t know when they’ll reach the next stage.
2. Lack of personalization
Your customers pay for a set of pre-built features, including those they don’t need.
3. Makes it hard to increase your ARPU (average revenue per user)
As customers pay a fixed price every month/year, it’s hard to make them pay more, even when they are power users. The average revenue per user may remain the same for a long period.
Usage-based pricing model
This model has been democratized by AWS with its pay-as-you-go pricing. It’s often presented as a full consumption-based model, where customers only pay for what they use.
Customers don’t pay any recurring fee, they only pay for what they use. It’s the most popular pricing among cloud and API companies (e.g. charges based on API usage, storage, data exchange and computation).
1. Makes it easier to test the product (product-led growth)
As your customers don’t have to pay an upfront or fixed fee, they can easily test your product. Bills will increase according to the level of adoption.
2. Fair pricing
Your customers don’t pay for the features they never use. This model fosters product adoption and increases customer satisfaction.
1. Unpredictable usage and spikes
As customers pay according to their consumption, usage spikes are difficult to predict. It’s not uncommon to see a Snowflake two-year budget spent in less than six months.
2. Less stickiness
As there’s usually no commitment, it’s easier for customers to churn and choose another product.
Max-usage pricing model
This model allows you to charge customers the highest usage value recorded during the billing period, on top of the minimum platform fee.
It’s a fair and transparent pricing model: your customers only pay for active users. It’s often a good pricing for tools built around communities, like Slack and Notion.
1. Hard to implement technically
It’s a pain for engineers to implement this kind of logic, as you need to track user activity and calculate prorated fees.
2. Bills are hard to read
You need to issue detailed invoices to account for user activity, but when there’s too much information, it can be difficult for customers to understand their bills. Frankly, I sometimes have a hard time reading Slack’s invoices.
We hope this will help you find the optimal model for your business. Keep in mind that pricing depends on your product, and the stage of development of your company. Whatever your decision, you can use Lago to set up your billing system in just a few days.
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