Which pricing model should you choose?

Which pricing model should you choose?

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.

Example ✍️

Typeform - see their pricing

Typeform's subscription-based pricing
Typeform's subscription-based pricing

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.

Advantages 👍

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.

Drawbacks 👎

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.

Example ✍️

Snowflake - see their pricing

Snowflake's usage-based pricing
Snowflake's usage-based pricing

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).

Advantages 👍

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.

Drawbacks 👎

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.

Example ✍️ - see their pricing's max-usage pricing's max-usage pricing

Customers pay the minimum platform fee each month, and may also pay additional charges depending on the highest usage value.

Advantages 👍

1. Pay-as-you-grow

This is considered fair pricing because your customers’ bills only increase if their user base grows.

2. Adapts to your customers’ business

If your customers’ business is highly seasonal, they will pay for maximum usage only during that period.

Drawbacks 👎

1. Hard to calculate costs based on maximum values

It’s hard to bill based on maximum usage as metrics can go up and down during the billing period. This model requires you to set up a reliable recording system.

2. Not easy to predict costs

For your customers, it’s hard to predict what they’ll pay at the end of the month, which may lead to a lack of transparency.

Hybrid pricing model

This pricing model is very popular among fintechs and neobanks. Customers pay a subscription fee and also have access to paying add-ons, whose pricing is based on usage.

Example ✍️

Revolut Business - see their pricing

Revolut's hybrid pricing
Revolut's hybrid pricing

The above example includes a monthly fee and many usage-based fees for transactions.

Advantages 👍

1. Predictable revenue

Your company’s revenue is more predictable, as the subscription fee is fixed. Your customers can upgrade to another tier if needed.

2. Only pay for the add-ons you need

Your customers will only pay additional options if they use them. There’s no surprise when they receive their bill.

Drawbacks 👎

1. Long price lists

Hybrid pricing is often associated with long price lists that include many fees and are difficult to read.

2. Hard to implement

Setting up a hybrid billing system is often a nightmare, because of all the fees and their logic.

Per-seat pricing model

A simple pricing model based on the number of users who have access to your application.

Example ✍️

Retool - see their pricing

Retool's per-seat pricing
Retool's per-seat pricing

Advantages 👍

1. Easy to read

This pricing is fairly easy to read and implement. Each time a new user is added, the customer’s bill increases.

Drawbacks 👎

1. Customers sharing credentials

Let’s be honest, we all do this. We share a bunch of credentials with our team to avoid paying for multiple seats.

Fair per-seat pricing model

Customers only pay for active users. If a user is added or removed during the billing period, the corresponding fee is prorated.

Example ✍️

Slack - see their pricing

Slack's fair per-seat pricing
Slack's fair per-seat pricing

Advantages 👍

1. Fair and transparent

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.

Drawbacks 👎

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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