Determining how much your buyer is willing to pay and then setting your price just below that is how you price anything—including subscription-based products. Ultimately, the key is estimating willingness to pay.
But when you dig deeper into subscription-based business models, there are interesting insights about willingness to pay that occur at different points in the buyer’s journey. And the single biggest difference between subscription and traditional business models is that subscription companies must manage three revenue buckets rather than just one.
Traditional businesses care almost exclusively about winning new customers—as do subscription companies. But subscription-based businesses also care about keeping and growing customers. These three revenue buckets—win, keep and grow—each must be managed separately.
The ‘Win’ Revenue Bucket
Subscription companies should treat this the same way traditional businesses do: by determining how much buyers are willing to pay and charging accordingly. However, subscription-based businesses face a few additional challenges.
Cash Flow
In a traditional business, companies typically receive their revenue in a lump sum. This makes it relatively easy to know if they’re selling at a profit or loss. Although costs shouldn’t be used to set prices, you do want to know that your revenue covers your costs, plus some profit.
In subscription business models, revenue is a stream. To know if your price covers costs, you must estimate the lifetime value of a customer. There are techniques and formulas to help with this, but you won’t really know if any single customer will be “profitable.” Instead, you want to ensure that total revenue from customers is profitable overall.
Packaging
Most companies—both traditional and subscription—have good-better-best packages. In traditional business models especially, good-better-best packaging becomes a powerful tool that simplifies the buyer’s decision process. It’s common for 50% or more of revenue to come from the middle (better) package.
Subscription companies also should use good-better-best packaging, but for a different reason: to give customers a growth path (more details on this in the section “The ‘Grow’ Revenue Bucket”). To win new customers, subscription companies typically lead with their “good” package, or even a “free” package if there is one.
The goal is to get a user to try the product and like it. Smart subscription companies focus on the total lifetime value of a customer, and the first step to that is winning the customer.
Pricing Metric
Another difference, especially in SaaS companies, is the pricing metric. What will you charge for? Per user? Per gigabyte? Per transaction? Per month? You name it. After studying SaaS pricing metrics, you realize these are important in many industries. Netflix put Blockbuster out of business by changing the pricing metric. Apple iTunes was the first to sell music by the song instead of the album. There are used bookstores in India selling books by the pound.
There are many pricing metrics from which to choose—if you’re thoughtful. However, if you want to win customers, choose the pricing metric based on what makes sense to your buyers. This typically means one of two things:
- Charge the same way the competitors do, or
- Charge for something highly correlated with how your customers receive and perceive value
The ‘Keep’ Revenue Bucket
From a pricing and packaging standpoint, this is the easiest bucket to manage. Don’t change anything. Sure, you can fix bugs and add more functionality to improve the user experience. But the point is, the customer chose you for a reason.
You likely still need a customer success department for onboarding and improving usage. One of my favorite observations about traditional vs. subscription businesses: Traditional businesses don’t actually care if you use their product.
With subscription-based businesses, however, you must worry about whether your users are getting value because, if they aren’t, they will stop paying you.
The price/value tradeoff also is interesting. Prior to the purchase, perceived value drives the purchase and you need to convince the buyer they will receive more value than the price. After the purchase, real value matters and you must make sure it happens. It’s still a price/value trade-off but it evolves over time.
The ‘Grow’ Revenue Bucket
Though critical for rapid growth, this revenue bucket often is overlooked and underemphasized. From a pricing and packaging perspective, it’s the bucket you should prioritize and give the most attention to once you’ve built a large customer base.
Grow revenue doesn’t really matter in the early stages of a subscription-based business. It becomes more important as your company grows and builds a larger user base. However, if you ignore this bucket early, you may make some decisions you’ll find are hard to change when you need to. There are four ways you can get any individual customer to pay you more money.
Raise Prices
Don’t do this too often, and be sure to implement any price increases thoughtfully. That being said, you can probably raise your prices now as long as you have a somewhat mature product. Here’s why: When the buyer first chose you, they didn’t know how much value your product would deliver. Then they acquired the product, used it, and realized it was worth the price—which is why they continue to pay you. Being certain about your value gives them a higher willingness to pay.
Also, as they become more comfortable with your product, your customers will use more of its capabilities, realizing even more value. You’ve also added new features to your product as time has passed, so your customer values your product more now than when they initially purchased it.
For a completely different reason, your customers are unlikely to leave because their switching costs have increased. Since adopting and using your product, they probably have built internal processes around it. They may have created API calls into other systems and trained many people on how to use it. Switching to another product becomes painful.
For these reasons, your customers are unlikely to leave if you raise your price—though that’s not a guarantee, and you’ll probably hear some complaints.
A great strategy is to first raise prices for customers who get the most value from your product. Do what you can to ensure they don’t leave, then work your way down to those customers who don’t get as much value. Use is a good indicator of value; those who use your product more than others likely place more value on it.
Increase Use
Increased revenue from increased use happens when you choose an appropriate pricing metric. (Remember: A pricing metric is what you charge for.)
For example, Salesforce charges by the user. As their customers grow and hire more salespeople, they pay more. Meanwhile, Constant Contact charges based on the number of contacts in their customers’ email lists. As customers grow their email lists, they pay Constant Contact more money.
Thinking through a pricing metric is a crucial step to pricing and packaging a subscription product. In fact, getting the pricing metric right is more important than getting the price level right. An ideal pricing metric makes sense to customers, is predictable, and highly correlated with the value they get. In other words: The more value they get, the more they pay you.
Upsell
Look through nearly every SaaS company’s pricing page and you will likely find three tiers of product features: good, better and best. Packaging and pricing these tiers may be hard, but it’s incredibly valuable. Say a user subscribes to your “good” package. Over time, they become more familiar, their company grows and their needs increase. Now you can upsell them to the “better” package.
Packaging your products well requires an understanding of how much your users value your product overall as well as how much they value individual features or capabilities. With this information, you can strategically put features into buckets so the customers who value those features most will buy up into the better or best package.
Cross-sell
If your company has chosen a market segment to serve, you likely are creating even more products to help it. Cross-selling simply takes advantage of the fantastic relationship you have built with a customer so you can offer them other products.
If the line between cross-sell and upsell is blurry, one way to think about cross-selling is that the product probably solves a different set of problems and it likely stands alone.
A Different Model Requires a Different Approach
Pricing and packaging for subscription-based businesses are different from traditional business models. There are three revenue buckets to manage, and one of them—the “grow” bucket—is powerful, yet usually misunderstood and mismanaged.
Master this win-keep-grow framework and learn to implement its different parts, and you’ll be the hero in your subscription-based organization. And the good news is, not many product professionals are doing this. Yet.
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