Default to price-based costingConsumption-based pricing Hosting feesMargin and markupPricing tiers Free tier limitations Open source versus free tierPricing webpage Service level agreementsWaitlistsSubscription termsTOS/Stripe Click-Through and subscription agreementsDiscount programs
Default to price-based costing
Don’t try and reinvent the pricing wheel. Default to using the price-based costing method which looks at what competitors or substitutes would charge to provide a similar product/service to get a sense of willingness to pay. Base your pricing off of existing incumbents and those who are defining the market at this time.
Pricing has a negative correlation with demand. When the price goes up, the number of customers willing to pay that price will go down. In general, pricing alone should be the primary reason 20% of people are not willing to buy the product.
Consumption-based pricing
The consumption-based pricing model is a service provision and payment scheme where the customer pays according to the resources used. The provider needs to track customer usage and bill accordingly. Consumption-based billing is best for businesses that can easily break down their offerings into small, variable units.
Advantages | Drawbacks |
Fair to the customer (paying for actual usage) | Difficult to predict revenue (can’t price annually) |
Align operating costs with customer usage rates (e.g. cloud storage) | Receive payment in arrears as opposed to in advance |
Hosting fees
Use hosting fees to control high hosting costs. When the cost of hosting is high, consider a hosting fee for small customers and a minimum size for hosting costs to be waived.
Two hosting examples:
Margin and markup
SaaS companies should typically target an 80-90% margin with a target of 15% or less of costs spent on infrastructure and a target of 5% or less of costs spent on support.
Calculating margin and markup
Margin = (Revenue - Costs)/Revenue = 1 - Costs/Revenue
Markup = (Revenue - Costs)/Costs = Revenue/Costs -1
Markup = Margin*Revenue/Costs = (1/(1 - Margin)) - 1
Markup = (1/(1 - 80%)) - 1 = (1/20%) - 1 = 500% - 1 = 400%
Pricing tiers
Use the Buyer-Based Open Core framework to determining what’s open source and what’s source-available. The open source project is always free and downloadable without restrictions and typically a separate offering from the free pricing tier.
Keep your pricing tiers simple by limiting to three tiers.
- Free: Typically a SaaS product that includes all the same functionality as the open source software and includes limited access to proprietary features and functionality. The open source version may be the “free tier” for self-hosted products but no limits should be imposed. Upgrades to paid plans will be driven primarily by features.
- Premium: Includes everything in free tier and introduces paid features. Premium tiers typically include some base-level support.
- Enterprise: The highest-paid tier that includes everything from free and premium plus enterprise-specific paid features and support.
Tier | Free (Good) | Premium (Better) | Enterprise (Best) |
Potential Buyer | Individual Contributor | Manager/Director | Executive |
Price | Free ($0) | $$ (e.g. $9) | $$$$ (e.g. $25) |
Billing | ă…¤ | per user/mo billed annually | per user/mo, billed annually |
Free tier limitations
The free tier drives upgrades to a paid version by imposing limitations, usually in the form of compute consumption, storage, a number of something (searches, projects, users), or some combination of those things. Avoid free forever plans. The intention of providing a free tier is to let people try out the product.
Design the free tier to start as a 30-day free trial of the premium offering and then revert to basic features. If hosting costs are significant, offering a free SaaS tier is not recommended. Provide a generous trial period that doesn’t require credit card information instead. Trials should always require a user account.
A well-designed trial period can help users understand the value of the product and encourage them to upgrade to paid plans.
Open source versus free tier
The open source project and the free version of your software are typically not the same thing. The open source project should always remain open source and be available to download, use, and modify via the repo it’s stored in. There are no restrictions, limits, or constraints on the open source version but it’s not usually available as a hosted SaaS product. It’s important to maintain a good, usable version of the open source project and contribute back to the open source community.
The “free tier” is typically a hosted SaaS product that includes all the same functionality as the open source software and includes some access to proprietary features and functionality. The goal of the free tier is to drive people to upgrade to paid versions. A free tier comes with limitations, usually in the form of consumption, number of users, storage, or some combination of those things.Limitations within the free tier should focus on quickly driving users to the paid tiers to reduce friction. We recommend providing a limited trial of premium features in the free tier upon signup.
The open source versions and free SaaS versions don’t need to match.
Pricing webpage
- Make the most desired choice the primary call to action.
- Use font size to show information hierarchy.
- Limit to three pricing tiers and clearly articulate the different tiers.
- Use the term “planned” when noting upcoming features. Don’t use “coming soon” because this can be interpreted as a promise.
- Use “SaaS” to describe hosted services (the company provides access to its own technology and infrastructure).
- Use “Cloud” to describe managed services (customers host the software themselves on their own technology and infrastructure). This is sometimes called “on-premise” or “self-hosted” but since most customers host at a hyper cloud, self-managed is a better term.
- Display the enterprise price on you pricing page. There are a lot of factors that can change the price for an enterprise company but including the price helps users self-select into the right category. If the listed enterprise is too much, it’s probably not the right category and acts as a gatekeeper for unqualified enterprise leads.
Service level agreements
Use a standard service level agreements (SLAs) for all customers. Don’t make it up based on what your customer asked for. Custom SLAs can quickly become unmanageable.
Waitlists
OCV doesn’t recommend wait lists. It adds an extra conversion point where you have drop-off and creates extra complexity. Withholding the download isn't very open as in open source / open core codebase.
Subscription terms
Simplify pricing plans by only offering an annual subscription. It makes it easier to instrument and finance your company when all customers are on the same plan versus segmenting by monthly and annual subscriptions. Companies can offer flexible payment terms and a money-back guarantee if customers have reservations about annual commitments .
Benefits of annual subscriptions
- Reduce customer churn
- Provide cash upfront, which is an effective non-dilutive way to fund the company (cash impact between monthly and annual contracts is substantial).
The recurring revenue metric of annual recurring revenue (ARR) versus monthly recurring revenue (MRR) differs based on the yearly or monthly billing subscription renewal period. Upfront billing ensures 12x recurring revenue when customers are billed yearly. Reporting metrics when a company has both annual and monthly customers is duplicated if both options are available to customers.
There is a risk of losing some business upfront in only billing yearly, but those customers are more likely to churn regardless. Often companies start with monthly billing and switch later to annual billing as they mature, but it is better to start with annual billing early on.
TOS/Stripe Click-Through and subscription agreements
If you’re starting with a low price point and offering self-serve onboarding (e.g., freemium models), it's best to use TOS/Stripe Click-Through for simple recurring payments. This approach minimizes user friction and streamlines transactions.
Subscription models and metered billing, on the other hand, are more complex and require more planning and thought, which can delay your launch. Unless you anticipate a significant volume of self-serve paid customers at launch (which is rare), it’s recommended to start with clearly defined pricing and terms of service (TOS). As customers cross payment thresholds, you can track this in your logs and manually invoice them. Once this process becomes unscalable, you can then automate and integrate billing solutions.
Discount programs
As your company grows to over 100 people and you can handle more complexity, you can consider discounted programs.
- Education: Free version without user limitations or paid offerings at a discounted price
- Non-profit: Discounted per-user price for paid offerings
- Startup: 50-75% discount for startups that meet specific criteria. For example, a seed-stage startup with less than $X in funding and less than $X in revenue.
Discounting may also happen outside of a specific program on a case-by-case basis. Companies don’t lose their ability to discount by having a list price.