Pricing
Default to price-based costing
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 on 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. Experiment with different deal structures & pricing units to see what works for your customers to drive sales.
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:
Pricing tiers
Keep your pricing tiers simple by limiting them to 3 tiers. It’s OK if you need to go up to four tiers, but don’t add more than that. Upgrades to paid plans will be driven primarily by features.
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.
Premium: Includes everything in the 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. Enterpriseready.io is a great resource to find paid features to build first.
Potential Buyer
Individual Contributor
Manager/Director
Executive
Price
Free ($0)
$$ (e.g. $9)
$$$$ (e.g. $99)
Billing
per user/mo billed annually
per user/mo, billed annually
Open source and free tier are not the same
The open source project is 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.
The free tier is 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 by imposing limitations, like limits on 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. The intention of providing a free tier is to let people try out the product. Avoid free forever plans.
For self-hosted products with no SaaS option, the open source version may be the free "tier," but no limits should be imposed.
Free tier starts as a premium trial
highDesign 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.
Only offer annual billing 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.
Wrap professional services into a subscription
Any subscription service is basically support when the product doesn’t exist yet. It’s important to get the customers on a subscription contract early on (instead of billing professional services hours) so they’ll have access to future product releases. This ensures high retention for the long term.
Instead of charging customers for building new features, use it as a point of negotiation for more subscriptions or higher-tier subscriptions. As the R&D team spends time supporting customer needs, they will gain valuable insights that serve as the basis for proprietary product features.
Companies can provide consulting services (hourly rates).
Support should only be sold through a subscription contract.
With a subscription, customers have access to proprietary features for free. There is no discount for not using the product.
It’s okay to do things that don’t scale - don’t worry about too much support with early customers. Just make sure it isn’t consulting work.
Customers like professional services—purchasing teams have the budget, but not enough time. Have on record that they’ll save XXX hours with your professional services team on board. The company will learn a ton from the professional services team. Make sure there’s internal knowledge sharing and transfer.
Looking a few years into the future, companies will have a professional services department (typically <10% of overall revenue). It’s recommended to build this in-house before onboarding external partners so the company retains knowledge acquired during the engagement.
Service level agreements
Use a standard service level agreement (SLA) for all customers. Don’t make it up based on what your customer asked for. Custom SLAs can quickly become unmanageable.
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.
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.
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