Working out how your product or service will translate into a recurring revenue model is an important first step in making the transition to a subscription-based business model.
You have to balance your strategy for acquiring new customers, retaining existing ones, and work out how you’ll increase your company’s average order value over time.
You don’t want prices to be so low that your business costs aren’t covered, or so high that customers compare price to value and decide not to buy or cancel their subscription.
Price metrics are a powerful lever for subscription products because there are so many ways to bundle and present an offer. The challenge is determining which price metrics align best with the needs of your customer and your business.
What are the Various Subscription Price Metrics?
Businesses designing their subscription model have to determine two things in the beginning stages; (1.) how they’re going to measure product/service costs for each customer and, (2.) how they’re going to define their pricing plan.
Service costs can be measured on the basis of:
- Customer acquisition costs
- Fixed costs
- Activity based transactional costs. i.e. transactions, downloads, reports, gigabytes used, etc.
- Volume costs. i.e. the size of your customer’s business, the number of customers they have, etc. The larger the business, often the higher the cost/fee they pay (business scale).
- Customer support and management costs.
When deciding how you want to charge your customer, remember to evaluate how the pricing plan you choose will promote the growth of your business revenue over time.
Here’s a look at the most commonly used subscription pricing plans.
Flat Rate Subscription
This is the simplest model – one set price for unlimited access to your product(s) or service(s) for a specific period of time, often a year. The advantage of a flat or fixed fee is that it’s easy to set, straightforward for customers to understand, and simpler to sell because you’ve got one clearly-defined offer.
Usage Based Pricing
Customers using this model only pay for what they use. All that needs to be determined is the unit of measurement. Customers can be charged per transaction, for the data they use, or for the time they use a service, for example.
Utility and telecommunications companies often use usage-based pricing, as do many cloud software companies, including Microsoft, Google and Amazon Web Services.
This pricing model has become particularly attractive to B2B customers because they know that they don’t have to overcommit budgets to services that they don’t require, plus they often have the freedom to adjust these services up and down according to their various business needs.
Below is an example of how Amazon prices computer capacity by the hour. The full details can be seen on the company’s webpage here.
Tiered Subscription Pricing
Tiered subscriptions are perhaps the most common pricing model because they allow businesses to cater to a broader audience by offering different features at different price points.
Below is a five-tier subscription plan from e-mail marketing company, EmailOctopus:
E-mailOctopus has set up a program that appeals to start-ups with small budgets, right through to larger businesses with bigger spend (in this case, the whales). Discounts are often applied to the higher price levels to incentivize greater order value purchasing.
Deciding how many tiers to include really depends on your service and your market. If you’re starting out, check your competition for ideas. If you want to include a subscription offer as part of your existing business, drill down and examine what your customers are buying/using and look out for patterns and spikes. This should help you to determine what you offer at each level. The average number of pricing tiers businesses advertise is between three and five.
In bundle pricing, companies sell a package of products or services for a lower price than they would charge if the customer were to buy each item separately. A kid’s meal at a fast-food restaurant is an example of bundling, as is an inclusive vacation, where you get hotel accommodation, flights and car rental as part of a package.
In the B2B world, bundles often deliver different features and functionality that answer a specific set of problems. Telecommunications companies often bundle phone and internet services together, for example.
Intercom, a US based software company that provides a messaging platform to businesses, has created separate bundles to support different types of customer interaction, as can be seen below.
Many businesses are also beginning to offer customers the opportunity to purchase products à la carte, and to even create their own product bundles.
Freemium is the offer of services at no cost in exchange for a user’s personal information. When managed well, the freemium subscription model can help drive massive traffic to a company website with the lure of ‘try-before-you-buy’. Prime examples of businesses that have been hugely successful at using this model include Dropbox and LinkedIn.
Dropbox has approximately 500 million users who receive two free gigabytes of storage. Once users go over this limit, they are offered the option to upgrade to one terabyte for a monthly or annual subscription.
Free features can be a very effective marketing tool because they enable businesses to scale and attract a growing user base without spending a fortune on costly advertisements or a big sales team. Many services, including Dropbox, also offer incentives for referring friends.
“Freemium is more successful than 30-day free trials or other limited-term offers, because customers have become wary of cumbersome cancellation processes and find indefinite free access more compelling, writes Veneet Kumar, digital technology expert at Yale School of Management.
Freemium is also a clever way to collect customer data, which is inherently valuable in and of itself, as John Warillow points out below.
Free trials give customers the opportunity to try out a product or service for a defined period of time (usually 30 days) at no cost. Unlike freemium, the customer often gets access to the product or service’s full range of features.
Conversion rates vary widely for free trials (and freemium) in main because there are so many ways to deploy each strategy. Netflix, for example, retains approximately one in three people who try out its video streaming service. The average may be closer to 10%. Some of the best performing free trials hit 60% conversion rates, or even higher.
Building Value for the Customer and Your Business
There is a myriad of ways to package a subscription plan and the common strategies/pricing models discussed so far don’t have to stand alone to be successful.
What is critical, is that you build value for the customer that also turns a profit for you. When customers assess your offer, they will be considering the following things:
- Is this a fair offer for the price? Do I fundamentally like the value of this offer?
- How flexible is this service? Can I grow with it, or will it put pressure on my budget over the longer term?
- Are the costs of this service transparent and predictable?
You also have to reflect on how the pricing model you choose will ultimately impact your company’s internal goals.
Some of the things you will have to evaluate are:
- the key metrics that will best drive customer adoption and enable upsell and cross-sell.
- how to maximize coverage of your customer segments and how to scale with customer growth and enable future price increments.
- how you can best manage the administration, monitoring and control of your subscription pricing model.
- How easy it will be to sell and communicate the new pricing plan.
Experiment with Your Pricing
Ultimately, the only way to work out if you’ve got the pricing and your subscription model right is to trial different approaches. By market testing different price points and access models you can evaluate if your strategy is resonating with buyers. You may find that your product is undervalued, or even overpriced. Reviewing your product pricing and the monetization of your model should be a constant so that you can keep step with the competition and the overall market.