You’re reading part II of a series.
Part I: 5 Subscription-Based Pricing Models, and How to Choose the Right One
We’ve explored various models for pricing a subscription offering. Now, with a model in hand, it’s time to dig into the details of how to attract and retain customers.
We’ll walk through strategic actions around pricing that can support your business’s growth goal — whether it be cultivating brand recognition, gaining market share or simply selling more of a subscription. Bonus: These strategies work for non-subscription offerings, too.
After all, in the immortal lyrics of “Milkshake” by Kelis, “My [pricing strategies] bring all the [customers] to the yard.”*
*Lyrics may have been altered slightly.
Definition: Captive pricing involves a company developing a core product that requires accessories and add-ons in order to function.
Best for: products with natural, complementary add-on options. SaaS companies have used the captive pricing strategy successfully. For instance, a web analytics software company charges $50 a month for its basic version. However, throughout their time using the product, customers will find that they absolutely need the add-ons — like more saved reports per seat, more data modelling capabilities and more monthly tracked users — to enable the core product. So, they buy the add-ons.
Example: A color printer costs $225. However, in order for the printer to work, it needs ink cartridges from the same company. Four-packs of cartridges cost $115, and you’ll need to purchase them on a recurring basis throughout the printer’s life.
Requirements: Products must require regularly replenished supplies.
Advantages of the Captive Product Pricing Strategy
Definition: This strategy entails pricing new products at the highest initial price that customers will pay, then gradually lowering it over time.
Best for: products that are innovative or trendy, have very little competition and appeal to early adopters. To use this strategy, a company and its products usually have to be well-known — and known for quality — in order to justify the hefty price tag. Price skimming is typically effective in sectors like technology and fashion.
Example: A highly-anticipated gaming console is released to the public for $800. However, after two months, the company decreases the price by 25%, to $600.
Requirements: Strong brand recognition; a premium, “must-have” product; and a loyal brand following.
Advantages of the Price Skimming Strategy
Definition: Penetration pricing, also referred to as loss leader pricing, is the opposite of the skimming pricing strategy. A low price allows companies to gain market share by attracting new customers who spread the word about the offering and enticing customers away from competitors. The goal is to rapidly penetrate the market — then eventually raise prices without losing those early adopters.
Best for: a price-sensitive market, unlike the one appropriate for price skimming. Products should have broad appeal with clear economies of scale, since this strategy relies on customers volume to help cover costs prior to the planned price hike.
Example: A streaming platform cuts through the noise of an intensely competitive market by offering its service for $6.99 a month, significantly lower than competitors’ $8.99 and $11.99. After a year at that rate, it increases price by 15% to $8 a month.
Requirements: Products tend to need broad appeal in competitive markets. Additionally, companies will need to be able to withstand any losses that low prices incur.
Advantages of the Penetration Pricing Strategy
Image Credit: Corporate Finance Institute(opens in a new tab)
Definition: Premium pricing, also known as image or prestige pricing, involves setting a higher price to give the impression of superior quality. The price communicates luxury and performance and encourages favorable perceptions among buyers. Unlike skimming, there isn’t a plan around premium prices to lower them.
Best for: companies with brand loyalty and reputation. The product or service, meanwhile, must have unique features to justify the premium.
Example: A car-rental subscription service offers a “standard” membership for $699 a month and a “deluxe” membership for $899 a month. While the programs are largely the same, “deluxe” offers access to more luxurious cars. The latter is the company’s “premium” pricing option. Depending on its products, a company might have multiple premium pricing options (e.g., Apple).
Requirements: The offering must have a premium, unique perception, which will likely require more marketing spend.
Advantages of Premium Pricing
Definition: Companies that use the freemium pricing strategy offer a basic product for free and an enhanced version with more features, services and/or content for a fee. The enhanced version can also be considered premium due to a lack of features — like ads.
Fast-Growing Software Firms and Product-Led Growth: Freemium and free trials (more on those next) are prime examples of product-led growth (PLG), which is immensely popular among young SaaS companies. With this strategy, startups engage directly with end users, allowing them to survive stretches of slow growth.
Best for: products that appeal to a large audience with a natural progression from “free” to “premium.” Freemium conversion rates generally fall between 2–5%, which means that a company needs a large user base and an effective conversion strategy.
Example: An IT management software offers a completely free IT help desk. Included are unlimited tickets, users, devices, agents and technicians. However, the free version is ad- supported. If a customer wants to get rid of the ads, it can pay $50 a month. The paid version also allows customer companies to display their logos in the ad space and in report PDFs.
Requirements: Companies need to have an obvious method for converting non-paying users to paying ones. People like free things — what makes the paid version worth the investment?
Advantages of Freemium Pricing
Definition: Free trials let customers try an offering at no cost for a limited time. A user can continue using the free version of the offering indefinitely, versus, say, 30 days with a trial subscription.
Free trials are classified as either opt-in or opt-out. An opt-in free trial allows a user to access the trial without providing any information up front. An opt-out free trial requires users to provide a payment method and explicitly leave the program prior to the end of their free trial to avoid being charged.
Best for: companies that want to provide prospects with their full service, not the stripped-down version common in the freemium strategy. With a free trial, users receive every feature they would get with the paid version of the offering — but only for a short amount of time.
Example: A digital media publication gives customers two weeks of free, unlimited content. After those two weeks, the customer must pay $5.99 a month to retain the same access.
Requirements: Companies must have the resources to convert free trial users to paid customers. For instance, does the business have the employee capacity to nurture and follow up with leads? Additionally, it will need to ensure the free trial is not abused. (For instance, can an individual use multiple emails to get multiple free trials of your product?)
Advantages of Free Trials
Definition: Product bundling combines several products or services into a package deal. The bundled price is usually lower than the sum of the individual prices of the products when sold separately — and the perceived value of the bundle is greater than those of the individual products.
Best for: companies with multiple products or services that are synergistic or complementary enough to appeal to users when bundled together.
Example: A software company has several apps that allow for digital content creation. A graphic designer can buy either one vector graphics editor app for $19.99 a month or a bundle of eight graphic design apps for $49.99 a month. The bundle’s apps have capabilities that complement the vector graphics app, including page layout and design, 3D rendering and word processing.
Requirements: Bundles should rarely be your only pricing option, as Nintendo discovered when it tried a pure bundling scenario. Customers tend to prefer a mixed bundling strategy that allows them to purchase just one product on its own.
Advantages of Product Bundling
Definition: With the volume pricing strategy, the prices of items are lowered when customers buy more of them.
Best for: companies looking to price based on individual items (licenses, users, transactions) rather than features. Volume pricing works well for businesses that typically receive — and want to encourage — large orders.
Example: A design platform charges $99 per license when customers buy fewer than 20 licenses. However, the price of each license is lower if customers buy more of them:
|Quantity||Price per license|
|1 – 19||$99|
|20 – 49||$89|
If a user buys 51 licenses, then the cost would be $79 each, totalling $4,029.00.
Requirements: Businesses will need to have enough of a profit margin to allow for discounting and possible other perks.
Advantages of Volume Pricing
Definition: Like the volume pricing strategy, the tiered pricing strategy entails volume discounting. However, it differs in its pricing structure: The price per unit applies to all units sold within a particular pricing tier. After a customer “buys up” one tier, it moves to the next.
Best for: companies looking to price based on individual items (e.g., users or transactions) rather than features.
Example: A remote team workspace platform charges $20 per user for the first 100 users. Once a customer exceeds 100 users, the price will decline per user.
Quantity Tier 1: For 0–100 users, the price is $20 per
Quantity Tier 2: For 101–1,000 users, the price is $15 per
Quantity Tier 3: For 1,001–10,000 users, the price is $10 per
Quantity Tier 4: For 10,001+ users, the price is $5 per
If a company wants seats for 10,500 users, the charge is (100 x $20) + (900 x $15) + (9,000 x $10) + (500 x $5) = $108,000
Requirements: More customer use means less value per unit, which means you’ll need to upsell your customers.
Advantages of Tiered Pricing
The Tiered Pricing Model vs. Tiered Pricing Strategy
If you read part I of this series, then you might notice that both a subscription pricing model and a pricing strategy are referred to as “tiered.” The terms “tiered subscription model” and “tiered pricing strategy” are often, and erroneously, used interchangeably. But they’re different concepts and should be treated as such.
For our purposes, the “tiered subscription” is a commonly-used pricing model in which an offering comes at several different price points, or tiers, for customers to choose from. The “tiered strategy” refers to the volume discounting tactic that means prices vary based on the number of units purchased, with specific unit volumes constituting the boundaries of each tier.
As you look to implement pricing strategies to help attract and retain customers, you will need to consider how a given strategy may or may not fit with your chosen subscription pricing model. The effectiveness of some strategies (e.g., skimming, penetration and premium) depends on factors like your product itself, brand recognition and competitors — and not on your chosen pricing model. And, other pricing strategies just won’t pair well with a given subscription pricing model. For instance, a flat- or fixed-rate pricing model doesn’t work with pricing strategies that make use of multiple pricing options (e.g., freemium, tiered, volume). Ensure the realities of your chosen pricing model match the requirements of your selected strategies.
|Subscription Pricing Model||Complementary Pricing Strategies|
Skimming, Penetration, Premium, Free Trial, Product Bundling
Skimming, Penetration, Premium, Freemium, Product Bundling
Skimming, Penetration, Premium, Free Trial, Freemium, Volume, Tiered
Skimming, Penetration, Premium, Captive, Product Bundling
Skimming, Penetration, Premium, Free Trial, Freemium, Volume, Tiered
Choosing pricing strategies isn’t a static or single-occurence activity. As the Harvard Business Review famously claimed in 1992, a 1% improvement in price can increase operating profit by 11%, making price tweaks some of the most effective for boosting business performance.
Patrick Campbell, CEO of Price Intelligently, recommends reevaluating pricing performance every three months. Price changes could occur every 6–9 months — or more often for a smaller, nimbler company. Specific signs that pricing strategies need a change include declining subscriber rates, missed profit goals and low retention rates.
Pricing strategies are a useful tool to use throughout a subscription offering’s lifecycle — not just in the beginning. Tweaking and testing new pricing strategies at a regular cadence can help ensure your company is maximizing profits and attracting customers in the most effective way.
Check back for our next piece in this subscription pricing series, on psychological pricing tactics you can use to grow a subscription offering in a competitive marketplace.
For more helpful information from the Brainyard and our friends at Grow Wire(opens in new tab) and the NetSuite Blog(opens in new tab), visit the Business Now Resource Guide.