How to price products in product-led growth
Convert more users into customers by pricing your product correctly
Authors of this article
Alvaro is the co-founder of Orb, which helps companies succeed with usage-based pricing and billing. Before Orb, he was the eng lead for the Product-Led Growth team at Asana
Tianyi Peng is on the Strategy and Business Operations team at Atlassian. He manages pricing and packaging for many of Atlassian's products and previously managed pricing for Salesforce.
Chase founded Flywheel after creating and launching Jira Work Management at Atlassian. He has executed product-led growth across multiple verticals and companies, ranging from SaaS to e-commerce.
An introduction to pricing
Deciding on a pricing and packaging model for your SaaS product will likely be one of the most impactful decisions you ever make for your company. Can you change it later? Of course, but no one likes balancing legacy and new customers on entirely different models. Product-led growth recently took the world by storm via freemium plans and free trials. But is that all there is to it?
Pricing is a relatively straightforward concept on the surface — how much does a customer need to pay to get access to your services? Of course, setting pricing thresholds takes a lot of time and experimentation. Pricing can also be very arbitrary while sitting on the back burner, but if you’re in that camp… don’t be!
Pricing comes in many shapes and forms depending on go-to-market strategy. In fact, your go-to-market strategy practically dictates your pricing. A company hoping to have a self-serve, also known as bottom-up, motion likely won’t be able to charge six figure contracts. Similarly, sales-heavy GTM strategies are too expensive to justify low prices. Much has been written on this already, so we recommend first reading this article from YCombinator to understand the introductory fundamentals of pricing strategy.
What’s different about pricing in product-led growth?
First, a warning. It’s a common misconception that adopting product-led growth forces a company to have a freemium plan. Freemium is an extremely difficult strategy to succeed with and the return on investment often takes years. Atlassian launched free plans for their products and the investment didn’t pay off for almost two years, only succeeding in the end because of a fully-bought-in C-suite and plenty of cash in the bank. Free trials are a much faster way to monetize and still allow your users to experience your product, so choose thoughtfully.
Now, what’s different about pricing in PLG? Here are three primary ramification of choosing a product-led growth motion.
Optimizing for smaller contracts
Do not assume you’ll be able to charge six-figure contracts with a self-serve motion. It may very well happen for some companies, but this is quite rare and usually the result of amazing brand authority. Much more likely is that you’ll attract significant signup volume that eventually converts into smaller contracts. This isn't a bad thing! It leads us to the concept of...
Compounding NRR
The flywheel is a concept where small contracts, over time, grow and compound. A decade later, some of your smallest initial customers (think Lyft, Notion, Airtable) will be paying you 10-100x more.
This phenomenon is often demonstrated numerically as NRR (Net Retention Revenue). NRR is a calculation that clarifies if customers are paying you more, the same, or less over time after accounting for churn, upgrades, and downgrades. Jason Lempkin has a great blog post about the compounding effects of NRR. In short, an NRR >100% means your company can grow indefinitely without adding any new customers.
If you’re going PLG, embrace the small contracts. Delight those customers. Then watch them grow with you over time.
Connecting price to value
The SaaS industry has accepted that the best pricing strategy is value-based pricing. That is, aligning subscription costs with the value customers receive from your product. Striving to associate price with value is a common strategy – especially for small companies or nascent markets. What’s different in PLG, though, is that customers are much more likely have their perceived value clouded by the experience they have directly after or while using your product. Traditional sales motions allow companies to clearly explain to customers what the ROI of their software could be. It's not until the contract is closed that most end users actually find out what the day-to-day looks like. Without this 1:1 hand holding, your product must speak for itself.
Most products don’t manage to deliver this level of value on Day 1. That’s why content is king for product-led growth – it supports the product via proof (customer testimonials), explanations (use-case guides), support (documentation), and interactivity (webinars and video) . Even this article is an example of a content-first strategy.
Pricing models overview
Now that you’ve read up on basic pricing strategy, you'll need to choose a pricing model. We’ll be walking through these five different SaaS pricing models:
1. Usage-based pricing
2. Seat-based pricing
3. Active seat pricing
4. Flat rate pricing
5. Modular pricing
6. Freemium pricing
Usage-based pricing
Today, we view usage-based pricing as a model where customers pay for the actual use of a product or service. This differs from upfront contracts based solely on feature gates or seats. Usage-based pricing services have become a popular alternative to traditional subscription pricing.
Usage-based pricing actually has multiple subcategories: consumption and pay-as-you-go pricing (Twilio), ROI pricing (App Academy), and pay-per-transaction (Stripe). The general sentiment is the same for each of these subcategories – the more you use, or get value from, a service, the more you pay.
+ Benefits of usage-based pricing
- Alignment with customers
Customer alignment and success is generally called out as the biggest reason for why this pricing model is compelling. Companies who leverage usage-based pricing only make money via real customer engagement with the product. In comparison, many other pricing models ask businesses to pay large amounts of money upfront with grandiose promises. This gives a higher chance for customer churn at the end of the contract. Usage-based pricing is a fantastic way for businesses to gain customer trust.
- Downsides of usage-based pricing
- Metric selection
Few businesses have a clear understanding of which metric to charge against for this type of model. The key to a successful usage-based pricing strategy is picking a metric that aligns with how customers perceive value from your product, and also makes it easy to predict how your usage will grow over time.
For example, Stripe primarily charges on transaction volume as a financial technology company. Jira, on the other hand, could reasonably have decided to charge for the number of issues created within their software. However, that decision may induce negative customer behavior. Jira is more valuable to customers when their data is all tracked in the same place. Incentivizing customers to use the product less would make it harder for customers to understand its true value.
- Variable financial modeling
It's common for finance teams to be wary of usage-based services as they makes it difficult to plan out annual costs. Modeling the potential increase, or decrease, in cost is hard without some version of a calculator provided by the software vendor. This is especially relevant for enterprise contracts and it's various accommodations are usually provided. These could be flat contracts with a guaranteed usage threshold included, or buying usage in bulk in the form of credits.
Seat-based pricing
Likely the most well-known SaaS pricing model, seat-based (or per-seat, or per-user) pricing charges a set amount for each additional user of the software. This model has the potential to scale extremely well and is easy to understand. Atlassian uses a seat-based pricing model for almost all of their products.
Some companies employ nuanced variations of this model, such as Miro, which promises unlimited free “guests” who are limited to basic functionality. Another alternative is HubSpot, which combines a seat-based model with a modular model. We'll talk about modular models more below.
+Benefits of seat-based pricing
- Scaling
SaaS companies scale more efficiently than IRL businesses (In Real Life) like Uber or Chipotle. Adding an additional user to a company plan is a negligible cost to the company providing the software. This allows SaaS companies to grow exponentially as their customers hire more employees that eventually become users. Most companies who exalt the success of their flywheel motions are able to do so because their extremely small customers who joined 10 years ago are now paying 20-100x what their original contract cost.
- Ease of understanding
More users = more money. Simple and straightforward.
- Pricing seems “lower”
While the overall contract may be tens of thousands of dollars, thinking in terms of each user makes the price seem more palatable if it’s only $7/user/month. This makes expansion easier because companies don't want to restrict new employees from accessing important software.
- Network effects
Seat-based pricing is particularly effective for companies whose products have a network effect. When the additive value is higher the more employees who are on the software, companies are incentivized to continue adding employees. Great examples of this include Slack and Jira.
- Downsides of seat-based pricing
- Inconsistent expansion
When a company doubles in size, departments are disproportionately affected. Legal departments, for example, are almost always significantly smaller in terms of headcount than sales, marketing, and engineering. A seat-based pricing model for lawyers may need to charge upwards of $200 per person to scale effectively. The importance of account management and customer success departments is much higher for seat-based companies.
- Wall-to-wall deployments
While the price may seem low at first glance for seat-based models, a company with 1000 employees will quickly pay $50,000 per year for a single contract at $4/user/month. This makes wall-to-wall (or rather, every employee in the company being on the software) deployments an enterprise sales motion instead of bottom-up. It’s often hard to justify that every team needs access to a certain piece of software.
- Plan-wide upgrades
Seat-based models bring with them a wide variety of users. One department may need the advanced features of a higher tier, whereas another rarely uses the software at all. Some products account for this with different roles that a user can belong to, but other times the entire organizational plan needs to be upgraded. Upgrading the entire organization is great for company selling software as it massively improves expansion MRR, but runs the risk of churning their customers.
Active seat pricing
This pricing model is similar to seat-based pricing with a simple change – only the number of active users are charged for the end of the month. Slack is a popular example of this model. Users who haven’t logged into the software in the past month are removed from the bill. While Slack was an early champion of this model, they've changed to a traditional seat-based model in recent years. In fact, it's rare to see this model in an era where revenue matters more than user growth rates.
+ Benefits of active seat pricing
Close alignment with value
Active seat pricing is arguably one of the most “fair” pricing models and is quite similar to usage-based pricing. Aligning customer value with invoices encourages good faith and helps companies feel better about reducing SaaS subscription bloat.
- Downsides of active seat pricing
Difficult to choose metrics
Be confident in understanding activity metrics if don't charge for inactive users. Most software can’t claim the same level of engagement as a communication platform like Slack or Zoom. This pricing model is “fair” for the customer for products where engagement is paramount. For companies like Stripe, or any other company with a “set it and leave it” model (Workato, Zapier, and other workflow automation products as great examples), this plan might actually be a disaster. Sometimes, keeping users out of your product means you're delivering value correctly.
Flat rate pricing
A flat rate pricing model is where customers choose a particular plan at a particular price and pay it indefinitely – until the service changes price or the customer downgrades / upgrades. This is slightly different from tiered pricing where customers start at once price and gradually increase in price as usage goes up.
LaunchNotes is a great example of this type of pricing model. Customers can choose between two options in two different categories. Each has certain feature gates that encourage users to choose the right plan for them.
+ Benefits of flat tier pricing
Predictable annual costs
Customers know exactly what they’re paying for and exactly how much to allot on their balance sheets. This makes budgeting easier for both the finance team and product champions. Choosing a plan is simple and it’s easy for customers to understand the value they’re getting for a static amount of money.
- Downsides of flat tier pricing
Packaging correctly
Really, it's all in the packaging. Choosing the right feature and usage gates between tiers can be extremely hard without good data and customer insights. Additionally, there is effectively a maximum amount you can charge any one customer. Whereas usage-based and seat-based plans can scale indefinitely as a customer grows, you may land Google as a customer at only $250 a month.
Modular pricing
Arguably the most complex pricing model, modular pricing allows companies to offer “a la carte” features for specific personas (think Sales, Marketing, etc). Modular pricing isn’t that commonly seen today but can be a competitive advantage for companies that are focused on optimizing for appearing to be cheap. Examples of this model include Wrike and Rippling who charge a platform price with additional add-ons available. This lowers the base cost of the software and allows them to charge a premium for additional features.
+ Benefits of modular pricing
Reduced initial cost
Customers may only want to leverage the CRM capabilities of HubSpot instead of buying their entire suite. In this situation, a customer could continue using the CRM of HubSpot but over time decide to centralize on their platform by adding on the marketing automation capabilities.
Easier to close deals
Other pricing models that bundle all platform features together may be more expensive or may include features that aren’t needed. This allows companies to close deals early and also allow for "future proofing" conversations. That is, internal champions can convince stakeholders that the software will scale alongside their company. In this scenario, customers can buy software "just-in-time" as they need specific capabilities.
Vertical packaging
Modular pricing lends itself well to industry-specific plans and packages. A fintech company might need features 1, 2, and 4, whereas a healthcare customer might want 2, 3, and 4. Custom packages can be more easily created, implemented, and positioned.
- Downsides of modular pricing
Decision fatigue
Choice is good for price-conscious customers but may be off-putting for customers who don’t want to do mental gymnastics to determine the final price. Internal discussions about which packages to choose often involve extra layers of decision making and stakeholders.
Feeling nickle-and-dimed
Famously, Spirit Airlines charges very little for the base flight cost but makes up for it by charging extra for everything else. By the time you're done adding features, often you've added an additional 50-100% of the base cost. This can be disorienting for an evaluator who made their initial case for the software at a different price.
Freemium pricing
Helping companies succeed with freemium pricing models is the primary focus for Flywheel. Why? It's insanely hard. We talk to companies every day who regret choosing a freemium strategy or ran into unexpected roadblocks. On the flip side, some of the most successful companies in the world got there by leveraging freemium.
At it's best, freemium is unbeatable. Your competition can't keep up and you gain market share majority. At it's worst, freemium companies completely fail to monetize. Both are outcomes to keep in mind when deciding to go freemium. Here's the unfiltered reasons we chose a freemium + usage-based model for Flywheel's own pricing:
Tying customer success to revenue
The combination of a freemium and usage-based model means that we won't succeed unless our customers do. While it's risky, we felt this alignment would help us build the very best product possible.
Faster product iteration
While the product-led growth space has become popular, there's no product quite like Flywheel. The most well known space in our category is the product-led sales subsection. However, Flywheel focuses instead on converting self-serve users and driving product adoption via marketing. We think it's the solution the market needs, but having little direct competition forces us to focus on user feedback instead of "inspiration" from other products. Of course, if you're reading this we'd always love your help as well!
Market share
Most of the companies trying out product-led growth are smaller in size. This lends itself to a freemium model more than an enterprise SaaS approach. We felt we could simultaneously pursue larger companies with a freemium pricing model by including maximum thresholds on our self-serve plans. More than 100k monthly-active users means an enterprise contract is required. This allows us to keep our product accessible, yet flexible.
Once a product is considered critical to a company's success it's very difficult to rip out. Freemium gives your product the best chance of accomplishing this.
+ Benefits of freemium pricing
Rapid product adoption
Getting new users is significantly easier when the upfront cost appears to be $0. The hallmark of product-led growth is the ability for a product to become ingrained in a user's workflow without a long deal cycle.
Forced focus on UX
We touched on this briefly above, but a freemium model demands your product to be, at an absolute minimum, useful. Whether or not you've found product-market fit is much more obvious with a freemium model. Companies with enterprise motions can often find sales-market fit with a bad user experience via a charismatic sales team and good connections.
- Downsides of freemium pricing - -
Unpredictable revenue
Choice is good for price-conscious customers, but may be off-putting for customers who don’t want to do mental gymnastics to determine the final price. Internal discussions about which packages to choose often involve extra layers of decision making and stakeholders.
Downturns hit harder
Many companies are finding this out the hard way right now. Freemium models are highly dependent on large top-of-funnel volume driven by content marketing. During a downturn, companies cut software spend and focus on their core applications. Additionally, employees focused on hitting harder-to-hit product KPIs will generally double down on what works instead of searching for novel approaches. There's a lot of truth to the "no one ever got fired for choosing IBM" adage.
Company buy-in
Since Freemium is rarely profitable from the beginning, the entire company must be bought in for the long haul. This is particularly difficult when a company isn't hitting their goals and a panicky c-suite may pivot away from freemium models.
Finishing up
If you've gotten this far, you should have a pretty good idea about the fundamentals of pricing. We'll leave you with a few last thoughts:
Pricing is never "complete". As you add new features, gain new competitors, or the market changes, your pricing should evolve. A good rule of thumb is the reevaluate your pricing every 6 months and treat it as another product your company offers.
Cheaper is only one strategy for winning deals. Businesses seem to be hard-wired to try reducing their cost to win a deal. Instead, try asking your customers which features drew them to specific plans and which features are rarely used. Doing so can help you repackage your product offerings in a way that's more compelling for potential customers but keeps your pricing the same (or higher!)
It's fine to make pricing mistakes. Unless you're some kind of pricing prodigy, you're going to make the wrong decisions… often. Embrace this and experiment. When something goes awry, opt for making it more than right for the customer in question. It's worth losing a little revenue to gain a loyal customer.
Packaging is likely more important than pricing. Keep a look out for our upcoming article on the art of packaging.
That's all on pricing for now — you've got this.
Published on
Sep 12, 2022
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