One daunting challenge faced by entrepreneurs and executives operating a subscription-based business is to determine optimal pricing strategies.
If you charge too much for your product, you won’t attract as many customers. Yet, if you undervalue your product, you might not be able to cover operating costs. Plus, if you do undercharge for your product, customers may assume you are providing a lesser quality than your competitors.
It is critical to offer pricing that customers find appropriate for the perceived value of the goods or services you are selling.
Value covers many different aspects of a subscription. When we choose to define a value metric in our pricing strategy, we do so with the knowledge that customers look for value in the quality of the product. Customers also factor in value for other aspects like usage, flexibility, brand credibility, cost certainty, and content.
While the value metric is central to pricing, there is no absolute formula for determining the best pricing strategy in any given business. However, there are several methods to determine the most effective way to charge your customers. It’s about finding a balance between the value metric and maximizing what customers are willing to pay for those perceived values.
The subscription business model isn’t just for newspapers and magazines anymore. In recent years, subscriptions grew in popularity for SaaS (Software as a Service) businesses, and predictions are that by 2020, the SaaS market will exceed $75 billion. The flexibility of payment options that is available with the subscription model has attracted many different industries, from avionics to media. The value metric for each of these industries vary based on the target buyer of their products and services.
A subscription to an online art class such as Bluprint, for example, commands a different customer base than a monthly grooming kit subscription like the Dollar Shave Club. The pricing strategy will differ accordingly.
Also, if a business has a certain niche market, they will be able to command a higher price, since competition is lower.
Researching your competitive advantage for subscription pricing
It’s important to do due diligence in finding out who your competitors are in the market because as more businesses turn to the recurring billing model, the market will continue to expand.
One of the consumer advantages of signing up for subscriptions is that she is secure in the knowledge that if a business falls out of her favor for whatever reason, she can easily cancel the subscription and look for another option—most likely your competitor.
There are several ways to determine your competition, such as searching databases like the Yellow Pages or doing keyword research online for other businesses in your total addressable or serviceable market.
For example, if you are in the telematics industry, your business might tap into the Internet of Things (IoT) trend by providing sensors in fleet vehicles. How many other companies are providing the same services? What do you offer that the other companies do not? Does this information you provide go directly to the fleet owner, or does it go to their insurance carrier as Usage Based Insurance (UBI)?
TIP: As you are conducting your research, take a good look at what your competitor’s customers are saying in online reviews. Use the information to beef up your marketing efforts on certain features that give you that competitive edge over other businesses.
Metrics for selecting product pricing
There are certain metrics that are important to examine as a business when determining the best pricing solution for their product. If you have been in business for a while, it’s critical to take a good look at your past sales and some SaaS metrics to make several determinations that factor into pricing.
- Customer lifecycle value. This is the amount that a customer will spend on your products from the time they sign up to the time they cancel their subscription.
- Customer acquisition cost. This is basically how much it costs to bring in a new customer. This figure is found by combining the total sales and marketing expenses and then dividing that number by the number of new clients you acquire in a month.
- Churn rate. This is measured by the dollar value of a customer discontinuing their subscription.
These factors, among other important business goals like revenue targets, all combine to help you determine what the best price is for your product, whether it’s on a monthly, quarterly or annual basis.
Leveraging the best pricing strategy for your subscription business
With the subscription model, it isn’t just about determining the price for one unit, or 500 units.
Are you going to offer different pricing levels per unit? Will you offer a free trial? There are numerous different ways to price your product in the subscription arena and it’s important to go out and test the waters to determine what is the best strategy for your business. Below are some of the most popular pricing options.
- Standard pricing. This is the traditional pricing option. Every unit costs the same amount, regardless of how many units are purchased.
- Tiered pricing. With tiered pricing, there are different levels of pricing, like offering a discount for customers who buy a certain number of units. Customers would pay the same price for the first tier, say, 1 to 100 units, and then a lower price for a second tier, and even lower if they reach a third tier.
- Volume pricing. Similar to tiered pricing, there are different pricing levels to encourage larger orders. However, with volume pricing, when a customer purchases their units, ALL the units are assigned the same price, depending on what level the unit reached.
- Stairstep pricing. With stairstep pricing, there are again different price levels constructed, but the customer pays one flat rate depending on the bracket their purchase falls into, versus paying per unit. So, for example, they might pay $100 for purchases in that bracket, regardless if they purchase one unit or 5 units.
Beyond these four general pricing levels, there are other ways to incentivize a potential customer to make a purchase.
A business may offer a freemium package—a SaaS company might have a product that they don’t charge for, but certain aspects are withheld from users unless they purchase the full product.
Another popular strategy is to offer promotional pricing through a free or discounted trial. This allows a customer the opportunity to give your product a test run. Similar to a freemium approach, you can choose to omit some features during the trial basis.
Make sure your customer realizes that there are other options that will be unlocked with a paid subscription. When offering a free trial period, you can either collect the credit card information at the time that a customer signs up for the free trial, or wait until they make that transition from the trial period to a full-blown paying subscriber.
For a business that offers a service, such as writing or developing websites, this might include providing a portion of the services for no charge during the trial period. A web developer might demonstrate the initial site design with just wireframes or placeholder text to tempt the customer into purchasing the full service.
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Taking the next steps with your pricing strategy
Pricing is a moving target, so even when you establish your different prices, levels, etc., remember that you might need to make some adjustments down the road. Markets fluctuate, competitors grow, or disappear altogether. Consequently, you may decide that it’s time for a price change.
1. First, you need to go back to your metrics, those values that helped determine pricing in the first place. Use this to set your new pricing.
2. Next, communicate those pricing changes across all the departments in your company. Your credibility can take a substantial hit if there is confusion with pricing, and that confusion is relayed to customers.
Communication with existing customers is essential, both before and when the new pricing plan goes into effect. Around April 2018, for example, Amazon announced to the public that its popular Prime membership rate would be increasing.
The increases, the company said, would take place on May 11, 2018, for new customers, and then would impact more than 100 million existing customers the following month.
This price increase was sent via email to current customers, with press releases sent to major publications as well. Good communication is crucial to avoid confusion and maintain that trust you have built with your customers.
While the e-commerce powerhouse made the decision to impact all subscribers, other businesses may opt to grandfather their customers into the current legacy pricing.
Why is this option popular when it might be easier to raise the pricing for everybody? It’s a way of maintaining that relationship with current customers. After all, it is cheaper to maintain customers instead of risking them churning out and having to acquire new customers to fill that gap.
In all, there are a lot of moving parts that figure into finding the best balance between your pricing and the value your customer realizes from your products. And while it’s not an absolute science, the right combination will help you maintain your customer relationships while continuing to make money, and scale your subscription-based business.