The ultimate guide to SaaS pricing models - 2023
SaaS pricing is turning complex by the day. The first step to navigating that is understanding how the myriad pricing models work. Here’s a comprehensive primer.
User-based, usage-based, transaction-based, consumption-based, value-based — there are myriad ways in which SaaS companies charge customers today. With an average high-growth organization using anywhere from 50 to over 250 tools across departments, the pricing calculation can become a complex maze. In this blog post, we give you a map to get in and out of the maze unscathed.
But first, let’s see why CFOs should pay attention to SaaS costs more than any other expenses on their P&L.
Why CFOs must pay attention to SaaS costs
SaaS is an expensive affair: SaaS is one of the top three expenses of any high-growth organization today. Organizations are spending over $5 million on software to optimize productivity, organizational efficiency, and process effectiveness.
SaaS pricing is complex: SaaS has become akin to consumer packaged goods that don’t have standardized sizes, making direct comparison practically impossible. Based on users, usage, functionalities, features, value etc. pricing models vary widely.
SaaS pricing is opaque: The enterprise-level plans of SaaS products is often behind a form. In order to find how much something costs, procurement teams have to go through discovery, demos and negotiations. So, they don’t evaluate all options possible.
SaaS buying is decentralized: The ease procuring SaaS by individuals has led to employees buying on their own and reimbursing later. This hinders visibility and forecasting.
SaaS wastage is common: Every organization has SaaS tools that employees dislike or licenses that no one uses. Little by little, these leaks add up to a significant portion of SaaS spends.
Controlling overspending, minimizing wastage and optimizing expenses begins with an understanding of how SaaS pricing works. This primer is intended to help you with that.
Various SaaS pricing models
In this section, we explore the most common SaaS pricing models. In the end, we discuss some edge-cases.
This is the simplest form of SaaS pricing. Here, you pay a flat fee for using a particular product. It is as simple as it is rare. Basecamp is one of the few popular tools that offer this pricing model. At $299 per month (billed annually), organizations can use Basecamp, irrespective of the number of users/features/usage etc.
While flat-rate pricing’s simplicity is a draw, CFOs must consider no. of users/usage while making ROI calculations. If you have only 5 members in your organization using Basecamp, it might be exponentially more expensive than products that use a different SaaS pricing model.
User-based pricing is where you pay for each person using that tool. The subscription renews monthly, quarterly, or yearly. Project management, time-tracking, and collaboration tools typically use this model. Slack, Asana, TimeCamp, and Trello are popular examples.
The biggest advantage of user-based pricing is predictability. CFO can forecast potential expenses by simply multiplying no. of users by cost. While choosing a tool that offers user-based pricing, CFOs must keep the following in mind:
Expenses multiply: For instance, $10 per user per month might seem like a small amount. However, as the number of employees increases — as it would in any high-growth organization — the expenses can soon mount.
Downgrading can be harder: While vendors are often happy to increase licenses, downsizing might not be as easy. So, while choosing this tool, read the terms and conditions for cancellations carefully.
This is becoming an increasingly common mode of pricing among growing startups. In this model, you pay for what you use. The unit of usage depends on the product under question. A few examples are as follows:
- Amazon Web Services (AWS) charges based on the space, computation, or services you use
- MailChimp charges by the number of contacts you have and the emails you send through the platform
- Chargebee’s pricing is dependent on the cumulative billing done through the platform
- Stripe charges a percentage of the value transacted through the platform
The draw of usage-based SaaS pricing is the ‘paying only for what you use.’ This helps organizations scale up or down based on their needs. For instance, a retail business with high demand during Christmas will only pay for using a platform like Stripe during that time. Through the rest of the year, their costs will remain low. Moreover, organizations that bill their clients for usage also benefit from this model. You can simply add the Stripe fees to the bill. However, usage-based pricing has its challenges too.
Wastage: Usage-based pricing models often lead to wastage. For example, teams can spin up unnecessary development/test environments of cloud platforms, or forget to close them, accruing costs in the dark. CFOs need to pay extra attention to monitor the usage of these tools.
Forecasting: Moreover, forecasting can be a big challenge with usage-based pricing. Without clear plans and boundaries, usage can spin out of control.
Additional fees: Sometimes, usage-based pricing is charged in addition to basic setup/onboarding fees. CFOs need to also check if such fees are incurred on a yearly basis.
Freemium is a portmanteau of free and premium. Essentially, the SaaS tool offers a free version with limited features. For additional capabilities, you will need to upgrade to a paid subscription. There are several tools like Evernote, Dropbox, Trello, HootSuite, etc., that offer this model.
Freemium is great for small businesses with limited needs. It is also suitable for larger organizations evaluating multiple tools. However, SaaS vendors offer better features, higher security, customer service, etc., for a fee. Therefore, once you start using the tool, you’re likely to find yourself needing features that you have to pay for.
Value-based or feature-based, or tiered pricing
As the SaaS industry matures, vendors are moving towards value-based pricing models, where customers are charged for the value they derive or the features they use. This model often overlaps with the above. Let’s explore a few examples.
User + feature-based pricing: Zenefits offers a tiered base plan — named essential, growth, and Zen — with a specific set of features billed per employee. However, it also offers additional modules such as payroll, recruiting etc., which are billed separately.
Flat fee + feature-based pricing: Drift offers a set of basic features for a flat fee, with additional tiers for advanced features such as A/B testing or flex routing.
Usage + tiered pricing: DataDog offers a number of functionalities for various purposes. For example, API testing is charged per 10,000 test runs per month and an add-on for parallel testing.
Bundled pricing: Adobe offers a highly discounted bundled price for those who buy the entire Creative Suite, as compared to individual products.
With multiple factors defining the price of each product, there is greater flexibility for organizations. However, there are several challenges too.
All users in one tier: Most SaaS organizations do not allow a small set of users to another tier. For instance, if only two of your 25 team members need the analytics features in the advanced tier, you will not be asked to upgrade all users, which leads to unnecessary expenses.
Paying for unused features: As features as bundled into tiers, you might be paying for dozens of features while you’re using just one or two. It is unlikely that you will be given access to just one or two features for a lower price.
What to consider while evaluating tools and their pricing models
For starters, SaaS vendors decide the price for their products, and customers do not have much say. Few vendors offer the customer choice of pricing model. Therefore, if you don’t like a tool’s pricing model, you will need to choose another tool altogether. To help you in that evaluation, here are some pointers.
Forecast total SaaS costs before signing the contract
Whatever the pricing model, give the SaaS vendor the number of users, quantum of usage, features needed, etc., to identify how much the tool is going to cost you for the next year or a few years.
Understand limits and overages
Even in usage-based pricing, there are often tiers for units of measure. For instance, Chargebee’s performance tier costs $599 for up to $100K of billing per month and 0.75% on billing thereafter. Such overages can turn out to be significantly more expensive than you anticipated. So, be more precise in your forecasts.
Benchmark against similar products
For every need, there are dozens of SaaS tools. While it is not practical to evaluate all of them, pick your top 3-5 and compare prices. It also helps to know what organizations similar to yours are paying for these tools.
Build mechanisms to track usage
Without your own systems to track usage, you’ll have to trust the vendor’s word alone for the costs you incur. While this is likely to be accurate, you might be incurring unnoticed wastage. To prevent that, set up a SaaS management solution to track licenses, usage, and costs.
Always negotiate the price
Depending on a number of factors, such as the number of users, contract length, payment options, etc., vendors offer discounts. Once you receive a proposal from a vendor, always negotiate the price with them. Understand their motivations and make a mutually beneficial offer.
Keep an eye out for promotional pricing
SaaS vendors offer promotional pricing to startups and small businesses. There are also huge discounts in the first year. Some vendors offer purchasing parity discounts for organizations in the global south. Some also offer special discounts to those switching from a competitor. Build rapport with the account executive to see which of these you can claim.
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