Defining a Winning Subscription Pricing Model
What is a Subscription Pricing Model?
A subscription pricing model is a business strategy that allows customers to access a product or service on a recurring basis in exchange for periodic payments, typically monthly or annually. This model has gained immense popularity across various industries, from software and entertainment to consumer goods and services, because it offers predictable revenue streams for businesses and convenience for customers.
Unlike traditional one-time purchase models, subscription pricing fosters a long-term relationship between the provider and the customer. It emphasizes customer retention and engagement, as businesses must continually deliver value to maintain subscriptions. Understanding and effectively implementing a subscription pricing model can significantly influence a company’s success in today’s competitive marketplace.
Types of Subscription Pricing Models
1. Flat-Rate Pricing
Flat-rate pricing is one of the simplest subscription models, where customers pay a fixed fee for access to the entire product or service for a specified period. This approach is straightforward and easy to understand, making it appealing to customers who prefer predictability in their expenses. However, it may not cater well to users with varying needs, as all customers pay the same rate regardless of usage.
2. Tiered Pricing
Tiered pricing divides the subscription offerings into different levels or tiers, each with its own price point and set of features. This model allows businesses to target various customer segments, accommodating different budgets and usage levels. For instance, a software company might offer a basic tier with essential features and a premium tier that includes advanced tools. This structure can encourage customers to upgrade as their needs grow.
3. Usage-Based Pricing
In a usage-based pricing model, customers are charged based on their actual usage of the product or service. This can be particularly appealing for businesses that experience fluctuating demand or for customers who prefer to pay only for what they use. For example, cloud storage services often charge based on the amount of data stored or the number of transactions processed. While this model can drive customer satisfaction, it may also lead to revenue unpredictability for the business.
4. Freemium Model
The freemium model offers basic services for free while charging for premium features or content. This strategy attracts a large user base by providing value without an upfront cost, which can lead to conversions as users discover the benefits of premium offerings. Popularized by apps and software, this model can be highly effective, but businesses must balance the value provided in the free tier with the incentives to upgrade.
5. Hybrid Models
Hybrid models combine elements from multiple pricing strategies to create a more flexible offering. For example, a subscription service might incorporate a flat fee for basic access and a variable charge based on usage for additional features. This approach allows businesses to cater to a broader audience while maximizing revenue potential from various customer segments.
How to choose the right subscription pricing model
It is crucial for you to create the right pricing model for your recurring revenue business regardless of whether you are launching a new subscription-based offering, transitioning from a perpetual to a subscription model, or wondering why you are not monetizing as well as you should be on your current subscription product.
Zuora partner Simon-Kucher & Partners has worked on hundreds of projects helping companies determine their subscription pricing model, and there are two aspects of determining price that are often marginalized as effective monetization levers:
Price metric: Define how cost is measured for customers (e.g. per seat, per concurrent user, by a usage measure)
Price structure: Define how the price level changes over time / usage / etc. (e.g. flat fee, variable, tiered)
Aligning subscription price metric with customer value
Price metric = customer’s unit-of-measure for price & value
Price metrics are a powerful lever for subscription products because there are many metrics possible for a single type of subscription business.
A good example of this is in online computer backup services. Customers in this space include both consumers, who often have no idea how much data needs to be backed up, and businesses, who often have a network of computers that need to be backed up. Some online backup service providers charge per computer while others charge by data storage limit, but the majority have only one price model.
Carbonite is a great example of a subscription business that aligns its metrics with customer value and needs. Carbonite offers “Personal Plans” that are charged per year per computer and “Pro Plans” that are charged per year per xgigabytes. Using multiple price metrics lets consumers use as much data as they need and lets businesses support multiple computers.
Systematically evaluate and choose your subscription price metrics
The first step in identifying the right price metric is to understand the possibilities – what metrics align with customer value? What are competitors using for their price metrics?
Price metrics for subscription products typically fall into the following categories:
- User-based: named user, concurrent user, etc.
- Activity-based: number of transactions, number of reports, etc.
- Business scale: size of business, number of customers, etc.
- Performance-based: against key performance metrics or client performance, etc.
Create a list of metrics in a workshop or through email threads to brainstorm possibilities. Discussing even seemingly odd metrics can spark good ideas.
Once you have a list of 10-20 possibilities, you should evaluate the performance of each metric on its benefits to customers:
- Fairness / acceptability: The metric is tied to the intrinsic value of the product, enables competitive comparisons
- Flexibility: The metric allows customers to scale service with their willingness-to-pay, overcome budget constraints, and scale with future usage & growth
- Predictability: Costs can be estimated and forecasted
The metric should also have a positive impact on your internal goals and be rated on its benefits to your business:
- Customer adoption: The metric drives adoption, enables up-sell & cross-sell
- Ability to capture full customer value: The metric covers all customer segments, scales with customer growth, and allows future price increases
- Ease of implementation: The metric makes it easy to administer, monitor, control and enforce prices; it is easy to sell and communicate
Create a single score for “benefit to customers” and another for “benefit to your business”, and plot the score for each metric on a matrix (as shown in the Metric Evaluation Matrix). The metrics you should use are the ones in the top right “Ideal” corner of the matrix.
It is likely you will find that a few metrics land in the ideal quadrant. As you are choosing the metrics to move forward with, keep in mind:
- It is alright (and typical) to use multiple metrics together
- It is possible to have different price models for different customer segments – like Carbonite did
- Align the simplicity or complexity of the price metrics you use with your company goals – just because a competitor or even the market leader is using a metric does NOT mean it is the best metric for your company.
Why do the best price metrics and subscription price models fail?
Even the most well-researched and strategically designed pricing models can fall flat if they are not aligned with a company’s brand identity and customer expectations. Successful subscription pricing hinges not only on selecting the right price metrics but also on ensuring that the entire pricing structure resonates with both the company’s values and the needs of its customers.
- You use a price structure that does not align with your brand
When building your price structure, you should evaluate whether the intended price structure aligns with the firm’s brand positioning. (See exhibit 1). For example, a company that operates with a brand positioning of sincerity should have fewer multi-dimensional prices/surcharges. Doing so may drive the perception of nickel-and-diming customers, which would contradict the projected image of Sincerity.
Exhibit 1: Price structure should align with brand positioning
- You use a price structure without understanding your customer’s needs & expectations
When building a price structure, you should consider customer preferences when choosing among the various permutations of flat & variable components.
Flat components increase predictability for the customers as they can estimate spend and budget accordingly. Typically, predictability is more important for larger customers with formal budgeting cycles. Higher predictability also benefits the firm by offering a consistent revenue stream to continue operations (smaller firms would oftentimes link this component with fixed costs in their business).
Companies with greater revenue coming from subscription pricing, which affords customers with higher predictability than transactional pricing (e.g. software license and implementation), get a higher revenue/EBITDA multiple in the market compared to their peers.
Variable components increase value-sharing. Customers like such components since the fee scales with their usage. Smaller customers also prefer higher variable components as their fee commitment increases as their business scale increases. When using such components, the firm is willing to position itself to succeed when their clients use their product. This increases the variance in revenue from month to month but the upside is oftentimes higher.
In some cases, one can also link variable components to business outcomes. The biggest challenge to adoption usually is the ability to measure & attractiveness of such a component to the firm. Such metrics are often not tracked directly through the firm’s products and the burden of reporting usage is the prerogative of the customer. For example, a firm that makes enterprise management software for insurance agents may not be able to measure the value of the insurance policies written by the agent (directly through the software).
A second aspect is if the business outcomes are not attractive. In the example above even if the firm can track policy premiums it still may not wish to use it in their pricing model as the overall premiums in the market may have remained flat or even have declined year over year.
The firm can also use a hybrid model by using structural modifiers. Establishing afloor (minimum commitment) can get predictability in a variable structure for the firm. Caps (maximum possible commitment) can help large customers address concerns that their risk is not unconstrained with a transactional model.
Tiers and breakpoints can be used to charge a different fee at different levels of usage. These components are used by firms to provide volume discounts to the customers with higher usage in a variable-component based model.
Price structure in action
A great example of using the right price model is a recent Simon-Kucher customer that sells trading software in the financial market space. The customer had been using multiple different metrics but had not seriously thought how that was affecting their customer base. They decided to focus on a “Sophistication” positioning and created a price model that had an upfront fixed fee and a tiered transactional charge that was capped. The company has since implemented and has received feedback from its customers that the new model is elegant (simplifies the unnecessary pricing complexity), scales well with growth and offers predictability as well.
Next learn about pricing and packaging solutions.