What’s Your Pricing Strategy, Part 2

August 27, 2008

by Tien Tzuo


In a recent blog entry, we talked about how subscription businesses can use pricing models as a powerful tool for achieving their business objectives. We discussed six common business objectives, including upsell, adoption, and cash flow, and provided examples of companies that use pricing to achieve those objectives.


Now let’s bring our attention to some of the most common pricing models we see out there. As you can imagine, there are many, many ways you can price for your subscription services. What follows is not intended as a comprehensive list, but just 5 common models that we see. Creative companies will even combine two or more models for a hybrid pricing strategy.


1. Module-based pricing: This is one of the most basic models. It allows customers to pick and choose which modules or features of your service they pay for. Many of the classic enterprise software companies like Siebel or Oracle use this. For example, you might charge $3000/month for an analytics feature. Module-based pricing is effective when you’re trying to upsell more services or increase adoption within your customer base.


2. Resource-based pricing: in this model, you charge a flat rate for a given amount of service. For example, your accountant bills you for the number of hours he works. Storage is another example: your price depends on the number of GB or cubic meters used. Resource-based pricing is useful if you’re trying to increase adoption of your service—the flat fee typically encourages more consumption. Especially if you combine it with an upsell model where you can sell more services priced on a usage basis (see #3).


User-based pricing is actually a very common type of resource-based pricing. Most businesses that adopt user-based pricing sell licenses that are assigned to users. Thus, customers are purchasing capacity, and not actual users. If your goal is to reduce barriers to entry and get customers on board quickly, user-based pricing is a great strategy. For example, Salesforce.com recently ran a promotion offering its Group Edition at $99/user/year.


3. Usage-based pricing: this model charges for service by consumption, for example $0.45/minute for your cell phone service. While you might be attracted to the simplicity of usage-based pricing, note that it’s not a great strategy for collecting cash upfront. With usage-based pricing, you can’t ask for a year’s worth of services (and cash) upfront.


4. Tiered + overage pricing: in this model, customers pay a given price for a specified amount of service, plus an additional fee when they exceed that amount. For example $39/month for 450 minutes, plus $.45 for overage. Offering a tiered usage pricing system is effective for bumping customers up to the next level, especially if they get charged for going over their limit.


5. Promotional pricing: we’re all familiar with this one—the special sale. In this model, you might discount by contract or calendar period, or by season to entice customers wary of spending a lot of money upfront. For example, you may charge an introductory rate of $19.95/month for the first three months, and then $39.95/month. Promotional pricing helps reduce barriers to entry and encourages adoption of your service.


These five pricing models act as levers to help you achieve important business objectives. And as you can imagine, your business is at a real disadvantage if your infrastructure can’t support these pricing models.

Pricing Model Business Objective
Module-Based Pricing Adoption
Resource-Based Pricing Target different segments and/or verticals,
adoption, reduce barriers to entry
Usage Pricing Linear revenue growth: might hinder adoption
Tiered + Overage Pricing Upfront cash, upsell
Promotional Pricing Reduce barriers to entry, adoption