Don’t try and reinvent the pricing wheel. Default to using the price-based costing method which looks at what competitors or substitutes would charge to provide a similar product/service to get a sense of willingness to pay. Base your pricing off of existing incumbents and those who are defining the market at this time.
Pricing has a negative correlation with demand. When the price goes up, the number of customers willing to pay that price will go down. In general, pricing alone should be the primary reason 20% of people are not willing to buy the product.
The consumption-based pricing model is a service provision and payment scheme where the customer pays according to the resources used. The provider needs to track customer usage and bill accordingly. Consumption-based billing is best for businesses that can easily break down their offerings into small, variable units.
| Advantages | Drawbacks |
|---|---|
| Fair to the customer (paying for actual usage) | Difficult to predict revenue (can’t price annually) |
| Align operating costs with customer usage rates (e.g. cloud storage) | Receive payment in arrears as opposed to in advance |
Use hosting fees to control high hosting costs. When the cost of hosting is high, consider a hosting fee for small customers and a minimum size for hosting costs to be waived.
Two hosting examples:
SaaS companies should typically target an 80-90% margin with a target of 15% or less of costs spent on infrastructure and a target of 5% or less of costs spent on support.
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Calculating margin and markup
Margin = (Revenue - Costs)/Revenue = 1 - Costs/Revenue
Markup = (Revenue - Costs)/Costs = Revenue/Costs -1
Markup = Margin*Revenue/Costs = (1/(1 - Margin)) - 1
Markup = (1/(1 - 80%)) - 1 = (1/20%) - 1 = 500% - 1 = 400%
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Use the Buyer-Based Open Core framework to determining what’s open source and what’s source-available. The open source project is always free and downloadable without restrictions and typically a separate offering from the free pricing tier.
Keep your pricing tiers simple by limiting to three tiers.