The Three Rules of Freemium

At the SaaStr Europa conference in Paris a couple of weeks ago I sat down with Joaquim Lecha, the CEO of our portfolio company Typeform, to talk about “Freemium at Scale”. Founded and headquartered in Barcelona, the company launched a free version of its service seven years ago. During our conversation Joaquim revealed that this free service helps drive 180,000 monthly signups, and about 3% of those signups convert into paying users who are billed anywhere from €25 to €70 per month, depending on the plan they choose. In other words, Typeform is effectively leveraging a free version of its product to drive paid subscriptions at scale.

I have a bit of a love/hate relationship with the freemium model. Done right, freemium can lead to amazing success. One of the best examples is Dropbox, which Tomasz Tunguz called the “King of Freemium”. What makes the company unique, he argues, is how it transformed its free users into evangelists. “Unlike other SaaS companies, Dropbox spends more of its revenue on engineering than sales and marketing,” Tomasz wrote. “Typically, businesses spend twice as much on S&M.” In a piece I wrote when Dropbox went public last year, I pointed to the section of the company’s S1 that detailed how Dropbox drove sales of its enterprise solutions. Unlike most other enterprise software, which traditionally used to be chosen by the IT department, Dropbox is typically adopted by individual employees from various departments, who then lobby management into switching. As I noted in my piece, Dropbox was one of the early champions of the ‘consumerization of enterprise software’ movement, which was one of the strongest drivers of SaaS success in the last ten years.

But not every SaaS company can be a Dropbox or a Typeform. Done wrong, freemium can end up cannibalizing your paid user base while also draining your company’s precious engineering and customer support resources. So how do you know if launching a freemium product is the right move for your company?

Let’s discuss some of the pros and cons of the freemium model.

The downsides of freemium

I think many SaaS companies are too optimistic in thinking that they can just offer a free, pared-down version of their software and that this will result in a wave of user signups followed by increased revenue once those users make their way down the purchase funnel. But there are a number of factors you should consider first:

Added costs: Given that SaaS is an extremely high-gross-margin business, one might think that you can easily support free users. However, even if your gross margin from paying customers is 80% to 90% (i.e. your CoGS are only 10% to 20%), those costs can become very significant if you grow a large user base that doesn’t generate any revenue.

From engineering to hosting, the freemium model will require consistent upkeep that drains resources that would be otherwise devoted to your paying customers. And even though your freemium users won’t be paying a dime, they will still expect some level of customer service. In our discussion at SaaStr Europa, Joaquim revealed that, on average, 70% of Typeform’s support tickets come from free users and that the company spends $130,000 per month supporting them.

Now, Joaquim didn’t consider this too high a price to pay for the various benefits of having a free plan (more on that below), but for other companies, the upside/downside assessment may look different. If your business has lower-than-usual gross margins (e.g. because your SaaS solution includes a service component or because your product is particularly costly in terms of infrastructure), you should think extra hard about whether freemium is right for you.

Cannibalization of paying users: For any freemium model, the running assumption is that a certain percentage of non-paying users will eventually convert into paying customers. But what should also be considered is how usage will flow the other way. In other words, some people, who without a free plan would have become paying customers, will be fine with the free plan and won’t need the paid version.

An imbalance of product features: A freemium approach requires a delicate balance. Provide too many features for free and you risk cannibalizing your paid user base. Offer too few features and you eliminate the value proposition for users to sign up in the first place. Typeform walks this tightrope well, limiting its free surveys to 10 questions and 100 responses. Converting to the paid version grants the user unlimited questions and responses, as well as advanced features such as logic jumps and design personalization options. Not every SaaS company can strike that kind of balance.

Less focus on core users: An important factor to keep in mind is that having a freemium model will almost inevitably have a strong impact on your product roadmap. If you have a free plan, chances are that for every paying customer you’ll have 10–20 (or more) non-paying users. It’s hard to ignore the feedback of a group of users that represents 90–95% of your total user base. Listening to those users doesn’t have to be a bad thing, but it may. It all depends on how similar your non-paying users and their use cases are to your paying customers. In this interesting analysis about the “rise, fall, and future of Evernote” — once the poster child of freemium — Patrick Campbell and Hiten Shah conclude that “trying to appeal to everyone and not building the functionality that core customers want to use made Evernote’s product feel stagnant, which is definitely a tradeoff they should never have made.”

Widening the top of the funnel also makes it critical that you are excellent at identifying the best leads effectively and efficiently. If you don’t do that, your valuable signups might fall through the cracks in all the noise.

The benefits of freemium

Most of the above challenges can be overcome if your free plan leads to a much larger top of the funnel and if you can convert enough free users into paid. A freemium model will likely lead to a lower conversion rate, but that’s OK if it’s more-than-offset by the increase in signups. Assuming that you can keep conversions at a sustainable level, then the freemium model can have several benefits:

More active users: One of the biggest challenges that SaaS companies face is driving adoption of their product. And while some users can be enticed by a free trial period, there’s a subset of consumers who are just more likely to keep using the product if it’s free. Others won’t even sign up in the first place if there’s no free plan.

More evangelists and a positive impact on your brand: You shouldn’t measure a user’s worth solely on whether they eventually start paying you. The larger the number of active users, the greater the pool of potential evangelists who will promote your product to new users. In my discussion with Joaquim, he told me that users who were aware of Typeform’s brand prior to signing up were twice as likely to convert into paid users than those who came in via non-organic channels. Qwilr, another Point Nine portfolio company, has made the same observation.

Amplify virality: The strongest rationale for going freemium is having a product with a built-in viral loop (like Typeform or Dropbox). If you’d like to dig deeper into viral growth in SaaS, check out this great post by my colleague, Louis. One caveat I’d add is that you can’t take it for granted that your free users will have the same viral coefficient (or k-factor) as your paid users. In many cases, your average free user will be less active than your average paying user and will therefore lead to fewer referrals. It doesn’t have to be like that, though. In an ideal world your paywall is built in such a way that users have an unlimited ability to share (or do whatever it is that makes your product viral) and monetize something else.

More user feedback: In our talk, Joaquim pointed out another advantage of having a large user base: It allows Typeform to learn from a much larger number of people. That’s a very interesting aspect that I hadn’t thought about before. Keep in mind, though, that as mentioned further up, depending on your product and industry, feedback from free users may be more or less relevant.

Re-engaging trial users: Every SaaS company will have a certain subset of users who will sign up for a free trial of the paid product and will not convert into a paying user once the trial period ends. Introducing a freemium version allows you to re-engage these users with the possibility of converting them at a later date.

Making the decision

So now that we’ve looked at the potential upsides and risks, how can you decide whether launching a freemium product is the right choice for your company?

Ultimately, only an A/B test can answer this question. However, getting reliable results will take a lot of time, especially if you want to measure the impact on virality and if you have a viral cycle time of, say, six months. If you can’t wait that long (or if you’re not equipped to do a complete-funnel A/B test), here are my “Three Rules of Freemium”:

1) Does your paid plan have a gross margin of 80–90%?
If you have a lower gross margin — for example, because your product is not fully self-service, requires extensive customer support or is extremely costly in terms of tech infrastructure — freemium will probably not work for you.

2) Does your free plan attract the right audience?
If your free users are too different from your paying users, your free-to-paying conversion will be low — and you’ll risk developing your product for the wrong audience.

3) Is your product inherently viral?
If your answer is no, that doesn’t make it a complete no-go, but it does mean that it’s much less likely that freemium is right for you.

Wrapping up

In the end, freemium only makes sense if a certain percentage of your free users do one of three things: 1) Eventually convert to paid, 2) refer paying customers, or 3) provide the kind of valuable feedback that will improve your product. A freemium product that fails to achieve any of these effects will merely saddle you with extra costs and distract you from servicing your most important users. Not every company can be a Dropbox, but the good news is that not every SaaS company needs to adopt Dropbox’s freemium model to succeed.


This post was first published on Point Nine's Medium channel.

6 things SaaS founders should keep in mind in 2014

First of all, a Happy New Year to all readers of this blog. I hope you've had a great start into the new year, and I wish you a happy, healthy and prosperous (and of course SaaSy) 2014.

I've done a bit of reflection on what I've learned in the last couple of months. Here are six things that I think SaaS founders should keep in mind in 2014. This is obviously not meant as a definite or comprehensive list by any means. Rather, it's a synopsis of some of the things that keep me up at night these days.

1) Have the right mix of paranoia and patience

In the spirit of Andy Grove you need to be paranoid about becoming and staying the #1 player in your market. For a variety of reasons, most SaaS markets have "winner takes most" characteristics, so you have to do everything you can to dominate your market. But since we're still in the early days of Cloud adoption and since it usually takes 5-10 years to build a large SaaS company, you also need lots of patience. Gail Goodman of Constant Contact reminded me of that in this excellent talk.

2) Work on your weaknesses until they become your strengths

At the outset, almost every SaaS founder team that we talk to is either very strong on the product/tech side or on the sales/marketing side, but rarely on both sides. It's like a team DNA, and it's hard for a product-driven team to become excellent at sales and vice versa. At the same time, you have to be great at both product/tech and sales/marketing in order to succeed, so you should do everything you can to work on your weak side. This usually means a combination of a) learning really fast and going out of your comfort zone and b) hiring senior people with complementary skills and experiences. I'm not saying that you shouldn't leverage your strengths, but I know you're going to do that anyway. :) Doing what you love to do and what you're good at is comparably easy. Fixing your weaknesses is the tougher part.

3) Have a plan for 2014

Become clear on what you want to achieve in 2014 and what this means for your product roadmap, your marketing plan and your financial plan. Define company-wide OKRs as well as quarterly OKRs for each employee. It sounds like a no-brainer, but my guess is that most startups will benefit from going through a more structured OKR exercise. More about this in my recent post about OKRs.

4) Prioritize "mobile"

Mobile is eating the world. 'Nuff said.

If you don't offer your customers a fantastic experience on smartphones and tablets (which usually means native apps that leverage the unique capabilities of the device or the mobile usage scenario) you're at risk of getting disrupted by a mobile-first startup, faster than you can disrupt the incumbents of your industry.

5) Don't optimize for the edge cases

One thing I've noticed is that many startup founders are trying too hard to make everyone happy, which leads them to optimize pricing, sales tactics and maybe even product design for a small vocal minority of users. When I discuss e.g. lifecycle email marketing and pricing with SaaS founders I like to say:

"If no one is complaining about your prices, you're most likely too cheap"
"If no one is calling your emails 'spam', maybe you're not sending enough emails"

Similarly, if one user requests a new feature or a change in the product that's no reason to do it, unless you think it makes sense for a large part of your target group.

The temptation to please every user is understandable but it doesn't mean it's the right thing to do. The pricing expectation of your users, for example, will probably follow some kind of bell curve. If you optimize for users on the far edges you're leaving a lot of money on the table in the much bigger middle area of the curve.

6) Raise money when you can, not when you need it

It's a pretty good time for SaaS startups to raise money. If you have the possibility to raise a meaningful amount of money at a good valuation, you should seriously consider it even if you don't necessarily need the money right away. First of all, it's usually unclear what "need" really means. Enough to get to break even? Enough to get to the next round of funding? Enough to win the market? More cash almost always means de-risking and an opportunity to accelerate. I venture to say that if you don't know what to do with an additional couple of million dollars that shows a lack of imagination. Secondly, I don't want to send a "R.I.P. Good Times" message, but currently the times are pretty good and no one knows what will happen in the next one or two years. Thirdly, just because you raise money doesn't mean you have to spend it imprudently, and most SaaS founders who I know are not at risk of failing due to premature scaling because frugality is part of their DNA.

What do you think about these six themes? Which additional ones do you think SaaS founders should pay attention to in 2014?

The 5th DO for SaaS startups – Get your pricing right

Following some advice on choosing the right market (here and here), building a team with product/tech DNA and the importance of an awesome product and an awesome marketing website I would now like to turn to the topic of getting your pricing right:

5th DO for SaaS startups

Get your pricing right

If you're following this blog for a little while, a part of this post won't be new for you because I wrote about the topic before and will repost a large part of it here. But I'm going to add a few new thoughts as well, especially about Freemium.

As you're getting close to the launch of your product you'll have to make a number of decisions around pricing:

1. Will there be a free plan?
2. What pricing model am I going to use?
3. How much am I going to charge?

Pros and cons of Freemium

Starting with the first question, there is no general answer on whether you should or should not adopt the Freemium model. Having a free plan can be extremely powerful in getting large numbers of users quickly but there are costs to it. Here are some of the factors that you should consider:

• How much does it cost you to serve a customer? While the marginal costs for hardware and bandwidth to serve an additional customer are of course very low, keep in mind that when you offer a Freemium model you might very well end up with 95% free customers and 5% paying customers. So assuming your CoGS are the same for free and paying customers (which may not be true), the free plan might increase your costs for hardware and bandwidth by a factor of around 20. Also consider the burden on your support team when you think about the costs to serve free customers.
• Is there a natural upgrade path from free to paying? That is, do you think a free plan will allow you to attract users who will eventually upgrade to a paid plan e.g. because their business grows or because they need premium features? Or would a free plan primarily attract users who will never pay for your product and who you might not be interested in acquiring at all?
• How price sensitive is your target group?
• Do you have a good idea for defining the limitations of the free plan? Will you be able to offer compelling reasons for upgrading?
• Is there an opportunity to make money off the non-paying customer base using alternative revenue channels? Or are there network effects in your business that let you benefit from a large user base?
• Is there strong competition? Are you in a "land grab" situation?
• How well are you funded, can you afford to give low priority to short-term revenues?

A good example for a successful Freemium model is MailChimp, the popular email marketing solution. MailChimp offers a free plan that lets you send up to 12,000 emails per month to up to 2,000 subscribers. If you look at the questions above you'll notice that for an email marketing solution there's a strong case for Freemium. Most of the aspects are pretty obvious (costs to serve a free user can be calculated fairly precisely, smooth upgrade path, high price sensitivity due to strong competition). One maybe less obvious aspect is that its large base of free users allows MailChimp to process and analyze hundreds of thousands of email lists and billions of email addresses. This for sure gives MailChimp lots of valuable insights which small competitors don't have. For example, it allows MailChimp to build a database of invalid email addresses which they can use to reduce bounce rates for their customers and thus become a better emailer (from the perspective of spam detection), improving email deliverability rates.

By the way – if your product doesn't lend itself well to a Freemium offer, try to think of something else that you can give away for free to get users and make them aware of your paid product. This could be an add-on to your core product, a mobile app or a small separate product. Hubspot's website grader is a great example.


Using the right model, charging the right amount

Let's move on to the second and the third question from above – what pricing model am I going to use and what should I charge?

It’s obvious that getting pricing right is extremely important: If you’re too cheap you will leave money on the table and reduce your ability to invest in customer acquisition. You may also hinder adoption especially from bigger customers who think that your product can’t be good because it’s so cheap. If you’re too expensive you might be scaring away the majority of your potential customers.

Unless your target customers are all very similar (which is unlikely), the most important thing that your pricing model has to accomplish is to capture different amounts of money from different customers based on their willingness and ability to pay, which correlates with the value that they’re getting from your product. In the old enterprise software world this used to be the job of the sales people – talk to the customer, find out about his needs, get a sense for what he can pay, offer him a solution and negotiate a price. In the world of SaaS, customers (rightly) expect more transparency and will look for a price list on your website before they start a trial.

In many cases a per-user pricing (often also referred to as “per seat”) is an obvious choice, and some of the most successful SaaS companies including Salesforce.com are using that. Other successful examples include pricing based on:

• number of clients managed with the software (e.g. Freshbooks)
• number of newsletter emails sent (e.g. MailChimp)
• number of email recipients in the system (e.g. ConstantContact)
• amount of storage that is used (e.g. Dropbox)
• number of events tracked (e.g. KISSmetrics)

What these companies have in common is that they've found an "axis" that highly correlates with their customers' willingness to pay, which allows them to keep their service affordable (and in some cases free) for small customers while asking bigger customers for much more. It also allows them to benefit from the growth of their customers, since a growing company needs more seats/emails/MBs/events/etc over time. Ideally this can lead to what is known as "negative churn" – the wonderful situation when the MRR growth of some customers of a customer cohort more than offset the effect of terminations from that cohort.

Importantly, most successful SaaS companies differentiate their prices along more than one axis (David Skok wrote about this here). Secondary axes include the level of support, additional features or other usage parameters. For example, Freshbook's pricing is based on a combination of the number of clients that you can manage and the number of seats, plus two additional factors:

So what's the right pricing model for your SaaS startup? The right answer is of course "it depends", and all I can do is offer a few practical tips:

• Try to find one or more axes which correspond with the value that your customers are getting from your product and which correlate with your customers' willingness to pay. Talk to your customers and analyze how your early users are using the system to find out the ways in which larger customers are using your product differently from smaller customers.
• If you don't know how much to charge, take a look at the prices of other products in the market and try to get a sense for the value that customers get from your product. How much time and thus money can a customers save with your product? Does it allow your customer to increase revenues?
• In the beginning, err on the side of being too cheap rather than being too expensive. In the beginning the most important thing is to get customers. You can optimize your margins later.
• Later on, make sure you're not leaving too much money on the table. If not a single customer ever complains that you're too expensive that's a strong sign that you're too cheap. Also keep in mind that a higher ARPU means more money that you can reinvest in customer acquisition and that a higher ARPU can open up completely new ways of acquiring customers, so higher prices can also be a driver of customer growth.
• Accept the fact that it's very unlikely that you will get your pricing right at the first shot. Go out with something that you think makes sense, get feedback from the market and be prepared to make changes quickly.
• If you increase prices, try to do it along with new value-add features that help justify the price increase. And offer your existing customers extremely generous grandfathering terms.
• If your pricing is differentiated based on features, consider giving all users the high-end plan with all features during their trial so that they can play around with the full product.
• Maybe not necessary to mention since these are all known best practices, but just in case: Give users a self-service free trial. Offer monthly pay-as-you-go subscriptions that users can cancel at any time. Provide an option to pay in advance for a year (with a discount). Create a clean, beautiful pricing page. 

A PS on grandfathering

If you've read my last blog post I still owe you a small PS. I mentioned that while I was writing the post I've learned two surprising things, so here goes. (Caveat: I usually try to provide some useful advice in my blog. What I'm going to write now doesn't have any practical value so feel free to skip it.)

Number 1: 

Do you know where the term "grandfathering" comes from? Maybe it's just my illiterateness and you're yawning but I had no idea that the term, which describes such a nice thing in the context of business and politics today, goes back to such a horrible concept:

The concept originated in late nineteenth-century legislation [...], which created new literacy and property restrictions on voting, but exempted those whose ancestors (grandfathers) had the right to vote before the Civil War. The intent and effect of such rules was to prevent poor and illiterate African American former slaves and their descendants from voting, but without denying poor and illiterate whites the right to vote.

(Source: Wikipedia)

Number 2:

I initially thought that the lower your churn rate is, the tougher it will feel for you to offer generous grandfathering. My thinking was: If you have a low churn rate and therefore a long customer lifetime, you're giving up a lot of incremental revenues by not increasing your prices for existing customers. If on the other hand you have a high churn rate you can more easily do without the price increase because you're existing customers won't stick around for a long time anyway.

Turns out this isn't true, at least if you expect churn to be constant – and if you're interested in the relative importance of the aforementioned incremental revenues as part of your total revenues (if you only care about the absolute dollars that you might be giving up, my original assumption is of course correct). If you take a look at this Google spreadsheet (let me know if you'd like to get the Excel version) you'll notice that the  relevant revenue portion that we're talking about (revenues from Group A customers due to pricing increase, cells E22-G22) is almost completely insensitive to changes in churn rate (cell B10)!

Look at cell G22 in the spreadsheet, which shows the revenue portion that you give up by offering grandfathering for year 3. If your churn rate is 1% p.m. that percentage is 7.35%. If it's 3% p.m., the percentage goes down to 7.22%, almost no change. And if your churn rate is 5% p.m., again almost no change to that percentage (7.08%). The reason is that revenues from your new customers ("Group B customers" in the model) are affected by your churn rate as well, and that effect almost completely offsets the effect of your churn rate on your existing customers with respect to the question that I was talking about. If you think about it, it's logical, but my original intuition was wrong.

The Case for Grandfathering

If you're running a SaaS startup it's likely that sooner or later you'll want to increase your prices. The reason is simple: It's impossible to find the perfect pricing right off the bat, so most startups launch with a pricing scheme that's on the low end to make sure that they don't scare away potential customers. "In the beginning, err on the side of being too cheap", was also one of the tips that I gave in my previous blog post about SaaS pricing.

Now let's say 12 or 18 months have gone by, you've acquired your first couple of hundreds of customers, you've added lots of features and made your product better and better. By now you also have a better feel for what your customers are willing to pay, maybe supported by A/B tests with different prices or customer interviews, and you want to increase your prices. 

There are a number of questions that you'll have to answer: Do you want to keep the pricing model and just increase the amounts or do you want to change the structure of the pricing – axes, plans, limitations – as well? How much do you want to increase prices by? Are you introducing new features or editions that justify a pricing increase or are you going to increase prices for the existing offering?

In this post I want to focus on just one question: Should the new, higher prices be applied to your existing customers as well or should their plans get grandfathered?

At first you might be tempted to increase prices for your existing customers. They like your product and are used to it (and will incur "switching costs" if they switch to a different product), so most of them probably won't leave even if they are not thrilled about the price increase. The additional revenue from the higher prices will probably more than offset the revenue that gets lost due to some customers who leave. So increasing prices for your existing customers promises to give you an immediate, maybe very significant revenue bump.

In spite of this I want to argue that if you take a long-term view grandfathering your existing customers is almost certainly the better choice. (At least if you're a fast-growing early-stage startup. If you're a big company in a saturated market things may be different, but then you're most likely not reading this post anyway!)

The main reason for grandfathering existing pricing plans is that it just doesn't feel right to attract customers, get them used to and maybe even locked into your product and then demand more. Unless the pricing increase is very modest or your customers all agree that the old price was way too low relative to the value of your product, this will almost certainly upset a significant percentage of your customers.

However, the reason I want to focus on is mainly a mathematical one and is related to the effect of fast growth. It also doesn't require you to think much about business ethics as I will argue that grandfathering is also better for you, not just for your customers. :-)

Take a look at this Google Spreadsheet. 

Let's say your customer churn rate is 2.5% per month, your customer growth rate is 5% per month and you're planning a price increase of 50%. Based on these assumptions, by year 3 after the pricing increase the additional revenue that you get from not grandfathering your pre-price-change customers (named "Group A" in the spreadsheet) will – maybe surprisingly – account for a mere 7% of your total revenues. Here's how it looks like on a chart:

This does not yet include the effect of cancelations due to the price increase! If you assume that you will lose 5% of your existing customers due to the price increase (see the second scenario in the spreadsheet), the net revenue gain of not grandfathering has shrunk down to less than 2.5% by year 3, and by year 4 the gain will have turned into a net revenue loss:

If you're assuming a higher cancelation rate that will obviously happen even earlier.

You can download the Google Spreadsheet to play around with the assumptions (or let me know if you want the Excel file via email, in that case you'll also get the charts which didn't survive the Excel => Google conversion). It depends on your assumptions if and when the positive effect of not grandfathering will reverse itself, but unless you're not predicting much growth it won't take very long until the additional revenue will have become a pretty insignificant factor.

Importantly, I have not even taken into account the potential negative effect which not-grandfathering might have on your future growth rate by reducing referrals from your existing customers and generally by losing goodwill in your target audience (whereas generous grandfathering could motivate your loyal customers to give you even more referrals than before). These effects are hard to measure but I'm sure they exist and if you keep them in mind the decision will be even clearer.

Finally, if you agree with the above, consider creating a "Customer Bill of Rights" which, upon signup, explains to customers how you're going to deal with pricing increases in the future. I think I've never seen this on a signup page but I'd be curious to find out whether this would have a positive effect on conversion rates.

PS: While writing this blog post I learned two surprising things (surprising for me, at least). More on that soon. :)

The Price is Right (or not)

One of the most important questions which every SaaS company has to solve is to find the right pricing – the right pricing model as well as the right price levels. It’s obvious that getting pricing right is extremely important: If you’re too cheap you will leave money on the table and reduce your ability to invest in customer acquisition. You may also hinder adoption especially from bigger customers who think that your product can’t be good because it’s so cheap. If you’re too expensive you might be scaring away the majority of your potential customers.

It is of course impossible to find the optimal price point in a way academic textbooks would define it. Finding that would require you to do more tests than you can possibly do. What you should do is try to get to that point as close as possible, and when I talk about the “right” pricing I mean a reasonably right pricing.

Unless your target customers are all very similar (which is unlikely), the most important thing that your pricing model has to accomplish is to capture different amounts of money from different customers based on their willingness and ability to pay, which correlates with the value that they’re getting from your product. In the old enterprise software world this used to be the job of the sales people – talk to the customer, find out about his needs, get a sense for what he can pay, offer him a solution and negotiate a price. In the world of SaaS, customers (rightly) expect more transparency and will look for a price list on your website before they start a trial.

In many cases a per-user pricing (often also referred to as “per seat”) is an obvious choice, and some of the most successful SaaS companies including Salesforce.com are using that. Other successful examples include pricing based on:

• number of clients managed with the software (e.g. Freshbooks)
• number of newsletter emails sent (e.g. MailChimp)
• number of email recipients in the system (e.g. ConstantContact)
• amount of storage that is used (e.g. Dropbox)
• number of events tracked (e.g. KISSmetrics)

What these companies have in common is that they've found an "axis" that highly correlates with their customers' willingness to pay, which allows them to keep their service affordable for small customers while asking bigger customers for much more. It also allows them to benefit from the growth of their customers, since a growing company needs more seats/emails/MBs/events/etc over time. Ideally this can lead to what is known as "negative churn" – the wonderful situation when the MRR growth of some customers of a customer cohort more than offset the effect of terminations from that cohort.

Importantly, most successful SaaS companies differentiate their prices along more than one axis (David Skok wrote about this here). Secondary axes include the level of support, additional features or other usage parameters. For example, Freshbook's pricing is based on a combination of the number of clients that you can manage and the number of seats, plus two additional factors:

So what's the right pricing model for your SaaS startup? For obvious reasons it depends and I have no general answer to that question, but here are a few practical tips:

• Try to find one or more axes which correspond with the value that your customers are getting from your product and which correlate with your customers' willingness to pay. Talk to your customers and analyze how your early users are using the system to find out the ways in which larger customers are using your product differently from smaller customers.
• In the beginning, err on the side of being too cheap rather than being too expensive. In the beginning the most important thing is to get customers. You can optimize your margins later.
• Later on, make sure you're not leaving too much money on the table. If not a single customer ever complains that you're too expensive that's a strong sign that you're too cheap.
• Accept the fact that it's very unlikely that you will get your pricing right at the first shot. Go out with something that you think makes sense, get feedback from the market and be prepared to make changes quickly.
• If you increase prices, try to do it along with new value-add features that help justify the price increase. And offer your existing customers extremely generous grandfathering terms.
• If your pricing is differentiated based on features, consider giving all users the high-end plan with all features during their trial so that they can play around with the full product.
• Maybe not necessary to mention since these are all known best practices, but just in case: Give users a self-service free trial. Offer monthly pay-as-you-go subscriptions that users can cancel at any time. Provide an option to pay in advance for a year (with a discount). Create a clean, beautiful pricing page. 

Do you know any examples of pricing models that worked or didn't work, or would you like to get my feedback on your pricing model? Get in touch!