Pricing Models for Business

There are many factors to consider when pricing your product or service. While customers might be drawn to the absolute price of your product, pricing also affects its perceived value (a lower price could be thought to indicate poor quality, whereas a higher price might signal luxury or premium goods).

The pricing model you decide to use largely depends on your product or service, such as whether it is a digital service or physical good, whether its value is based on long-term or once-off usage, the flexibility customers have on using it, payment options and how sustainable your revenue would be in the long run.

It is important to get your pricing model right from the start. It may be difficult to justify pricing changes to your existing customers if your pricing model were to change, and you could lose some of them during the transition. Your pricing model may also influence how your business is perceived by potential customers, so you should consider what you can achieve in the long run, and not just focus on short-term profit.

Here are five different pricing models you can consider:

Freemium

Freemium products are a combination of “free” and “premium”. They typically provide a free basic version with features with sufficient value for most users. Users have to pay or subscribe to access added features that enhance the user experience (e.g. no ads). One example is the music streaming service Spotify, which has a free basic app, and a paid version with more features and content. This model is suitable for branding and growth, while revenue streams are developed through other areas such as advertising and sponsorships.

Pros	Cons
- Users are more willing to try the product or service since it is free. - Potential for rapid growth and virality. - A large user base that has the potential for indirect revenue streams (e.g. ads)	- Difficult to convert to paying users if they are sufficiently satisfied with the base product, or if the paid version is too costly. - Easier for users to stop using the product. - More overheads to sustain a large base of non-paying users.

Flat rate fee/Flat rate subscription

Flat rate pricing is when a single bundled product with a set of fixed features is sold at a predetermined price. Many bundled physical goods are sold this way, though this model can also apply to digital subscriptions. For instance, a magazine might provide a print + digital subscription at a regular annual price, or a subscription service may send its users a curated box of imported snacks or a bouquet of flowers every month.

Pros	Cons
- Easy for customers to understand with minimal confusion over expectations. - Easy to promote and sell, since there is only one bundled form of the product to concentrate marketing efforts.	- Difficult to sell to users who may not need all the features (and would rather pay less). - Difficult to retain customers in the long-term, unless improvements and new features are added over time.

Tiered pricing

Tiered pricing offers different prices on various bundles of features or products. There are typically three packages at low, medium and high price points, each tailored towards a certain user profile and need. Sometimes, as a sales tactic, the low tier is tailored in such a way that the medium tier and pricing would seem more worthwhile. This model is employed by many online service providers (also known as Software-as-a-Service).

Pros	Cons
- The low tier is an affordable way for users to try out the product. - Easier to upsell by promoting the added features of the next tier. - Flexibility of changing tiers is attractive for users who have changing needs.	- Difficult to sell to users who may not need all the features (and would rather pay less). - Difficult to retain customers in the long-term, unless more improvements and newer features are added over time.

Per feature/Item pricing

Like shopping at a supermarket, users only pay for the items they want. This model can be extended to online or digital services, where added features are priced individually. Usually, a base product is required (which may be provided for free, or for a basic fee). For example, a mobile phone subscription requires a SIM card as a base product, but additional features such as a data plan and call minutes are priced separately.

Pros	Cons
- Easier to market and sell with no complicated bundle conditions. - Easier to upsell additional features. - Users find the flexibility to add and drop features attractive.	- Pricing many individual features is complex, especially when considering overall profit margins

Usage-based fee/Prepaid wallet model

In this model, users are charged for what they have used. This can apply to physical goods (e.g. wine consumed, weight of flour purchased), or digital products (data downloaded, hours of video streamed). For example, household utilities are billed based on what was used the previous month.

A variation of this concept is the prepaid wallet, where users load a specific amount of money (either determined by the business or the user) into a “wallet”, and whatever amount is due is then deducted from this wallet. For instance, a prepaid coffee card that gives the customer 10 coffee redemptions, or a mobile wallet that can be topped up and used at partnered vendors. The wallet model provides the business with upfront revenue, instead of potentially fluctuating returns over a period of usage.

Pros	Cons
- Potentially lower churn rate (rate of customers leaving/lost), as users are only charged for what they use. - Users who have committed funds are also likely to continue using the product.	- Revenue may be hard to predict as usage may fluctuate. - Tracking usage (and billing the user) accurately will require robust administrative or IT backend systems.

While there are many other pricing models catering to more niche areas and industries available, the models listed above are common for many products and services. Each model may be adapted (or creatively combined) to suit your business needs. As your business model evolves, your pricing model may also need to be updated.

References

Campbell, Patrick. “Saas Pricing Models, Strategies, and Examples of Success.” ProfitWell. Published 28 May 2020, https://www.profitwell.com/recur/all/saas-pricing

Cuofano, Gennaro. “Pricing Strategies and Models to Enable Your Business Model.” Four Week MBA. Published 12 June 2020, https://fourweekmba.com/pricing-strategies/

Decker, Allie. “The Ultimage Guide to Pricing Strategies.” HubSpot. Updated 17 March 2022, https://blog.hubspot.com/sales/pricing-strategy

Mohammed, Rafi. “The Good-Better-Best Approach to Pricing.” Harvard Business Review. Accessed 5 September 2022, https://hbr.org/2018/09/the-good-better-best-approach-to-pricing

Skriveris, Janis. “Business Models (vs. Pricing Models).” LinkedIn. Published 5 August 2020, https://www.linkedin.com/pulse/business-models-vs-pricing-janis-skriveris/