Choosing a pricing formula is one of the first — and most important — steps when creating a pricing plan. If you’re a new subscription business owner, it’s easy to assume you need to use something like “$X a month for Y product.” It’s simple, intuitive, and it works well in a spreadsheet.
However, there are other options that may fit your business model better and result in a healthier bottom line. In addition to understanding the basic pricing formulas available, you need to know how to combine those into a value-based pricing structure for your subscription business.
The most common pricing formulas are:
- Fixed fee
- Flat rate
Fixed fee pricing is probably the pricing formula you immediately think of when you think of a subscription. The unit quantity is always one, the price is the same, and the only factor that changes with this formula is the time period (whether it’s billed per week, month, year, etc.).
For example, “Petflix,” a dog movie streaming company, charges their customers $13.99 per month to have full access to their dog movies database. The quantity of movies streamed at the end of the month does not affect the price paid.
Good for: Subscription businesses where there’s no need to measure units because the quantity is always one. This is often the go-to model for membership programs or digital subscriptions. For example, Hulu is $5.99/month with ads or $11.99/month without.
This is another simple formula, represented by a price per unit. An example might be $0.10 per transaction or $12 per seat.
Good for: Businesses where customers might want to vary the amount of product they’re getting from month-to-month (or quarter-to-quarter, etc.), where volume discounts don’t come into play. This is also great for businesses where the value the user gets increases as the amount of units increases. For many businesses, “users” are the units here — for example, Front charges $9/user/month for their “Starter” plan.
The volume pricing formula uses quantity brackets. Volume-based is the price for the quantity bracket multiplied by the number of units. It’s essentially the same thing as flat-rate per unit pricing, but with a volume-based discount.
This is a very popular formula in retail. Let’s take a look at the following pricing table:
- For 0 to 1 apples, each apple is $5
- For 2 to 5 apples, each apple is $4
- For 6 or more apples, each apple is $3
If you were buying six apples, each of them would cost $3, for a grand total of $18.
Good for: The same businesses that work with a flat rate per unit, but want to add a volume discount (or frequently get requests to do so). It’s also good for businesses where there’s less overhead for a larger volume of units, so they aren’t leaving money on the table by not offering a volume discount.
This is especially popular for physical subscriptions boxes. An example is Freshly, a meal delivery service, which offers plans that start at $12.50/meal for four meals a week, with the per-meal price going to $8.99/meal for twelve meals a week.
Stairstep pricing is best for units that are only sold in a specific quantity. Using eggs as an example, if Joey wants to buy four eggs, he has to buy a carton of six eggs. He can’t buy ⅔ of a carton of eggs. If he wants to buy seven eggs, he’ll have to buy a carton of twelve eggs.
Good for: Businesses who want to avoid selling products in smaller quantities, or businesses who want to keep their pricing simple (instead of having per-unit pricing). This formula lets you extract more value per unit from particular price brackets. Another example might be businesses who want to cap usage within specific pricing brackets — for example, Zapier’s free plan allows for 0 to 5 zaps a month, whereas their $20/month plan covers up to 20 zaps a month.
The tiered pricing formula also works by brackets, with a few differences from stairstep or volume-based pricing. A common example of this is per-user pricing for software as a service products. On a basic plan, you can have up to three users for a certain price per user, and additional seats are charged at a different rate.
Let’s take a look at the following example:
- For 0 to 3 seats, the price per seat is $25
- For 4 to 5 seats, the price per seat is $20
- For 6 or more seats, the price per seat is $15
If you decide to buy 6 seats, here is how much each would cost based on the tiered pricing plan:
- Seat #1: $25
- Seat #2: $25
- Seat #3: $25
- Seat #4: $20
- Seat #5: $20
- Seat #6: $15
For a grand total of $130/month.
Good for: Overall, tiered pricing works well in the same businesses where volume pricing works. It’s often found in digital products, including SaaS products and hosting companies. One example of tiered pricing is Amazon S3’s Storage pricing, which charges $0.023 per GB for the first 50 TB used in a month, then $0.022/GB for the next 450 TB used in a month, and $0.021/GB for everything over 500 TB used in a month.
In many cases, a subscription business might use a combination of these formulas to create a pricing structure that makes the most sense for their business and users. Intercom’s pricing is one example:
Their pricing involves:
- Fixed fee (the minimum monthly price for any given plan)
- Tiered pricing that’s metered based on usage (an additional fee for more than 200 active leads/customers, that goes up in tiers depending on how many active users you have)
- Flat rate per unit ($19/month for extra seats on the Essential plan)
An example subscription rate might look like:
- A user signs up for the Essentials plan, which has a base rate of $136/month for up to 200 active people and two seats
- The user has 525 active people (leads and customers), which adds $15/month.
- The user needs two extra seats, which adds $19 x 2 = $38/month
The user’s total rate is $189/month.
Using multiple pricing formulas like this is one way to make sure you’re maximizing your profits, but you do run the risk of confusing your customers. If you use hybrid pricing structure, make sure that it’s as easy as possible for your customers to figure out what their costs will be. Check out MailChimp’s pricing calculator for one example of how to make it clear.
You probably noticed above that we mentioned Intercom has tiered, metered billing as part of their pricing structure, and might be wondering why “metered” wasn’t listed above as one of the pricing formulas. Metered billing isn’t a pricing formula as much as it is a method of determining what quantity of units the customer is billed for.
It’s likely you have more than one metered subscription account — energy bill, anyone? With metered billing, the customer is charged for what they use, and nothing else. Sometimes, it’s referred to as “usage based billing” or “variable price billing,” since it goes up and down from month-to-month depending on the usage.
One easy way to determine whether something is metered or not is:
Is the customer choosing the quantity of the item, or is the quantity based off of the customer’s usage?
Since it’s determined by usage, metered billing is usually done after the fact (more on that in a moment). To use the above Intercom example, the seats are determined in advance by the customer and are paid every month whether the customer uses them or not. The customer pays for the seats to be used in the next 30 days, but the price for active users is metered and is billed after the fact.
Depending on how you’re billing users, it might make more sense to bill in advance or in arrears (after the fact). Most subscription services are billed in advance (for example, the customer pays on June 15 for service from June 15 to July 15), but businesses using metered billing often bill afterwards. There are exceptions, though — for example, Slack bills per active user, per month (or year), but bills in advance, and if you remove active users throughout the month, they issue you an account credit. You can also do things like prepay for mobile phone usage, and only renew once you’ve used up the amount you prepaid for.
People often think of subscription services as being monthly, but they don’t have to be. Depending on the industry and product, it’s not uncommon to find weekly, biweekly, quarterly, or annual billing. There is some debate about which of these options might be best — we’ve discussed the research before, but here’s a quick overview:
- Annual plans can be better for getting upfrontcash, which can help you recoup your customer acquisition costs faster.
- Compared to annual pricing, monthly pricing can increase user commitment. If your product requires more habit formation than others (for example, something fitness related vs. a streaming movie service), it might actually be beneficial for you to bill monthly instead of in larger periods, because your customers might be more likely to use it.
- Showing annual plans and/or annual costs can be used as a form of price-anchoring to incentivize people to sign up for a higher plan than they may have normally (read about that in the previous post)
One last thing to note is that there are two factors to account for in how you price each unit (whether that’s a membership, GB of storage, active users, or something else). Those two things to keep in mind are:
- The value your customer gets from using the product
- The cost involved for you in creating/selling the product
Obviously, you need to make sure that you’re covering your costs. Otherwise, you won’t have a business for very long! However, it’s all too common for people to price based on just their costs, without considering the value for the customer/end user. This goes both ways:
- If you’re pricing a subscription at $200/month because that’s what you think it’s worth, but the average customer doesn’t, then you’re going to run into issues
- If you’re pricing a subscription at $20/month because that covers all of your costs and also has an okay profit margin, you could be leaving money on the table if your customers would be willing to pay more
This is something you can test over time (which you can read more about here). To start, you can get a feel for what kind of value your product provides by talking to your customers (or would-be customers) about the impact it has on their life, and looking at what your competitors (or would-be competitors) charge.
Choosing how to structure your pricing to use can feel intimidating, but now that you’re more informed, you can make the right choice for you and your business.
Want to keep optimizing your prices after you choose a formula? Download our Price Optimization Guide to get a list of experiments you can do right now, categorized by funnel stage and difficulty, starting today: