Getting your pricing right is hugely important for the health of your SaaS company, both short- and long-term. To help you make smart pricing choices, today I’m answering one of the biggest pricing questions we get asked: is a freemium or premium pricing model best for your SaaS company?
The Fatal Assumption
If I asked you to name ten SaaS companies, chances are a sizeable portion would fall into the ‘freemium’ category – companies that offer both free and paid-for packages.
Slack, Evernote, Buffer, Dropbox… these big-name SaaS companies have used the freemium pricing model to propel themselves to incredible heights. But because of this catalogue of high-profile successes, many founders assume the freemium pricing model is the only way to achieve success with a SaaS product.
In reality, different pricing models will work better for different SaaS companies. While freemium might work for some, and help you to unlock rapid, viral growth, it’s not a one-size-fits-all solution. At the other end of the scale, some SaaS companies may find they can’t manage the costs of serving all their customers (free and paid) from the revenue generated by their paying customers alone.
So how do you know which is best for your SaaS product?
When a Freemium Pricing Model Works Best
There are several scenarios when a freemium pricing model will be the best option for your SaaS product:
- Your service has the potential for viral growth.
- Your service has a huge potential market (which is why it’s normally more successful in B2C than B2B).
- Your service becomes more useful with more people using it (hence the potential for viral growth).
- Your service is simple to start using, so you don’t need to manage high support costs.
- Your service has a clear upgrade path, delivering more value and greater functionality that users actually want.
To be sustainable in the long-term, the best freemium services need to be low-cost to run (in terms of customer acquisition, maintenance and support costs), and have the potential for viral growth with a large audience.
To help you make the right choice for your SaaS business, we’ve created an easy-to-use calculator, to highlight the costs of a freemium pricing model:
When a Premium Pricing Model Works Best
The biggest problem with a freemium pricing model is that you will have a large free user base, and a much smaller paid user base. Your paid users will need to generate enough revenue to serve your users at both price points. This makes it extremely difficult to grow, and runs the risk of financially crippling your business.
Put simply, if your SaaS product doesn’t tick the boxes above, you’ll be much better suited to a premium pricing model.
A common concern when switching from freemium to paid-only pricing is that no-one will want to pay for your SaaS product. If this is the case, you’ve got two fundamental problems:
- You’re attracting the wrong type of visitors to your website.
- Your SaaS product isn’t providing your users with enough real value to justify its cost.
Which Should You Choose: Freemium or Premium?
When choosing between a freemium and premium pricing model, it’s important that you calculate the costs, and work out whether your SaaS company can support a freemium pricing model in the long-term.
If you’re using a freemium pricing model, your SaaS company will only be profitable when your paid users’ lifetime value is greater than the combined costs of acquiring new customers, serving free users and serving paid users.
It’s likely that your freemium user base will grow more rapidly than your paid-for users. Therefore, it’s crucial that you track this month-on-month, so you can identify the tipping point when it’s no longer profitable to support your free user base.