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Freemium Pricing for SaaS: Optimizing Paid Conversion Upgrades

Posted by Dharmesh Shah on Tue, May 22, 2012

 


The following is a guest post by Rishi Shah, Co-Founder of Digioh and 500 Startups Mentor. Join his newsletter and get his eBook "10 Paying Customers in 10 Days" for free.

I've been building a new product and I'm almost ready to launch it. However, I'm having a really hard time figuring out the right pricing structure so I'm going to analyze my favorite Freemium SaaS businesses.

Here is what I know I want:

  1. A free plan. Since we are just starting out I really want people to use the product for free (no credit card required). I'm okay with killing off the free plan if it isn't working economically (existing free users would be grandfathered in).
  2. It is a hosted product so it will be recurring revenue. There will be a monthly fee for the paid packages (with an option to pay yearly upfront for a discount).
  3. Based on many many studies the paid packages will end with a "9". So the packages will be priced with that in mind (i.e. $11.99, $24.99, etc.)
  4. I want to leverage our free plan to get more referrals. For example the free members can earn more features or storage by referring a friend or posting a status update with our link in it. Pretty much exactly what dropbox and appsumo does.

Questions:

  1. How generous should our Free plan be?
  2. What limits should we place on it?
  3. We need our free plan to be something amazing so people will sign up. However we don't want it to be so amazing that they don't ever need to upgrade.
Graph showing the free to paid upgrade sweet spotI decided to take a look at some Freemium SaaS company that I know of and analyzed what I think they did well at.

Screenshot of 37Signals Basecamp

I'm going to start with 37Signals (the godfather of small business SaaS). This was their pricing page before their relaunch. I like how they have the free plan but don't promote it at all. They don't mention it on their homepage and it is hidden at the bottom of their pricing page. A few years back they heavily promoted their free plan and said that 98% of all accounts were on the free plan. Check out their call to action on their homepage. They don't even mention the free plan. They do mention a 30-day free trial though. Basecamp Screenshot Call To Action

Some insights (and assumptions) from 37signals' pricing strategy:

  • They really focus on getting paid customers.
  • The # of Free-to-Paid Upgrades is probably really low. They probably get most of their paying customers right at sign up which is why they have a 30-day free trial on paid packages and have their call-to action towards paid sign up (not the free plan).
  • I think a great way to launch is having an amazing free plan and once you start getting bigger focus your homepage on the paid signups.

Wufoo Pricing

Wufoo is probably my favorite SaaS business. In a presentation about SaaS he says:" always always display your highest priced package to the left and your cheapest package to the right". I made this switch for Flying Cartand he was right about it. Here is what I like:
  • Highest priced on the left, the reasoning is customers read from left to right. The $14.95 price tag doesn't seem so bad when you just read the $199.95 price.
  • The Free plan is perfect. Just enough to start (not super limited) but I am happy to pay once I have a little bit of success. This is what I call investing in your customers.
  • I also like how they have multiple thresholds from the free to the paid plan. Notice how the "Bona Fide" $29.95/mo plan has 5 users and the free plan only has 1 user. If you have 5 users you must be a bigger company and can afford the cost. This also gives a chance for Wufoo to get paid customers right from day #1.
  • I really like how they don't offer a 30-day free trial. They have a free plan so there is no need to have a free trial as well, allowing them to pull in cash as soon as possible.

Above is a screenshot of the DropBox Pricing Page. They don't promote the pricing page on the homepage at all.

Here is what I like:
  • Heavily promote their very generous free plan on their homepage - they don't show any prices, just a video and a download button
  • They leverage their free users to get more customers - amazing referral program. You can earn more space by referring people.
  • Up-sell customers after many months of usage and dependence on their product. I bet they have really good lifetime value on their paid customers.
  • My assumption is that DropBox has an amazing free account to paid account upgrade ratio which is why they focus on getting you to use the product as soon as possible.
Intuit Pricing Screen Shot I'm including Intuit but I really don't like it at all. This is exactly what I don't want.
  • Very confusing. Each pricing tier looks like it could be a different product.
  • An Asterisk next to their prices? Are you kidding me. Whenever I see an asterisk I get really scared that the price is going to jump after the first month.
  • The "Try it Free" is an okay call to action. The word "Try" makes me think I'm getting roped into something.
  • The reason I think this works is because they have a really strong brand value. People trust Intuit and they have a solid product for business accounting.
MailChimp Pricing ScreenshotMailChimp is similar to dropbox. They have an amazing free plan.
  • Mailchimp puts a "MailChimp" ad in the footer of the newsletter promoting their services and allowing the end user to earn more credits with them.

Carbonmade Pricing Screen Shot

Carbonmade has one of the most fun pricing pages. Here is what I like:

  • The top package is super cheap. $12/mo - wow. That's it and I get it all
  • How they display Free vs. Paid. The Paid package seems so much more fun and cool. I feel like a total loser clicking on the "Meh" package. I would rather just pay the $12 and feel better about myself. Other companies do this by highlighting their middle package with a "Best Option" headline.
Screenshot of the Experts Exchange Experts exchangeis a developer focused question and answer service. So if you need a coding question answered you can sign up and a real live person will email you right back. This is sometimes better than Stack Overflow or Quora because at times no one answers your questions. The Experts Exchange isn't your traditional Freemium business. When you sign up you are signing up to a paid plan (with a 30 day free trial). However when you become a customer you are given the opportunity to answer questions, the more questions you answer the cheaper your member ship becomes. This is a really interesting freemium approach. Their "Free" customers are helping Experts Exchange get paid customers. What I like:
  • The plans get cheaper if you pay for multiple months
  • They allow you to earn Free. It isn't given.

So what am I going to do?

I'm going to take the best from each one:
  1. Launch a free plan that is amazing. We aren't the first service that will be doing what we do so we need to go the Mailchimp route.
  2. Allow people to earn more features and storage if they share our service (similar to dropbox)
  3. Make our paid plans feel amazing by adding a fun icon next to them (similar to carbonmade but won't be as awesome)
  4. Make our highest paid package displayed to the left and offer multiple barriers so we can take payment on day one for bigger companies (similar to wufoo)
  5. Learn from our data after 7 months and either de-emphsize our free plan (like 37Signals) or over emphasize it (like dropbox).

Here is what my current pricing page looks like: Digioh Pricing Page

What do you think of my freemium pricing analysis? Any tips or tactics you've learned from your own freemium pricing experience?  



Article has 20 comments. Click To Read/Write Comments

Secrets Of Freemium Pricing: Make The Cheapskates Pay

Posted by Dharmesh Shah on Mon, Jan 31, 2011

 


The following is a guest post by Andy Singleton.  Andy is the founder and CEO of Assembla, a company that provides online workspaces for software teams, including bug tracking, repositories, and collaboration.  Remember, as with all guest posts, the opinions and views of our guest bloggers do not necessarily reflect the opinions of OnStartups.com — but sometimes they do.   – Dharmesh

Make The Cheapskates Pay

[I originally presented this material at Barcamp Boston.  As the presentation went on, and tweets went out, the room got more and more packed.  So, I know that a lot of people are interested in this subject.  I wrote an outline for the presentation in five minutes just before the session, so it is surprising that this writeup has taken five months to compile, and has grown far beyond the usual size of a blog article.  Some subjects are important enough to deserve 8 pages.  Without further delay, I bring you “Make the cheap bastards pay.”]wallet empty

Even being a cheap bastard myself, I made every possible mistake in selling to the rest of you.

My grandparents on one side were Scottish pennypinchers, and on the other side, Armenian rug merchants.  They would be proud that here at Assembla we spend only 3% of revenue on general, administrative, and overhead expenses.  Even fewer dollars go to pay for online services, although we depend for our commercial lives on the ones that we do buy.

And what about you?  Do you pay for all of the services you use?  How many of you use gmail or Google apps?  How many of you buy the paid version?  Are you a cheap bastard too?

We don't want to contribute our OWN hard earned money, but we should remember that it is important that our vendors maximize revenue, preferably from somebody else.  This helps them deliver better quality for payers, and more services for non-payers.  We want that better quality, and those extra services, so we should always give vendors at least moral support in their search for revenue.

My support will come in the form of cheap advice – this blog post.  I have made a study of my errors and come up with some basic principles that might help you.

The number one goal: Maximize Revenue

The number one goal of your pricing strategy is to maximize revenue.  That is what allows you to deliver more and more value to your free, cheap, and full price customers.

The number two goal:  Reduce Cost of Sales

The number two goal is to reduce your cost of sales.  That's why a lot of online vendors, Assembla included, offer free trials.  It's a marketing tactic that reduces cost of sales.  We give customers a chance to try the product, in the hope that they will figure out its value on their own, instead of forcing us to spend time and money explaining and persuading.  In the bad old days, “enterprise” software companies would spend half their revenue on selling, and they would pass these costs onto customers.  Eventually, customers figured out that they were paying twice as much as they had to, for something that had very little value once the software was installed.  They started buy self-service products, and the enterprise software business began its long decline.  For all those venture capitalists out that wanted  to invest in “sales and  marketing” - how is that working out for you now?  How does it  feel to invest in something that your customers don't want?  These sales practices continue today.  But, the general trend is to reduce the cost of selling, and increase the amount of energy you can apply to actually delivering a good product.

The number one sin: Not getting something from payers

The biggest sin is to not get any money from people who will pay.  They won't respect you, and they won't get the quality of service they want, and you will starve.

When we first started charging for Assembla.com services, private workspaces were free, and we offered encryption and backup for $20 per month.  We figured that if you were running a serious commercial project, you would want encryption and backup.  We were wrong.  One of my co-founders has a day job as a venture capitalist, and I remember that he called me after visiting a company where his group had just invested $1M.  His report was “They use Assembla, and they love it.  I wanted to kill myself because I knew they weren't paying anything.”  We were committing the number one sin.  Our free package was so seductive that we were leaving money on the table with customers that could easily afford to pay and needed the quality of a premium service.

Free is a lot different from cheap

This example shows the incredible power of free offers.  Free is not the same as cheap.  Psychological research shows that people will take a free option even if they really like the cheap option better.  Some people rail against free offers saying that “free is not a business model,” and they are right.  You don't have a business model until you get paid.  However, free is a marketing technique that is so powerful that few can ignore it.

Users are predestined to be payers or non-payers before they register

Let's talk about what makes people cheap.  Basically, they are born that way, or maybe deprived as small children.  By the time people sign up for your freemium service, they are pre-sorted into “Will pay” and “Won’t pay”.  You can't immediately tell what category a new user is in.  The payers generally stay in the closet, but they already have needs,  hidden needs of their own that will eventually provoke them into paying.  There is nothing you can do to turn a non-payer into a payer.  In the lifetime of the universe it might happen, but they aren't going to turn over a new leaf during the free trial period.

You don’t care about people who won’t pay.  They have little impact on business decisions.  They are just statistics, “traffic” to be “monetized” (or not).  They are neither good nor bad.  They are side effects.  They are part of your marketing expense.  You want them to be happy because all people deserve to be happy, and you want them to say good things about you, but they are not customers.

So, I lied.  I don't have any secrets for making cheap bastards pay.  Let them have their free fun.  They can be useful to us, they can even BE us, but they won't pay us.

People who will pay are not statistics.  Their lifetime value will be significant.  That's why, when a paying customer calls Assembla, and nobody else is available, my phone rings, even when I am at home and getting ready for bed.  I love my wife, but I get a cheap thrill out of that marginal $24 subscriber.

So, why do anything for free users?  Once they get used to free services, we know they are not going to pay.  In a recent survey, 0% of Twitter users said they would pay for the service.  Free users howl with indignation if you remove services.  They cost money for servers, bandwidth, and administration.  They also cost money because they cannibalize from paying services.  Some free users might be in the category that would pay – a direct loss of revenue.  And, with the attractiveness of free offers, you end up getting a lot of these freeloaders.  This seems like the worst of both worlds.  You are losing money, and you are making it up in volume.  For this reason, experts like Jim Geisman recommend providing free trials, but not extended free services.

And yet, the free offers just keep coming.   Let's look at some reasons why.

Free users can attract or refer paying users

Free users can attract or refer paying users.  They become a marketing expense, like a referral fee.  For every X users that a free user introduces to your service, some percentage will be in the paying category.

This leads to some math.  Free can be a terrible idea, or a great idea, depending on how social your free users are, whether they have paying bosses, and how many potential paying users they introduce to your service.

The Curious Case of the Reverse Volume Discount

A normal business selling widgets will offer volume discounts - $2 for one widget, $150 for 100 widgets, $1000 for 1000 widgets.  Software is not a normal business.  In enterprise software, and especially management software, you typically see a reverse volume discount, where bigger buyers, with more users, pay more per user. 

Why? I notice three things about this situation:

* The most important factor is value.  Managing a small group comes naturally, and you can do it without a lot of tools.  Managing a big group is complicated and hard.  If you can actually solve a hard problem, you can charge more.

* Cost of sales.  Bigger organizations take longer to make a decision, they negotiate terms, they require more security and services, and it costs more to sell to them.

* Individuals and small groups are amazingly price sensitive about software.

The prices that small groups will pay is often small enough, compared to the value of enterprise upgrades and referrals that come out of small group pilots, that it makes sense just to go free.

In fact, many of Assembla's bigger competitors offer free services for the first five users.  It's the most common type of free offer in our category.  Prices then escalate as you increase the number of users and add various reports and workflows that are useful only to bigger groups.  It's a strong business model, and I recommend it to any vendor that is willing to make an investment (higher cost of sales!) in selling bigger packages for real money.

More reasons for free offers

Product testing: You need a lot of users to test new features, so you do a Free Beta.  It makes sense.  It's a good trade between consenting adults.

Traffic:  Maybe you can make money off advertising, and this works better if you get more traffic  because of free offers.  Even if you don't think advertising is relevant on your site,  you might run experiments to see how people respond to variations of your own offers.  Yes, if you visit Assembla.com, we run experiments on you.

Accident of history:  A lot of Web services don't start out as products.  They don't have a pricing strategy, billing infrastructure, customer service, marketing, etc.  They are just things that you share on the Web, maybe things that you use yourself.  That's where Assembla started.

Give back: Most vendors in Assembla's category offer free services for open source  and community projects, and many also contribute code. This is great marketing.  Open source projects  attract a lot of  potential customers.  However, most people would  provide services and code anyway, to give something back to communities that give us a lot of value.

So, we might have good reasons for making free offers.  But, we can't sustain them unless we also have a pricing plan for our paying customers.  That's where the mistakes pile up.

Ask “What is the minimum we need to deliver?”

We were working completely backward on pricing the non-free stuff.  In my mind, I was asking users, “how much do we need to deliver to get the price we want”.  We kept adding.  This is completely hopeless.  It was my worst mistake.  The answer is basically that there is little you can do to move the customer to pay your price.  When they sign up, they are predestined to pay $0, or $X, or $Y.  They set the price, not you.  Anything extra that you throw in doesn't help you.

The smart guys in SaaS pricing ask “What is the minimum we need to deliver to get the price the customer is willing to pay.”

If you offer customers a minimum package that meets their needs, that package won't steal business from the more generous customers.  This is especially important for your $0 offer.  And, some argue that customers appreciate the simplicity of NOT getting extra stuff in their package.

Assembla doesn't follow this advice very well.  We give away a lot of stuff in our basic bundle, but we're always trying be stingier (I mean, simplify and improve our model).

The metered pricing mistake

The next mistake we made was metered pricing, and this cost us probably half a million dollars before we corrected it.  We were coming from a free service, that we had offered just to get to know programmers.  We knew that asking for payment would be a shock, so we wanted it to be cheap.  We offered our services for $2 per user per project.  We called this “metered”.  Every month we would bill you only for the users and projects that you actually used.

What happened?  First, people complained bitterly.  Cheap was more expensive than free.  Second, a pretty high percentage of them bought the service after we made it a requirement for “private” permissions.  They did need the service, and they were much more willing to pay for privacy than security.  Third, they immediately went to work removing users, removing projects, and relentlessly reducing our average selling price.  It got to the point where the average subscriber was paying for less than four users.  They went crazy trying to save themselves $2.  It was totally irrational.  I would spend 15 minutes on the phone with a guy who makes $100/hour to figure out how to save $2.

People hate to make purchase decisions.  They hate to think about spending another $2.  It doesn't matter if the money is noticeable.  It still hurts.  They hate to make purchase decisions even for one penny.  That's why micropayments never go anywhere.

I actually knew this before I burned the half million bucks that I needed for the kid's educations, because in the 90's I worked in the “retainer advisory service” business.  We were selling services (Gartner is one you have probably heard of) where the customer pays for advice and reports.  We learned that they would never pay for just one report, no matter how cheap.  Instead, we would sell them a big bundle of reports and advisory time, most of which they would never use, that would cost at least $20K, and they only had to decide once per year, and this made them feel better.  As the guy building the online version, I figured out that I could deliver profits by delivering even bigger bundles, in the form of online “enterprise licenses” for everyone in the client company.

Not only do people hate purchase decisions, they also hate uncertainty.  Assembla metered customers called me to tell me they were unhappy, uncomfortable with the idea that they didn't know how much they would pay each month, and how they wished they had the certainty of fixed price bundles.

When we came out with fixed price bundles, our average selling prices jumped up.  But, the most surprising change was in customer satisfaction.  Even though our new customers were paying significantly more, they were also significantly happier.  They didn't complain.  The money was small enough that it didn't matter.  They could make the commitment and forget about it.

So, not only was metered pricing making us poor, it was making our customers miserable.  It had negative value for them.  They were willing to pay extra to get rid of it.

The right sized bundle

If the small purchases of “metered” pricing have bad effects, should we switch over to selling the biggest possible bundles?  That's the approach that advisory services take.  Salesforce.com is the most successful SaaS company, and they succeed by charging high prices (typically, $80 per user per month, compared with about $5 for Assembla or Google Apps), and by forcing the customer to buy for a full workgroup, a full year in advance.  So, the bundles that they sell are big.  The actual purchase decision comes to $1000 per user per year.  They assign a salesperson to work with you while you make this decision.

Selling bigger bundles works against the goal of minimizing the cost of sales.  You have to spend time and money to sell those big bundles.  That pushes you toward smaller bundles that reduce the cost of sales.

Try this rule of thumb:  The effort to move to a smaller bundle should be big enough that it is not worth a subscriber's time to figure out how to reduce usage to the next lowest package.  You want to save the subscriber time.

But, metered pricing does work!

The rule against metered pricing is made to be broken.  Actually, we buy a LOT of stuff on a metered basis.  When I drive to the store, I don't think about burning an extra 70 cents worth of gas.  When I leave a server running on Amazon EC2, I don't think about the $2 in charges I am going to incur by morning.

Why is a metered pricing a deterrent for online services, but not for cloud servers or gasoline?  I can only guess.  Maybe if the billing is in small enough increments, I stop thinking about it as a purchase decision.  Somebody should do research on this.

They start by trying a commodity

I kept banging my head against wall because our customers were comparing us to some cheap competitor – often a barebones repository vendor, or an open-source ticketing tool.  Why were they treating us like a commodity?  We put a lot of time and thought into making distributed teams more productive, building a great solution for managing a project shop, repository alerts – browsing – builds, accelerating software development, selling MORE than a commodity.

What customers think they are buying is not what you think you are selling.  At some point you have to forget what you wanted to sell, and rotate around to see what the customer is actually buying.  We were selling a high value solution.  In this case, the customers were buying the commodity, at least initially.  When costumers start a trial, they don’t actually want something that is new and better.  They want something that is easy to compare other products.  They want to open three tabs in their browser, compare some similar offers, and make a choice.

Wouldn't you want the same thing?  You want to be able to compare a product to competitors.  You want to evaluate something that you understand.  Buying a commodity makes you feel secure.

This observation had some immediate positive benefits.  We stopped trying to sell the “benefits” and the unique “solution” on our Web site, and instead, we described specific features that customers could compare to competitors: ticketing/issue-management, repositories, and collaboration.  It's the opposite of what most marketing people would recommend, but calls from confused prospects went down, and sales went up immediately.

Luckily, that's not the end of the story.  It's just the beginning.  Once you have satisfied the need for a commodity product, you can move on to selling the high value solution.

Understand Anchoring

Customers often don't know the value of your product.  To get an idea of how much it should cost, they “anchor” to examples.  For example, they check your competitor's price.  That's a good, logical way to figure out how much to pay, since in fact they can buy the competing product.

However, this anchoring effect is strong even when the anchor doesn't have any facts to back it up.  Studies show that in negotiations, the first person to throw out an offer sets an expectation (an anchor) that holds, even when the other side knows it is an arbitrary negotiating tactic.  Even expert appraisers are swayed by the asking price of a house.

Most vendors who sell products online use this anchoring effect in their presentation.  If they are selling a set of bundles at different prices, they will position the bundle they want to sell in the middle with a “Most popular” or “Best  Value” label.  Just having the other packages serves as an anchor to validate the price and value of the middle bundle.  Studies show that people prefer to buy the middle-priced option in a list.  Vendors will try to pull you up a notch in price by adding even higher-priced bundles, which may actually be less attractive.  The middle bundle (hopefully) looks like a bargain.

There are lots of other ways to use anchoring.  For example, customers like a pricing plan that is similar to the plans for competing products, because it is easy to compare.  You might be able to use this to your advantage, by offering a plan that is similar to your most expensive competitors, and not similar to the less expensive.  This creates a point of comparison – an anchor – that looks good for you.  For example, Assembla's more expensive competitors charge by the user, not by the project.  If we offered a per-user plan, it would look cheap in that market, even if on average it was a price increase.

Use Anchoring for Good, not for Evil

Assembla isn't the cheapest option, but it is cheap compared with many competitors.  It's very cheap compared with labor, or even the cost of computers, networking, and phones.  It's extremely cheap if you think of the increased productivity.  However, we frequently got complaints about price.

Here is the thought sequence that we uncovered:

1) I start by trying a commodity feature – repository hosting

2) I can get a subversion repository for $6/month with unlimited users

3) Therefore, Assembla is worth only $6/month

This is irrational.  I could just as easily construct a sequence showing that Assembla substitutes for something that costs $1000/month.  But, it is a sequence that a lot of users followed.  Anchoring is not rational.

Commodity + Anchoring is potentially a bad combination.  It can anchor you to the cheapest commodity.  You need to manage what you are getting anchored to.

This argues for breaking out the commodity – repositories in this case – as a separate product with competitive pricing.  What is competitive?  I didn't see a big future in marketing a product with prices moving down through $6 toward 0.  Our response was to offer basic repositories for free.  This was an expensive move for us.  We have great repository features, way better than the commodity hosts, and a lot of people were paying a premium to get them.  In giving up some of that revenue, we are leaving money on the table .  We also accept the hosting and storage and admin costs of handling hundreds of thousands of repositories in the future, at our promised commercial level of quality and reliability.  But, by cutting the anchor loose, we have a bold move that makes a lot of people happy, generates traffic to look at our other offers, and gives us the freedom to price our other features closer to their actual value.

So how did free repositories work out?

Now, it is the competition that hears price complaints.  Nobody complains about our prices.  Not handling complaints is worth a lot to me.

By other measures, free-repo is a terrible free offer.

Conversion of free users to paid is low.  Out of the first 10,000 people that signed up for free repositories, only about 1% have purchased paid subscriptions.  Of the small number that tried the full-featured  product, only about 15% of them ended up buying.  Normally, about 50% of the people that start subscription trials end up buying.

Free-repo users have very small teams.  They don't invite many colleagues, so the probability that a free user will introduce us to a paying user is low.  And because these are free PRIVATE repositories, they don’t show up in search engines and get browse-by traffic.

You don't even have to use the Assembla Web app to use the repositories.  You can just use your  repository client.  So, although we are providing servers, we aren't really influencing you as a user.

Free repositories cannibalize a lot of business.  Assembla's repository features are good, and a lot of people will pay for them.  So, we are cutting our own revenue with free repo.

Repositories are our most expensive and complicated feature.  We invest a lot in development and administration of repository feaures, and about 2/3 of our servers are specialized repository servers.

We reserve the right to drop the free-repo offer at any time, as long as we continue to serve the people that already signed up (see below about “never take anything away”).  However, I think that we will keep it.  I'm stubborn that way.

An example of a good free offer

Free Standup is a great free offer: http://www.assembla.com/offers/standup/index2.html

It doesn't cannibalize.  Nobody buys Assembla just to get the Standup report

It's immediately useful to almost anyone without any training

Standup is a management tool that you use with your whole team.  The teams are bigger, and they include managers that tend to make actual purchases.

To use Standup, you log on to the Web site every day.

It is cheap to deliver.   It is a simple feature that is part of the normal database app.

It converts.  About 10% of free standup users will eventually buy.

The catch?  No volume.  People don’t know – yet – that they need an online Standup report.  For every person trying free standup, there are 50 people that want repositories.

Never take anything away

In November 2008, we told our “free private” users that we were discontinuing free service, and that in the future they would need to buy a paying subscription.  We were bombarded with disappointed, melodramatic, vituperative, ANGRY comments, claiming that we were doing something evil, sneaky, and fundamentally unfair.  It didn't matter that we had worked nights and weekends for the previous two years to provide free services.  Nobody thanked us for that, or for the free public services we continued to provide, or for the four months of additional free services that we provided for the transition, or for the low prices going forward ($13 per team on average), or the simplified export for those who wanted to take their stuff and go home.  They had lost something, and they were angry.

People are always more unhappy to losing something, than they were happy about getting it in the first place.  There is a word for this: Loss aversion - http://en.wikipedia.org/wiki/Loss_aversion

If I gave you a beautiful car to drive around for a year, and then showed up and took it away, would you be grateful for the free ride?  No.  You would be pissed off because I took it back.  That's human nature.  Psychologists have a way of testing this.  Take $1 out of your wallet.  Will you trade it for a 60% chance of winning $2, and a 40% chance that I am going to TAKE THAT DOLLAR AWAY?  Most people won't, if it is put that way.  We're totally illogical on this point.  Monkeys are the same way, as demonstrated in this amazing video - http://blog.ted.com/2010/07/29/a-monkey-economy-as-irrational-as-ours-laurie-santos-on-ted-com/

So, never take anything away.

Make changes and raise prices for new buyers only

You must change your pricing.  It's impossible to answer customer requests, maximize revenue, lower sales costs, and generally bring forth joy through innovation if you don't change your pricing.  Phone companies know how to do it.  They often raise prices, and remove options, but they do it only for new subscribers.  They don't change existing subscription plans.  You can usually keep your existing phone plan for quite a while after it has been removed as an option for new buyers.

I recommend the same technique.  Change your options for new subscribers without bothering your existing subscribers.  You should program your system so that it keeps track of all of  your historical and current subscription plans.  Then, it can continue doing billing for all of the old subscriptions, even while you add and change the options for new subscriptions.  This buys a lot of flexibility, at the (minor) cost of having a more complicated billing program.

Reducing prices?

What about reducing prices?  In the technology business, costs are constantly declining.  You might want to lower your prices to compete for new customers.  On the other hand, you might have a significant number of existing customers that are happy paying your higher prices, so if you lower your prices, you lose a lot of money instantly.  I'm not sure if there is a right answer for this situation.  Sometimes, you just have to take the hit to stay competitive.  However, we do see some clever workarounds.  For example, new customers often get X months free, or some sort of discount coupon, or faster servers, which are not available to existing customers.  In the extreme case, the vendor will launch a new, cheaper brand to compete for new business.

Never take pricing advice from your customers

When we took away the free-private service and replaced it with the (admittedly flawed) metered plan, our users bombarded us with suggestions for alternate ways to price the product – more than 90 different proposals in all.  In 100% of the cases, the proposals would reduce the amount paid by that user, transferring costs to a different category of user.  Users with a lot of team members wanted to pay for storage, users with a lot of storage wanted to pay for team members, etc.  Some of them tried the claim that my business would be totally, utterly ruined if users like themselves were forced to leave as the result of a misguided pricing model that forces them to pay more than $2/month - without stopping to think about how little money is actually lost if they leave.  Not one user was able to go against the instinct of self-interest, and think about ways to raise enough money to guarantee a high quality service.  In other words, not one single user out of 90 actually gave good advice.  This is why you should not take pricing advice from your customers.  They are smart people, and they can give you good feedback about what they like and do not like, but deep in their reptilian brains they are incapable of giving you pricing advice that will meet your goals.

Sometimes I see a new service that launches free, and then asks users for pricing advice.  The advice is inevitably for incredibly cheap, metered pricing, and often, the vendor actually tries to follow it.  Later this same vendor, gaunt from starvation, will need to confront the pitchfork wielding mob and ask for a price increase.  LOL.

Pricing is like other aspects of product management.  Customers can tell you what they want, but they are ineffective in telling you how to deliver it.   It's your job to figure out how to deliver what they want.  That's why they pay you.

Thanks go out to Jim Geisman of Software Pricing Partners for his insights.



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How To Price Software Without Just Rolling The Dice

Posted by Dharmesh Shah on Mon, Nov 23, 2009

 


I’m going to open this article with a short (and true) story.  I officially kicked off my marketing software company, HubSpot, about 17 months ago.  If you’ve read my blog for any period of time, you likely know that I’m a big beliver in the “charge early, charge often” mantra.  As it turns out, in order to “charge early”, you have to figure out what you’re going to charge people.  That is, you have to have a price for your product.  Thankfully, both my co-founder (Brian Halligan) and I had recently graduated from a top 5 MBA program.  And, it wasn’t just any top 5 program — it was MIT.  You know, that place where science and math and uber-geeky analytical stuff happens.  So, you’d think that when it came time to figure out a price for our product, we’d really dig in, do some heavy-duty analysis, some really hard thinking and come up with a relatively well thought-out price.  That’s not what happened.onstartups software pricing

When it came to deciding on the price for our software, we basically just rolled the dice.

I’d love to for the statement above to be an exaggeration.  Surely, we spent some time pondering that oh-so-important factor in our business sucess.  Nope.  We didn’t.  One of us (I think it was me) suggested “how about $250/month”, and that’s what we went with.  And, that’s where the price remained for about 2 years. 

Things turned out fine for me and HubSpot.  But, you still shouldn’t do this.  Don’t just roll the dice when it comes to pricing your product.  Give it some thought, consideration and (gasp!) some analysis.  Your first step towards this path should be to run over, right now, and get the book “Don’t Just Roll The Dice: A usefully short guide to software pricing” by Neil Davidson.  Even if Neil weren’t such a nice guy (he is) and even if he doesn’t run my favorite conference (he does) and even if he didn’t build a really successful software company himself (he did), I’d still implore you to read the book.  It’s got the highest value-to-length ratio I’ve seen in a business book in a long time.  Go get it, right now.  And, if you’re still not convinced, Neil’s even been nice enough to give it away for free in convenient PDF form.  Yes, that’s right, you don’t even have to buy the freakin’ book on Amazon for $9.95 (though you could). 

Just on the off-chance that I caught you at a particularly skeptical time and you’re still not convinced, here are some of my notes from the book.

Insights On Software Pricing From “Don’t Just Roll The Dice”

1.  Your product is more than just your product.  You might think that your software product is just the bits and bytes that your customers download (or access online), but you’d be wrong.  What customers are actually paying you for is the entire experience of doing business with you.  Everything from how you market and sell the product, to how you help people use it and how you maintain it going forward.  All of it.  Your pricing should be based on this reality.

2.  There’s a difference between perceived and objective value.  It doesn’t matter how much “real” (objective) value you have baked into your product if your customers don’t perceive that value, they are not going to pay as much for it.  Hopefully, their perceived value is a function, to some degree, of the objective value.  If not, you’re screwing something up. 

3.  Community matters.  The group that your customers belong to, or want to belong to will impact the price they’re willing to pay.  For example, some people buy hybrid cars not just because of the environmental benefit or the higher mileage but because they want to be part of that community.  The same reason some people buy a BMW.  Determine what kind of community you can build (or tap into) around your offering.  Help people belong to the community they want to belong to.

4. As it turns out, people do buy drills (not holes).  There’s the reasonably famous adage around “people buy holes, not drills”.  The point is to focus on the benefit to the customer (not the product itself).  I generally agree with that notion.  But, it’s useful to keep in mind that holes can be a commodity, but people still sometimes pay $400 for a drill.  Benefits are important, but the direct benefiit is not the only one that customers value.

5. The more differentiated you are, the more you control price.  This one should be obvious.  If you have a product that’s about the same as all of your competitors, then you don’t really set your price — the market does.  Of course, nobody thinks of themselves as being identical to their competition (especially software companies).  But, what we often forget is that it’s difficult — and very risky, to try and create a completely new category and be totally differentiated.  Decide which dimension you’re going to differentiate on and make sure it’s reasonable given your particular constraints (like cash).

6. No battle plan survives contact with the enemy.  This quote is not actually in the book, but I think it still fits the theme.  When setting pricing, it’s important to consider what the “market response” is going to be — particularly if you’re in a well-defined category.  Just because it doesn’t make economic sense for a competitor to get in to a price war with you, it doesn’t mean they won’t do it.  Particularly if they’re big or well-funded. If you’re thinking about competing on price, keep that in mind.  Better yet, don’t do it at all.

7. Remember to be fair.  As humans, we often have a sense of what we think “fair” pricing is.  Even though a particular pricing model is “theoretically optimal”, it might not be wise in practice.  As software entrepreneurs, we often think we can get away with certain types of price segmenting simply because it’s enforceable in the software.  Just because you can keep customers from doing certain kinds of things (unless they pay up), doesn’t necessarily mean it’s the right (optimal) thing to do.  In the long term, it could actually hurt.  Try to put yourself in the customer’s shoes and envision if they think the way you price things is fair.  [Note: I’m not suggesting you be all rainbows and cupcakes and suggest that you price based on being “nice”.  I’m just saying that you might actually make more money by being empathetic]

8. Pricing complexity has a cost.  One of the things you learn in micro economics (and is discussed in the beginning of the book) is the concept of supply and demand curves and how you can segment your pricing in order to capture the maximum value (i.e. optimize revenues).  This can be a wonderful thing.  But, it’s critical to remember that this segmentation has a price — it’s not free revenue.  For example, when HubSpot went from a single price ($250/month) to two prices (still pretty simple), life got a lot harder.  All of a sudden, our marketing, sales and even our operational efforts got more complicated.  The product got more complicated.  All of our pretty charts that we used to talk about the business and measure success got more complicated.  The reality is that when you add a new dimension to your pricing structure, you’re adding a new dimension of complexity.  Oh, and by the way, the *second* price that you add to your product is the most expensive.  After that (third, fourth, etc.) things get a tad easier because you’ve already built some of the infrastructure to support multiple prices.  And by that point, your brain is already used to the pain.

Phew!  I typed this entire article in one sitting while simultaneously reading a majority of the book for a second time.  If I haven’t convinced you yet that you should go read it then I think I’m hopelessly inadequate at conveying the importance of this topic and the usefulness of the book.  Or, maybe you’ve already got it all figured out.  If so, may the wind be in your sails and may you go forth and prosper.  For the rest of you, just download the book.

And, on a more selfish note, what are your biggest insights when it comes to software pricing?  What challenges have you dealt with?  What questions do you have about pricing your software?  If you’re looking for some great answers, you can post a question on Answers.OnStartups.com where a bunch of smart folks like Neil Davidson (the guy that wrote the book) hang out.  Hope to see you there.



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Startups and The Challenges Of The Freemium Pricing Model

Posted by Dharmesh Shah on Wed, May 16, 2007



It has been a while since I wrote my last article on pricing models titled "Startup Pricing Models:  Free Forever, Freemium and Freedom To Pay".  This article ended up being reasonably popular (and continues to rank on the first page of Google for a search on "freemium").
 
I was reminded once again of freemium by a very interesting article from Don Dodge which notes that the average conversion rate of free to premium offerings for companies using the freemium model is about 3%.  I was actually quite surprised (in a pleasant way) by this level of conversion.  I've been considering the freemium model for one of the products currently being built at my startup, HubSpot.
 
The product under consideration, WebsiteGrader, is a website grading tool and recommendation engine that helps business people get a sense of how effective their website is from a marketing perspective, how it compares to competitor websites and makes recommendations for improving the site.  The tool is currently free.  Even in it's current beta state (very little PR and promotion), it has graded over 28,000 websites and gets over 500 visitors a day.
 
So, what are the challenges with releasing a product under the freemium model?
 
Here are the ones I've come up with (so far).  I'm sure the a few of you will have some of your own.  If so, please share.
 
Challenges Of The Freemium Model
 
1.  Deciding what to include in the free version and what to offer in the premium version is non-trivial.  The trick is to put enough in the free version to get traffic and usage -- but not so much that there's not enough incentive for a certain percentage of people to upgrade.
 
2.  Though hardware, bandwidth and infrastructure are cheap (and getting cheaper), they're still not free.  Supporting thousands of free customers costs money and unless there's enough money coming in from paying customers, there might not be enough cash coming in to subsidize the free folks.
 
3.  Support is a problem.  Though in theory you can take the position not to offer any support to the free users, in practice, it's hard to have the discipline and processes in place to actually do this.
 
4.  Pricing for the premium version is likely impacted by the fact that there's a free version.  For example, I don't think one could successfully offer a premium product for $250/month if there's a free version out there.  The premium version would have to be really good and an order of magnitude better than the free version.  This is probably why most freemium products are less than $50/month.
 
5.  It can get a bit tricky to use scaling pricing models for a freemium product.  For example, let's say you charge $20/month "per user" (per seat or per whatever).  For many customers, this creates an added barrier to upgrading.  If they have 10 users, there's even more incentive to just have all 10 users use the free version.  Or, they could just buy one paid license (for the key features they need) and keep the other 9 on the free version.
 
6.  Attrition rates can be unpredictable and potentially higher than traditionally priced products.  For example, if there's not enough "value" in the premium version, it's possible that even customers that upgraded will eventually revert back to the free version. 
 
Of course, there are lots of benefits to the freemium model too -the most important of which is efficient marketing.  It's a greaty way to get early users to use the product and have a pool of potential people to upgrade.
 
What are your thoughts?  Have you tried the freemium model?  If so, what has your experience been?  Are there other challenges that I missed?  Would loveto hear your ideas in the comments.



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7 Pithy Insights On How Not To Give Your Software Away For Free

Posted by Dharmesh Shah on Mon, Mar 26, 2007



If you are a startup entrepreneur, at some point, you will need to make a decision regarding your business model.  Many software startups have a strategy to build early market traction by giving away their offering for free with some plan to monetize at a later date.  I'm not going to make a strong argument against this.  So, for purposes of this article, lets assume for a moment that as a software startup, you actually *want* to charge money for your software someday. 

For some background on the issue of pricing models, I suggest my previous article:  Startup Pricing Models: Free Forever, Freemium and Freedom To Pay

Here are my thoughts on how to go about charging (gasp!) money for your software:

7 Pithy Insights On How Not To Give Your Software Away For Free

1.  Design for Dollars:  If you are hoping to charge for your software someday, it helps to actually design it from the beginning with this goal in mind.  As you are building the product, try and think about how you might build it so that someone, someday will actually pay you money for it.  Trust me, it helps.  [Note:  Apologies for the reference to dollars (vs. rupees, Euros or something else).  The poet in me likes the alliteration and I happen to reside in the U.S.)

2.  Resist Guilt:  This is a tough one.  Many software people find it hard to rationalize in their heads that they can actually charge money for their product.  Though I'm a big fan of free (as in beer) software myself, the reality is that not all businesses can afford to do this.  There's nothing inherently wrong for charging for a product that costs you money and talent to build.  If doctors, lawyers and architects can charge for delivering something of value, why not you?  The key is point #1 -- build something people are willing to pay for.

3.  Charge Early:  Try and find a way to start charging for the software as early in your development process as possible.  This can get a bit tricky in the early days, but it is worth the effort.  The key here is to build something of value as early in the process as possible and then to amplify that value by throwing your personal passion into it.  For example, at my startup HubSpot, we're still in beta but have been bringing on paying customers for months.  Rather than being embarased that the software is so early, we make up for it by fanatical support for our early customers -- and letting them help drive the product development.

4.  Charge Often:  Avoid trying to lock your customers in to some long-term contract.  I'm a big fan of monthly agreements.  If you are charging your customers monthly (instead of a big up-front fee), the burden is on you to "earn" your customer's business every month -- or they leave.  Keeping your customers happy is your problem not theirs. 

5.  Let Them Try Before They Buy:  This one is obvious.  Minimize buyer's remorse by letting customers try out your offering before making a large committment. 

6.  Ease Adoption:  Reduce the "time to enjoyment" for the customer. Help them get immediate benefit and enjoyment.  We live in a fast-paced world.  If it takes your customers days or weeks to get even marginal enjoyment from your product, you're going to have a hard time charging for it.  Make it simpler and make adoption easier. 

7.  Make Your Customers Smarter:  This is a bit of a weird one.  When you're charging your customers, remember that not all of your value is delivered through the software -- a lot of value can be through the experience of dealing with you.  Customers want to learn and grow.  They want to improve their lives and/or businesses.  When buying from you, customers want some direct benefit from your product (basically, the ones you promised), but they also want to feel like they got something out of the relationship.  Seek ways to help your customers get smarter in whatever area of expertise you have.

Those are my thoughts.  If you have any additional insights on ways to make it easier to charge (gasp!) money for your software please share them in the comments.  



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Selling Software: Why Free Trials Aren't

Posted by Dharmesh Shah on Fri, Sep 22, 2006




Some time ago, I wrote an article titled “Startup Tips for Enterprise Software Pricing”.  If you’re selling software to big companies, it’s likely worth a quick read.  When writing the article, I left a note to myself that I should revisit the issue of free trials and pilot projects.  I’ll look at pilot projects (for larger deals) next week, but this time, will explore the free trial a bit more.

Software Startups And The Free Trial
 
  1. Shifting Customer Risk:  One of the biggest motivations for offering a free trial to your product is the obvious one.  It reduces the risk for the customer to determine if your software meets their needs.  The idea is get more prospective customers to try your product, with the hope that this generates more sales.  There’s really nothing to argue here.  A free trial, in many categories of software is almost a requirement.   What you are trying to do is reduce the cost to the customer so that the potential benefit of your product outweighs the total cost of trying out your product.  But, it’s not that simple.  Simply making a “free trial” (for some period of time) available is not always sufficient to overcome this barrier.    We’ll look at reasons why.

  1. Time To Actual Enjoyment:  Often the actual price of your software is only a fraction of the actual cost a customer incurs to try your product.  Lets say you are charging $499 for some business application.  You give away a free trial of your product (downloadable via the web, of course).  However, it takes 4+ hours for them to download, register/activate, learn and play with your product before they can get to see the enjoyment/benefit they were promised.  In this case, the customer is spending more (in terms of time) than the cost of your product.  Just because you have a free trial doesn’t mean the customer is not taking risk.  The free trial is not always “free” from a customer’s perspective.

  1. Your Cost To Deliver Enjoyment:  In order to get customers to enjoy your product, how much of your company/s time/resources will be consumed (on average)?  Chances are, to deliver a great “free trial” experience (and increase the odds that more customers buy), you’re going to have to expend resources. Some of the cost is upfront (designing the “trial experience” from end to end) and some of it is after a customer has committed to try (like making support available).  Obviously, you should try and drive this cost as low as possible – but be careful that in doing so, you are not decreasing the odds dramatically that more customers will buy.  Offering free, human support to your trial customers may cost you money, but not doing so may prevent many customers from actually reaching that point of actual enjoyment.

  1. Intrusion Risk:  In today’s world of malware of all sorts, including both intentional malware (spyware, viruses etc.) and unintentional malware (the product uninstallation doesn’t work and hoses the customer system sometimes) customers are often weary of installing anything.  Technical folks don’t worry about this as much (because we have our ways of protecting ourselves and getting ourselves out of a mess if its necessary).  But, normal users don’t have this degree of confidence.  As such, if they suspect that your free trial may fall into one of the malware categories, there is a “cost” to them for taking that risk.  So, you need to make it abundantly clear to them that this is a low risk.  Ways to do this are to make them aware that installation (and uninstallation) will only take minutes.  That there are actually people working in your company (so if they do have problems, you’ll help them out).  Put yourself in the customer’s shoes and think of ways to ease their mind on this risk.    (Of course, if you have a product that doesn’t require installing any bits on the customer’s computer, that takes away a lot of this headache).

  1. Lock-In Risk:  Many of the free trials out there are “limited” versions of products.  I’ve actually worked with trial versions of products that didn’t allow “saving” a user’s work.  What I would do here is to make your trial “full featured”.  To really win over the customer, also provide a way to “get their data out” (even after the trial has expired).  For example, if you’re providing some email campaign management or other database-centric application (hosted or installed), make it easy for the customers to get their work out of your software (even if they decide not to become a customer).  This creates goodwill. 

  1. Price Ambiguity:  If you are going to offer a free trial, you really need to make your pricing transparent.  Don’t hide behind sales reps and pricing proposals sent to customers after they have tried the software.  Potential customers will be worried that if they try your software, if it does actually work and bring value for them, they’re going to fall in love with it and perhaps the price still doesn’t fit.  In fact, by being closed about your pricing, many customers will assume (sometimes rightly) that the free trial is just to lure them in, get them to fall in love with the product and then be “sold” when you, the software company have the most leverage.   This is the old car dealers trick (“I’m sure we can work out a price that’s just right for you, but why not take this baby for a test drive and first see if you like it.”)


Overall, I’m a big fan of the free trial.  It puts a lot of pressure on you to deliver value since you are assuming a large portion of risk.  An incidental benefit of the free trial (other than more customers) is that it will likely make your product experience better.  If your product sucks and nobody can figure out how to enjoy it, the free trial will make that painfully obvious very early in the game.  You won’t get many “conversions” to paying customers. 




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