SaaS 102 #21 4 Reasons to Charge for SaaS Products
Whenever a new product comes out, I’m always particularly interested in its pricing model.
Unsurprisingly, for many products, words like “free” are placed in a very obvious location where they’re easy for everyone to see.
Some products, especially B2C products, have gone so far as to try and attract users with claims such as “it’s free and always will be” (Facebook previously used this slogan) or “free forever” (messaging app Telegram previously made this claim).
“Should we charge for new products?” This is a question which many companies have to face and consider.
One factor affecting this decision is that many people are already used to free products on the internet. As a result, product creators are afraid to even discuss payment with their customers or users.
Another factor is that when a lot of products enter the market, companies are often so focused on gaining customers they haven’t yet thought of a reasonable profit model.
There have already been several cases of “cash-burning wars,” where companies spend cash fast to gain customers. We’ve seen this several times across the market for internet companies. Some examples are:
- The ride-sharing race: Uber vs. Lyft
- The streaming wars: Disney vs. Netflix
Many internet companies have rocketed their way to market giant status. (The cash they burned on the way was their “rocket fuel.”) Many B2B SaaS companies, developing at a much slower pace, have found it hard to look at this fast growth without feeling a little uneasy.
A lot of companies also started to wonder: If a B2B SaaS company tried something similar and stopped charging customers, would the results be good enough for them to shoot up above their competition?
This article will discuss free and paid pricing models and how they relate to B2B SaaS.
Business is fundamentally about earning money for creating value
We see many SaaS companies that are not profitable for long periods of time. Some people even look at those companies and say:
“It’s a backwards approach to always try and earn money directly from the pockets of your users. Internet businesses should try and create new business models.”
But if a business cannot earn money by creating value, then what is the reason for that business to exist?
The internet can change the form of products, but it can’t change the fundamentals of business.
Creating a sustainable revenue business model through subscriptions, subscription renewals, and add-ons is fundamental to B2B SaaS products.
The saying that there is no such thing as a free lunch also applies to some free B2C products.
It might seem to B2C users as if they can use apps and products for free, but in reality third parties, such as advertisers, are often paying for the product.
Effectively the third party “pays the bill” for the user, but of course they want something (such as advertising rights) in return.
For B2B products, this kind of business model is less practical. For B2B products, what third party will be willing to come along and pay the bill?
From looking at the current market situation, most successful B2B SaaS products and companies create profit by charging their customers.
If a company doesn’t have a reasonable pricing model from the start, that will only make it harder to start charging customers at a later point in time. Without the ability to charge customers, profit will remain a distant aspiration.
When we create B2B products, it’s fine for us not to charge at first. But we need to know how we will charge for our products from the very first day.
If you charge by number of customers you need to be clear on how you will calculate your number of customers.
If you charge by usage amount you need to be clear on how you will calculate usage amount and costs.
And if you charge by value, you need to be clear on how you will measure how much value your product actually provides to your customer.
Business customers are willing to pay for value
A lot of SaaS companies say the reason they don’t earn money is that small to mid-sized businesses aren’t very willing to pay. But I don’t think that’s the case at all.
If your customers don’t want to make payments, then it’s very likely that one of the following scenarios will apply:
- You are finding the wrong customers.
- Your product doesn’t provide the customer with enough value to make them willing to pay.
Suppose there was a SaaS company that could guarantee that customers using their product would save 100,000 USD in costs, and that the product price would only be 5,000 USD, or 5% of that amount.
Suppose they could also guarantee that there would be no charge if their product didn’t help the customer save costs. I think that such a company would have no shortage of customers willing to pay.
Customers actually aren’t concerned with what features you are selling. What they care about is how much money your product can help them save, or how much it can help them earn.
That’s why what you need to do is find customers for whom you can help save 100,000 USD in costs, and convince them to use your products.
AfterShip has a real-world example that can help illustrate this point.
When AfterShip was first founded, we provided our services for free.
But after our product was officially available for a month, we had a customer who reached out to us and asked us to take payments. That customer said:
“You have to accept payments from us. If you take payments we can use your services without worry. Otherwise we will be worried that either your company will go out of business or that you will sell our data to make money.”
As a result, AfterShip started charging for services shortly after being released. We charged 0.01 USD per shipment tracked.
So, why were our customers willing to pay us at that point in time?
In the United States, the costs of providing customer service are very high. Hourly wages for customer service staff might be around 20 USD.
If customer service staff are paid 20 USD per hour, and tracking a shipment takes a member of customer service staff one minute, then the cost of tracking a shipment once is 0.33 USD.
Many shipments need to be tracked more than once. So by charging customers 0.01 USD to track each shipment, we were charging them a fraction of the costs they would have otherwise spent.
After we started charging, we quickly entered our rapid growth stage.
Perhaps this story sounds a bit too good to be true, but actually it vividly illustrates the following:
What customers care about is how much value your product can provide, not whether or not there are charges for using it.
According to Gartner forecasts released in April 2022, global end-user spending on public cloud services is expected to grow 20.4 percent in 2022 to reach 494.7 billion. In 2021, 410.9 billion was spent by end-users on public cloud services.
The prediction was also for global cloud service customers to spend over 30 billion more USD on SaaS products in 2023 than in 2022. In 2023, spending on SaaS is projected to reach over 208 billion USD.
How can products create more value for customers, and gain a share of that 208 billion USD? These are questions that need to be considered by everyone in the SaaS industry.
Paid services increase the appeal of free services
All of the above is not to say that free service models have no place in B2B businesses. If you can provide an appropriate free service plan for your products, then those free services will become a highly effective point of entry for your customers.
Mature SaaS companies typically like to use a freemium model. Common types of freemium models include:
Temporarily free: Services are free for a trial period only, and charges apply after the trial period ends (for example, QuickBooks).
Partially free: Charges apply for business users, but not for individual users. Or, charges apply for high-level users, but not for ordinary users. Examples: Hubspot, EverNote.
Our AfterShip product is another example of a partially free pricing model. We offer separate Free, Essentials, Pro, Premium, and Enterprise plans. There are separate levels of pricing which depend on the size of our customer’s businesses and the depth of the feature access required.
The benefits of this kind of solution are:
Customers can first experience the value provided by the product's basic services. If the customer then decides they need services or features that provide more value, they can then choose to pay more accordingly. This way, customers are less likely to doubt the value offered by a high-price solution and are more likely to be willing to pay for it.
With SaaS products, the best approach is to offer a free version which doesn’t include all available features, but still allows the user to appreciate the value of the product. After using the free version, customers can be prompted to purchase or subscribe to a level of service that meets their needs.
All SaaS products must move towards paid models
It’s true that “free” does sound extremely appealing to users. If your product is free, it will usually gain users much faster than an equivalent paid product.
But I think that from a long-term point of view, SaaS products need to move towards paid models. There are three reasons for this:
First, free users use a lot of your resources
Regardless of whether the resources in question are resources used to run a backend server or for product operations and customer service, the costs are far from small.
And because the base number of free users is often the largest, they will use a large amount of your resources.
Second, free users may give you incorrect feedback
We need to continuously collect user feedback on our products. We can use that feedback to update and iterate to new versions.
As the number of free users is usually higher than the number of paid users, free users can have an outsized influence on the kind of feedback you receive for your product overall.
Free users may be vocal in their feedback, but this doesn’t mean that the features we provide to them based on their feedback will have more value.
If you have a user who loudly says: “I want this feature, this feature would be really great.”
Then it might not be a bad idea to ask that user:
“We’ll consider developing that feature, but before we do, would you mind telling us how much you’d be prepared to pay for it?”
If the user’s reply is that they hope the feature would be free, or they’d only be prepared to pay a small amount for it, then their feedback might be misleading.
After all, if the feature they’re talking about really has that much value, then why aren’t they prepared to pay a bit more for it?
Third, only a profitable business model can be a sustainable business model
In this day and age, we see different companies seeking funding every day.
We even see companies that lose money year after year, but so long as they keep adding users at a fast enough rate, they still have a chance of winning further rounds of funding.
But investment companies are not charities. The only reason they are willing to give companies money is so that they can make more money in returns from those companies at a later date.
So no matter what business model your product follows, in the end, it has to be profitable.
Summary
The following are the main points I hoped to express by writing this article:
- The fundamental way that SaaS products make money should be by charging for SaaS services, rather than by other means.
- What business customers really care about is how much value your product can provide and not whether or not there are charges for using it.
- The best way for SaaS products to use freemium models is to offer selected services and features for free, and let free plans work as an on-ramp to paid plans.
- For SaaS products to be successful in the long-term, they definitely have to move towards charging for their services, as not charging can lead to many negative consequences.
- When customers make requests for features, only those features which they are willing to pay for have actual value.
I'm Teddy, Co-Founder & CEO of AfterShip, SaaS 102 is a series of articles where I share my experience in SaaS startups.
We are looking for great SaaS sales talent and welcome you to join us at careers.aftership.com.
(Article translated by Joseph O'Neill)