Tiered pricing strategy - definition, examples and benefits
The right tiered pricing strategy can ensure you effectively monetize your APIs and other digital products, encouraging your customers to spend more whilst ensuring they are happy about doing so. But get it wrong and you can irritate your customers and push them towards your competitors. In this post we’ll explain how to get your tiered pricing right and maximize your API’s revenue.
How to Implement a Tiered Pricing Strategy
Tiered pricing is a way of packaging your product into fixed-cost bundles, rather than using a usage-based pricing model. Each tier delivers a fixed range of features: number of users, volume of data, depth of support, etc. Customers can choose the tier that best suits their requirements and their budget. Then, once the customer expands their usage of your product and exceeds the levels in their chosen tier, they move up to the next. It’s a common pricing strategy for Software as a Service (SaaS) products, such as APIs.
Understanding how to implement a tiered pricing strategy involves clearly and carefully defining your tiers. It also means considering how best to incentivize your customers to progress from one tier to the next.
What is a tiered pricing strategy?
Tiered pricing strategies center on what’s included in each tier and how much is charged for those capabilities. To set your pricing strategy, analyze your product offering and determine which features are germane to your product, which are add ons and which could be considered custom. Divide up those features into tiers and determine the price for those tiers using the analysis presented in our companion blog post.
As a sanity check, you could look at your competitors and see what they’re offering and at what price. You may need to reconsider your strategy if you’re pricing yourself out of the market.
An effective tiered pricing strategy ensures your customers feel they get good value on every tier. Consider starting with a free tier to encourage product adoption, with the aim of moving those who adopt your product onto paying tiers as their usage increases.
What is a tiered pricing structure?
A tiered pricing structure relates to how you price each tier and what you include in it. This is crucial to the success of your whole tiered pricing model.
The nature of your product and the way in which your customers use it will impact what you provide on each tier. Whether your business model is B2C or B2B will also impact your custom pricing approach, as these models require different strategies.
What is an example of tiered pricing?
You can set up your tiered pricing structure through a solution such as Moesif and Stripe, or you can implement a custom solution, although the latter would take longer and involve greater complexity).
Let’s take the example of an API that you’re charging your customers to use. You can charge customers for each query/call that they send to the endpoint. You can then offer a cheaper price per call based on increasing usage, thus incentivizing customers to move up to more expensive tiers in order to enjoy discounted rates.
What Are the Benefits of Tiered Pricing?
Implemented well, a tiered pricing structure can make it easy for your customers to understand what your product will cost them. It can also make them feel like they gain additional value each time they move up a tier and increase their spend.
When you get your tiered pricing right the benefits are multifaceted, as follows.
Pricing structure is easy to understand
With your pricing arranged into tiers, it’s easy for your customers to understand precisely what they get for their money. You can define the offering in each tier with a couple of bullet points and a comparison table to show the tiers side-by-side.
This kind of pricing structure makes costs predictable for your customers. And by making it easy for them to budget for your product each month, you’re reducing friction in the adoption process. Everyone wins.
Commonly accepted pricing
The tiered pricing model is well understood within the SaaS industry. As such, you’re presenting your customers with something known and familiar. Again, this reduces friction in terms of them deciding to adopt your product.
Using a commonly accepted pricing structure also supports those who want to adopt your product but need their managers to sign off on its adoption. Managers will see clearly what the product will cost and have the comfort of working within a familiar pricing model.
Easy to implement
All you need to implement your tiered pricing is a subscription billing software. It’s super simple to put in place and won’t drain your time or resources. You can use the software to set up a lower priced tier, plus one or more at a higher price - an established strategy that means you can capitalize on a downward sloping demand curve.
Reduced complexities around billing
Fixed pricing, as opposed to dynamic pricing, also means you can reduce complexities around the billing process. You don’t need to implement any metering or usage tracking through analytics. You simply decide the price of each tier and bill accordingly.
So far, so good. But there is also a downside to tiered pricing…
Shortcomings of Tiered Pricing Strategies
It’s only fair to unpack the cons of tiered pricing strategies, as well as to consider the benefits. After all, using tiers is just one kind of pricing model. Before you decide to implement tiered pricing, take the following into account.
Price jumps can cause friction
The predictability of tiered pricing means that your customers will quickly get used to what your product costs them each month. It also means that they may feel irritated by the price increase when they move up a tier.
Value perception comes into play here. Your next tier up might include a whole bunch of exciting features. However, if your customer is moving up to it simply because they’ve hit a limit (such as a certain number of users or number of events), then they may not want those additional features. As such, a major jump in cost could cause discontent, as the customer doesn’t perceive they are getting sufficient additional value to justify the increase. This is certainly something to factor in when deciding your pricing strategy.
Too many variables
If each of your tiers has too many variables, it may trigger a customer to move up a tier before they feel they are ready to do so. After all, a customer is unlikely to exceed all of the plan limits at once. As such, it’s easiest to stick with just a couple of volume pricing metrics. This makes it easier for the customer to understand when they will hit the tier’s limits and reduces the likelihood that the tier jump will come as a surprise.
Too many tiers
It can also be a problem if you have too many tiers. Make things confusing and it becomes hard for potential customers to see which tier would suit them best. Analysis paralysis kicks in and you’ve slowed down or even lost a potential sale. Offer three, or four tiers at most, to avoid this.
Lack of flexibility
A tiered pricing strategy doesn’t allow for personalized pricing, where you can take into account the differing amounts that your customer base can afford to pay. By using fixed-price tiers, you cut out the ability to price your product differently to suit each customer.
Loss of revenue
If you misprice your tiers, you could miss out on revenue. You need to price your tiers in a way that not only appeals to customers, but also covers your costs sufficiently. This means thinking carefully about each tier, including the top tier, where any kind of “unlimited” offering could end up being a major drain on your time and resources.
Having taken the time to unpack the cons of tiered pricing strategies, as well as review the benefits, it’s worth taking a quick look at alternative pricing models. The main alternative to tiers is pay as you go (PAYG) pricing.
Popular Alternatives to Tiered Pricing with API Leaders
No decision to adopt a tiered pricing strategy should be made without a thorough pay as you go explanation and examples. The main alternative to tiered pricing popular with API leaders, PAYG means that customers only pay for precisely what they use.
Pay as you go explanation and examples
From pay-as-you-go (PAYG) cell phones, to utilities such as gas and electric bills, usage-based billing – another way of saying pay as you go – is a familiar concept. It is based on metering, which can be applied to a range of digital products, as well as to services such as utilities.
PAYG explained in simple terms means billing based on something you have measured. That could be anything from transaction volume to unique users. Obviously, you would need to do some serious number crunching to find out what would work best in terms of monetizing your product, just as would if deciding what to offer at each level of a tiered pricing model.
Benefits of PAYG billing
PAYG billing offers a range of benefits. One is that, thanks to extensive PAYG implementations in SaaS products, it has become a familiar payment structure to many of those who will be making decisions about whether or not to use your product. As we noted above, delivering a sense of reassurance and familiarity when it comes to your payment structure is never a bad thing!
Perhaps the greatest benefit of the PAYG pricing model is that it reduces friction as customers increase their expenditure. Instead of customers experiencing a sudden jump in cost, along with associated issues such as feeling they’re not ready or not getting sufficient additional value, their costs increase and decrease in harmony with their usage. Whether they spend more or less in any given month, they will understand that the cost is justified by the degree to which they have used your product.
Consumption metrics for PAYG billing
If you’re going down the PAYG pricing route, then you will need to decide on your consumption metrics. Your thinking on this will likely be driven by the kind of product you are offering. If it’s an API, for example, or an event-based platform (such as SMS and analytics), then you could consider a metric such as the number of API calls or the number or messages sent. Platforms handling financial functions such as payments or expense reporting, meanwhile, might be better to use a percentage of revenue or transaction fee.
Other consumption metrics for PAYG billing include data volume (gigabytes sent, minutes made), user volume (number of users/seats) and resource factors (computer units, active hours).
This is where Moesif comes into its own. Working with Recurly, Stripe or Chargebee, you can use our analytics platform to implement PAYG billing and invoicing to monetize your APIs effortlessly, driving revenue in a few clicks.
The decision to implement either a tiered pricing strategy or a PAYG pricing model should not be taken lightly. If in doubt, why not talk the options through with the Moesif team.