The Art and Science of Tiered Pricing: Strategies to Optimize for Buyer Persona
Why are these models so popular? And what do you need to think about as you design your own pricing architecture?
Let’s start with some examples. HubSpot is a great example of best practices.
There are three things to note about the Hubspot model.
- The pricing metric (the number of contacts) maps closely to the value metric. HubSpot helps you form relationships with the opportunities in your funnel, so ‘contacts’ is a metric that resonates.
- The tiers are well differentiated. They go up 4X Basic to Pro and then 3X from Pro to Enterprise. Enterprise plays a critical role in framing the value proposition and establishing a relatively high reference value.
- The tiers are tied to buyer personas. Basic is ‘an entry tool for those new to online marketing. Pro is ‘an integrated solution for professional marketers.’ Enterprise is ‘an advanced platform for marketing teams.’
Let’s compare this to HubSpot’s competitor Marketo.
Here we have four tiers. At first glance the pricing architecture looks similar to HubSpot: Records instead of Contacts, and the figure of 10,000 crops up again. But looking closely we see that Marketo is capping the number of records at 10,000 for all three tiers and is fencing its pricing using functionality. Marketo does not provide a clear way to add records above 10,000. And Marketo directs large companies to custom quotes. The tier-to-tier price increase is much flatter: Spark to Standard is about a 50% increase; Standard to Select is a 78% step.
Salesforce also uses four tiers.
Here there really are four distinct tiers. The slope is steeper than Marketo (but not as steep as HubSpot): Starter to Professional is 1.6X; Professional to Enterprise is a smaller increase of 92%; and then Enterprise to Unlimited is a 2X increase. When you move up from Professional to Enterprise you are paying for the ability to customize the software and integrate it with other applications.
Docusign has even more tiers; four plus customized pricing for the enterprise.
Here the slope gets steeper the higher you climb: Individual to Professional is 2X; Professional to Business is 2.5X; Business to Business Premium is just over 4X!
What is going on here? How many tiers should you have and how should you set pricing at each tier?
One reason to have tiers is to capture more of the market while optimizing pricing. As you provide more functionality (and one hopes value) you can increase prices, but if you do so you lose the buyers who are price sensitive and do not need the full functionality. This suggests you should have lots of pricing tiers (in fact, HubSpot does charge you more for additional contacts once you go over the limit for each tier). But in this case a pricing calculator makes more sense than having tiers. So why tiers?
Each tier should play a specific role in your pricing strategy.
The top tier should be positioned to establish a reference value. It should be high. HubSpot and Docusign are doing the right thing here.
The middle tier is generally where you are going to get most of your revenue. Note that Salesforce and Marketo tell you which tier is the most popular. HubSpot is a bit more subtle. They make the middle tier more prominent.
The entry tier is the interesting one. What are you trying to do with this tier?
It may be that this tier’s job is to lure people in with minimum functionality so that they get frustrated and upgrade. This is what Salesforce is doing. Not many people are happy with the Starter offer, they either upgrade or move off to some less expensive alternative.
To execute on this strategy you have to test different price points and function bundles until you get the upsell you are looking for.
The entry tier could also be a way to capture the bottom part of your market while optimizing pricing for the middle tier. In this case you will test pricing and possibly functionality until you get the optimal distribution between the two tiers.
Of course it is not really that simple. Your pricing strategy also plays a big role.
If you are running a penetration strategy, setting the price low to get as many customers as possible, then you will design your pricing architecture to draw as many users as possible into the bottom tier. You do this when there is a land grab going on or there are real economics of scale (not often the case for B2B software). Here the revenue ratio between tiers will like range from 50:40:10 to as high as 80:15:5. You should have a dashboard showing the performance of each tier on a weekly basis.
If you are running a skimming strategy, and trying to optimize your operating profit, you will want a different distribution. If you have a low level of upsell from Tier 1 to Tier 2 the ratio you are looking for is probably about 20:70:10 or even 10:80:10. If you have a good level of upsell you can have more people coming into Tier 1. The actual targets depend on the upsell percentage, but a normal distribution would be 20:70:10 or 30:60:10, whatever optimizes operating profit.
If you are very good at upsell you might want to go as high as 50:40:10. This is the same as with a penetration strategy? But the logic is different as you are assuming that at least 30% of the Tier 1 users will convert to Tier 2.
Pricing optimization is not the only thing to think about while designing your tiers. You also want to map tiers to buyer persona. The name of the tier and the functionality called out in the bundle should map directly to a buyer persona. HubSpot is a good example of this.
A Simple Process for Designing Pricing Architectures
- Connect your pricing metric to your value metric
- Define the role of each tier (draw people in, optimize revenue or operating profit, set a high reference price)
- Develop buyer persona’s for each tier
- Build a model of (i) how much upsell you want across tiers and (ii) how much revenue or operating profit you want from each tier
- Set prices and design bundles across tiers
- Test and adjust until you are matching your optimization model
This will be a moving target. Your competitors will be tracking your pricing model and trying to disrupt it. But if your product provides real value to your target segments, and you have done a good job of matching buyer personas to pricing models, then you will be pleasantly surprised at just how robust B2B SaaS pricing can be.