Tiered pricing – the basics: A guide for a strategic approach

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  1. Introduction
  2. How does tiered pricing work?
  3. How to calculate tiered pricing for your business
  4. Benefits of using tiered pricing
  5. Challenges of using tiered pricing
  6. Tiered pricing vs other pricing models
  7. How to maximise profit margins with tiered pricing
  8. Tiered pricing best practices

Tiered pricing is a strategy that businesses use to set the costs of products or services based on the different levels or quantities that customers purchase. The more a customer buys, the less they pay per unit. This structure, which is common across industries, is a way for businesses to reward customers for making larger purchases.

Some businesses that may not have considered differential pricing in the past are now leveraging this model to unlock potential for revenue growth and customer engagement. The appeal is clear: tiered pricing structures allow businesses to address a broad customer base, with different levels of value and service at varying price points. As Harvard Business Review notes, such tiers are often an example of Good-Better-Best (or G-B-B) pricing – a straightforward way to think about pricing tiers. This strategy maximises market coverage and also caters to a customer's willingness to pay, which can increase overall sales volume.

Tiered pricing models offer businesses stability. By providing customers with options, businesses can convert single-purchase customers into repeat buyers across different tiers. This variety contributes to more precise financial predictions, as well as improved resource distribution. Tiered pricing's multiple entry points allow customers to scale their commitment to a brand's products or services, which can lead to customers upgrading to higher tiers as their needs grow.

Tiered pricing can benefit businesses in major ways. The challenge with tiered pricing is in its execution: identifying a pricing structure involves many stakeholders. This process requires a business to analyse product or service offerings, and understand the customer base and the specific demands of the market. Below, we'll cover what businesses should know about tiered pricing models, including which businesses can use them most effectively and how to choose the right model to meet business goals and market needs.

What's in this article?

  • How does tiered pricing work?
  • How to calculate tiered pricing for your business
  • Benefits of using tiered pricing
  • Challenges of using tiered pricing
  • Tiered pricing vs other pricing models
  • How to maximise profit margins with tiered pricing
  • Tiered pricing best practices

How does tiered pricing work?

With tiered pricing, a business will set the price for the first tier of a product at a certain rate. As customers buy more, they move to the next tier, where the price per unit is lower. For example, if a customer is buying software licences, the first 10 might cost US$100 each, but if they buy 20, all licences might be priced at US$90 each.

Each pricing tier represents a rung of a ladder. As customers move up the ladder, the total price increases – along with product quantities or benefits for the buyer. For example, a software company might offer a basic package at the lowest tier with standard features. The next tier up may include more advanced features and higher usage limits for a higher total price. The top tier might include all possible features, the highest usage limits and premium support services.

How to calculate tiered pricing for your business

Calculating tiered pricing for your business is a strategic process in which you match your products or services to different customer segments' willingness to pay – all while covering costs and achieving desired profit margins. Because this can be an involved undertaking, many businesses direct specific resources to this project: 63% of executives who responded to EY's 2023 Software Pricing Survey have dedicated pricing teams. Here's how developing pricing tiers works:

  • Complete a cost analysis
    Begin by analysing the costs involved in producing your product or service. This figure should include direct costs – such as materials and labour – and indirect costs, such as overheads. Find the minimum price that you can charge to cover your costs.

  • Conduct market research
    Conduct market research to understand the price sensitivities of your customers and the pricing strategies of competitors. This will help you determine realistic pricing levels for the market.

  • Define customer segments
    Identify customer segments that are likely to have different needs and levels of willingness to pay. Eventually, you will target each pricing tier at a specific segment, from the most price sensitive to those seeking premium options.

  • Determine value proposition
    For each customer segment, define the value proposition. What will customers in each tier value the most? Possibilities include more features, greater quantities or better service. This will help you design tiers that customers feel are worth the price.

  • Set pricing tiers
    Decide on the number of tiers and set the price for each tier so that there is a clear difference in value between each one. The lowest tier should cover all costs of producing your basic product or service, while upper tiers should increase in price in accordance with the added value and cost to serve.

  • Assign features or quantities to tiers
    Allocate features, quantities or services to each tier. Lower tiers might have basic features or limited quantities, while higher tiers could include additional features, greater quantities or enhanced services.

  • Implement a cost-benefit analysis
    Perform a cost-benefit analysis for each tier. Make sure the cost of providing the product or service at each tier is less than the price you plan to charge.

  • Review and adjust
    Review the tiered pricing model to make sure it's reasonable and that the benefits escalate appropriately with price. Adjust as necessary based on feedback and further analysis.

  • Communicate the value
    Communicate the value of each tier to your customers. It should be clear to customers what they gain from paying more.

  • Monitor and refine
    After implementation, monitor the performance of each tier. Are customers finding value in the higher tiers? Are most customers choosing the lowest-priced option? Use this data to refine your tiers and pricing.

Throughout this process, keep the customer's perception of value at the forefront. The goal is to provide options that customers regard as fair and aligned with the value that they receive, which in turn can support a strong revenue stream for your business.

Benefits of using tiered pricing

Tiered pricing brings businesses several advantages, both in the short and long term. Here are the biggest benefits of this model:

  • Market penetration
    You can attract a broader customer base with entry-level pricing, while also catering to those who seek premium options. This flexibility means you don't leave money on the table from customers who would be willing to pay more for extra features or services.

  • Customer growth
    Tiered pricing encourages customer growth within your business. Customers might start with a basic tier, but as their needs grow, they may move up the tiers. This natural progression can lead to increased revenue without the need to constantly acquire new customers.

  • Inclusivity
    Tiered pricing can create a sense of inclusivity because it accommodates different budget levels without excluding potential customers. Every potential customer can find a tier that suits their budget, which can broaden your market reach.

  • Decision simplicity
    Pricing tiers simplify the purchase decision for customers. Clear options make it easier for customers to compare features and decide which tier suits them best, reducing the decision-making burden and potentially shortening the sales cycle.

  • Scalability
    Tiered pricing provides a simple structure for scaling your services or products. As demand grows or as you develop your products, you can add new tiers or adjust existing ones – following a rationale based on the existing structure.

  • Appropriate expectations
    Pricing tiers allow you to match customer expectations with service levels. Customers see that paying more will get them better service or more features, which can contribute to their overall satisfaction.

  • Brand perception
    A high-end pricing tier can elevate your brand's status – even if most of your customers select lower tiers – by associating your brand with premium products and services.

  • Competitive strategy
    With multiple price points, you can compete on price and value simultaneously, potentially outflanking competitors that only operate at a single price point.

  • Customer insights
    Tiered pricing allows you to collect valuable data on customer preferences and price sensitivity. You can track which tiers are most popular and adjust your product development and marketing strategies accordingly.

Challenges of using tiered pricing

Tiered pricing comes with its own set of challenges. These include:

  • Complexity in management
    Managing multiple pricing tiers adds obstacles to business operations. Businesses must keep track of different service levels, customer entitlements and billing arrangements, which can strain administrative resources.

  • Customer confusion
    Too many options or poorly defined tiers can overwhelm customers, leading to decision paralysis. If customers can't easily determine the differences between tiers or see the value in a higher-priced tier, they may choose the lowest tier – reducing your revenue potential.

  • Cannibalisation
    If your tiered pricing model is not designed with care, lower-priced tiers can cannibalise sales from higher-priced ones. Customers may downgrade if they perceive that the lower tier provides better value for their needs, thereby affecting your overall profitability.

  • Revenue prediction
    Predicting revenue can be more challenging with tiered pricing, especially if your projections rely on customers upgrading to higher tiers. There will always be some uncertainty around how many customers will move up the pricing ladder and how quickly this will happen.

  • Pricing balance
    It can be tricky to find the right balance for pricing each tier. Set the price too low and you risk leaving money on the table; set it too high and you might scare away potential customers.

  • Value perception
    You must prove the value of higher tiers on an ongoing basis. If customers don't perceive the benefits as being worth the additional cost, they won't see a reason to upgrade, which can limit the effectiveness of the tiered pricing model.

  • Brand risk
    If your premium tiers are too expensive, it could damage your brand's reputation. Customers might view your business as overpriced or out of touch with their needs, leading to a loss of trust, and potentially, a loss of market share.

  • Market fit
    Not all products or services fit well with a tiered pricing model. The model works best for products with differentiated offerings and for which the market shows a range of needs and budgets.

  • Adjustment challenges
    Once customers are accustomed to a particular pricing tier, they may react negatively to changes. If you decide to adjust features or prices, you risk upsetting your customer base.

Each of these challenges requires thoughtful consideration and ongoing management to ensure that tiered pricing serves its intended purpose, contributing to business growth and customer satisfaction.

Tiered pricing vs other pricing models

As a strategy, tiered pricing has characteristics that make it distinct from other pricing models. But it's far from the only way to create a pricing model for your business. Here are a few alternatives:

  • Flat-rate pricing
    Unlike tiered pricing, flat-rate pricing involves a single price for a product or service, regardless of usage or customer type. This model is straightforward and easy to communicate to customers, but it may not appeal to all segments of the market and can limit revenue potential.

  • Pay-as-you-go pricing
    This model charges customers based on their usage. While it's flexible and fair from the customer's standpoint, it can make revenue unpredictable for the business and complicate budgeting for customers.

  • Freemium pricing
    With freemium pricing, a basic version of the product or service is free, while advanced features require payment. The challenge is in converting free users into paying customers by means of premium features that are compelling enough to justify the cost.

  • Volume pricing
    Volume pricing involves discounts based on the quantity purchased. It's effective for encouraging larger purchases, but it doesn't account for the different needs of customer segments in the way that tiered pricing does.

  • Value-based pricing
    This model sets prices based on the perceived value to the customer rather than on the product's cost or market prices. It requires a deep awareness of the customer and can be hard to quantify, but it results in prices that match the value customers attribute to the product.

  • Penetration pricing
    A business sets a low price to enter a market and raises prices after gaining a foothold. This can build a customer base quickly, but it risks long-term profitability if customers are resistant to price increases.

  • Premium pricing
    The opposite of penetration pricing, premium pricing sets prices high to create a perception of quality or luxury. This can limit the customer base, but it can generate high margins from each sale.

How to maximise profit margins with tiered pricing

Maximising profit margins with tiered pricing means finding the sweet spot, where you can provide your customers with maximum value while still seeing healthy returns. Here are a few ways to do that:

  • Crafting your tiers with precision
    Each tier should have a value proposition that's one step up from the previous tier. As customers ascend these tiers, they should feel like they're getting a deal – one that's too good to pass up – at every step. Businesses must offer enough value at the lower tiers to entice customers, while making the upper tiers irresistible for those who want more.

  • Cost structure dissection
    Understand exactly how much it costs your business to provide each tier. Your lowest tier price should cover these costs with a little wiggle room, setting the stage for the higher tiers to bring in maximum revenue.

  • Psychological pricing techniques
    Pricing your tiers just below common thresholds (such as charging US$9.99 instead of US$10) can make a difference to how customers perceive value. Anchor your customers with the highest tier first. This makes the other tiers seem more reasonably priced by comparison.

  • Data-driven decisions
    Harness the power of data by monitoring which tiers are most popular with your customers and adjusting as you go. Maybe there is a popular feature in a higher tier that you could leverage to encourage upgrades. Or perhaps there's a little-used lower-tier feature that can be cut to reduce costs.

  • Incentives for upgrades
    Entice customers to upgrade with well-placed incentives. These could include a discount on the first month of a higher tier, or exclusive content or services that customers can only access with the premium options. Make the transition between tiers smooth and appealing.

  • Feedback loops and adaptability
    Establish feedback loops and listen to your customers. If there's a feature everyone wants that you don't yet offer, consider adding it to a higher tier. Stay adaptable and willing to make changes to your product or service.

  • Customer lifetime value focus
    Keep your eyes on customer lifetime value. Attracting a customer at a lower tier is great, but the biggest win is when they use and love the service, and they decide to upgrade. This is the source of your long-term profitability.

  • Communication clarity
    Customers should know exactly what they're getting at each tier and understand why the next tier up is worth the extra expense. A customer should never struggle to find out what they're paying for.

  • Competitive analysis
    Keep an eye on the competition. If they're offering more value at lower tiers, you'll need to respond. If they're pricing their tiers too high, take the opportunity to attract customers with a better deal.

  • Dynamic pricing considerations
    Consider dynamic pricing strategies where appropriate. Maybe there are peak times when you can charge a premium, or special events where promotional pricing for higher tiers would make sense.

Using tiered pricing to maximise profit margins is a matter of strategic positioning, customer psychology and your willingness to continuously fine-tune your product to meet customer needs while also improving your bottom line.

Tiered pricing best practices

Creating and managing a tiered pricing plan demands a blend of strategic planning and ongoing management to ensure that your business remains relevant and profitable over time. Here are best practices for cultivating a tiered plan:

  • Conduct market research
    Know your audience. Who are they and what do they need? What are they willing to pay to get it? This knowledge is key to creating tiers that resonate with your market.

  • Complete a cost analysis
    Know your numbers. Work out the cost of delivering each tier, and set the pricing so that it not only covers those costs but also contributes to your profit margin.

  • Perform a competitive analysis
    Look at your competitors' pricing models. They can provide valuable insights into market standards and help you position your tiers.

  • Provide clear value propositions
    A customer shouldn't have to wonder why they would choose any given tier. Pricing should be justified based on features, services or other benefits.

  • Offer scalable features
    Design tiers so that you can easily scale services up or down based on customer feedback or market trends.

  • Display simple choices
    Choice is good, but too much choice can be overwhelming. Keep the number of tiers manageable, so that customers can easily select the one that's right for them.

  • Maintain flexibility in structure
    Be prepared to adjust your tiers as you learn more about what your customers value most.

And here are best practices for managing an ongoing tiered plan:

  • Monitor customer behaviour
    Pay attention to how customers are interacting with your tiers. Which tiers are most popular? Are customers upgrading or downgrading?

  • Review costs and margins regularly
    Periodically reassess your costs and margins to make sure each tier remains profitable as costs and market conditions change.

  • Adjust based on feedback
    Use customer feedback to refine your offerings. If certain features are in high demand, consider adding them to higher tiers.

  • Incentivise upgrades
    Occasional promotions can encourage customers to move to higher tiers.

  • Communicate changes
    Make sure that any changes to your tiered plan are communicated to customers well in advance.

  • Use data analysis
    Use data analytics to understand usage patterns and customer preferences, which can inform strategic decisions about pricing and features.

  • Perform A/B testing
    Test different pricing structures and features to see what resonates with your audience and leads to higher retention and upgrade rates.

  • Offer customer support
    Provide excellent customer support in all tiers, but consider premium support options for higher-tier customers.

Learn more about how Stripe supports tiered pricing models.

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