Subscription pricing allows a business to set up a structure where customers pay at regular intervals – often monthly or annually – for the right to use a product or service. This method is favourable for businesses as it sets up a reliable source of income. It can lead to more stable financial planning and forecasting because the business can anticipate a certain amount of income at regular intervals. It also tends to build a loyal customer base that uses the product or service consistently. According to a 2022 survey by C+R Research, the average monthly spend for American consumers was US$219 on various subscriptions.

On the customer side, this model is advantageous because it spreads the cost over time, making services or products more accessible – especially those that might be financially out of reach if priced as a one-off purchase. Instead of having to commit a substantial amount of money up front, customers can budget for smaller, more manageable payments. This can also lower the barrier to entry for trying a new service, as the initial cost is minimised.

This guide will explore some of the upsides this pricing structure has for businesses, as well as challenges that can arise when implementing it.

What's in this article?

• Types of subscription pricing models
  
• How does subscription pricing work?
  
• Benefits of using subscription pricing for your business
  
• Challenges of using subscription pricing
  
• Subscription pricing best practices for businesses
  

Types of subscription pricing models

Not all subscription models operate along the same lines. Here's an overview for each of the most common subscription pricing models' main points:

Tiered pricing model

The tiered pricing model offers customers a selection of packages with incrementally increasing costs and value. It's like a set menu in a restaurant where each subsequent level gives a few more choices or larger portions for a higher price.

How it works

With tiered pricing, a business divides its products or services into different levels or "tiers", each with a set bundle of features and a corresponding price. Each tier is designed to meet the needs of a particular segment of the market. The base tier typically covers the essentials, with each higher tier adding more features, services or greater capacity.

Common use cases

• Software-as-a-service (SaaS): Many SaaS businesses use tiered pricing to serve a range of customers with different needs. These can target anything from small businesses that need basic features to large enterprises requiring full functionality and customisation. For example, a project management service may have a starter tier with limited projects and users, a mid-range tier with additional integrations, and a top tier with advanced analytics and unlimited projects.

• Content services: Streaming services and online publications often use tiered subscriptions. They might have a basic plan with access to standard content, a premium plan with high-definition or exclusive content, and an all-inclusive plan with additional family accounts or offline access.

• Membership organisations: Gyms and clubs commonly use tiered memberships. Basic access at these establishments may allow use of the main facilities, while higher tiers offer classes, personal training sessions or access to premium areas.

Benefits for businesses

The tiered model is versatile and can be tailored to the individual needs of different customer segments, potentially maximising the customer base. It also encourages customers to self-select into the appropriate tier based on their needs and budget, which can lead to higher customer satisfaction as they feel in control of their purchase.

Businesses like the tiered model because it can simplify the sales process. With easily defined packages, sales teams can more easily explain the value proposition and help customers find the right fit. The tiered structure creates a path for customer upgrades, allowing customers to move into higher tiers as their resources and needs increase.

Constructing a tiered model requires careful consideration. The perceived value must increase with each tier to justify the higher price, and businesses must be transparent about what each tier provides to avoid customer confusion and dissatisfaction. Too many tiers can also overwhelm customers, leading to choice overload. As a result, businesses often stick to three or four clearly differentiated options.

Usage-based pricing model

The usage-based pricing model pairs charges with the consumption of services or goods. It's similar to a pay-as-you-go phone plan where you're billed for the minutes or data you actually use rather than paying a flat monthly fee.

How it works

In usage-based pricing, a customer's bill is directly proportional to the extent of service they consume. Businesses usually track usage with metrics such as data volume, bandwidth or active user hours. The service provider sets rates for these metrics, often tiered to encourage more consumption through incentives such as cost reductions linked to increased use.

Common use cases

• Cloud services: Providers such as Amazon Web Services (AWS) and Google Cloud Platform charge based on the amount of computing power, storage and additional services a business consumes. This model is ideal for businesses with variable demands, where usage might spike with seasonal traffic or project-based workloads.

• Utilities: Traditional sectors such as electricity or water supply have long used this model, billing customers based on metered consumption.

• Telecommunications: Mobile and internet providers often have plans that can bill based on data usage, call minutes or text messages sent.

• SaaS: Some SaaS products, particularly those related to data services or web infrastructure, charge based on the level of usage. A database service might, for instance, charge based on the number of queries or the amount of data processed.

Benefits for businesses

This model can be appealing because it allows businesses to start small and scale their costs with their growth. It's also transparent for customers, as they can directly correlate their bill to their usage levels. For businesses, it can lead to more predictable revenue that grows in line with their customers' usage rates.

However, implementing this model requires meticulous system tracking and a transparent billing platform, as customers will want detailed insights into their usage and costs. Businesses must also be aware of the potential for bill shock, where a customer uses more than they expected and faces an unexpectedly high charge. Businesses can attempt to mitigate this by providing usage alerts or budgeting tools to help customers monitor and control their usage.

Freemium model

This model is a two-tiered approach: basic services at no cost and a premium for advanced features. Spotify operates on this principle, providing free music streaming with ads, while the premium tier removes ads and unlocks additional functionality. It's a strategy to lure users with no up-front cost, betting on a percentage upgrading to paid accounts.

How it works

In the freemium model, the core product is given for free, and users can use it indefinitely without cost. The business monetises by selling advanced features or enhancements for a fee. The free service acts as a teaser, giving users a taste of the product and encouraging them to buy the full version to access its full potential.

Common use cases

• Digital media: Music streaming services such as Spotify allow users to listen for free with advertisements between tracks and limited functionality. Users can pay for a subscription to remove ads and gain additional features such as offline listening and unlimited skips.

• Mobile apps: Many mobile applications are free to download and use, but offer in-app purchases for additional features, functionality or virtual goods. This is common in games where players might buy virtual currency or items.

• Software tools: Productivity tools or software platforms often use a freemium model. For example, photo editing software might be free to use with basic functionalities, but make advanced editing tools available for a one-off purchase or subscription.

• Professional networks: Networking websites such as LinkedIn provide a free basic service, with the option to subscribe to premium services that provide more in-depth tools for job searching, recruiting and networking.

Benefits for businesses

The freemium model has the advantage of reducing barriers to entry for users. By offering a no-cost option, businesses can quickly build a large user base. A segment of these free users may then convert to paying customers after they've seen the value in the product.

The model also provides businesses with valuable data on user behaviour. By analysing how free users engage with the product, businesses can make informed decisions on which premium features to develop and how to market them effectively.

Challenges to this model include making sure that the free version is compelling enough to attract users, but that it doesn't cannibalise the paid version. The free service must be balanced so that it's useful but leaves room for users to want more. Since only a small percentage of users typically convert to paid customers, businesses also need a large user base to make this model work. This often requires substantial initial investment in the product and marketing to reach a large mass of users.

Flat-rate model

The flat-rate pricing model is straightforward: customers pay a single, fixed fee for a product or service – regardless of usage or consumption. It's like an all-you-can-eat buffet where you pay one price to enjoy everything that's available.

How it works

In this model, businesses provide their full range of services or access to complete product lines for a single set price. There's no differentiation based on usage, feature access or tiered value propositions. This simplicity is the hallmark of the flat-rate model. Customers appreciate knowing exactly what their bill will be without having to consider how much they use the service or which features they access.

Common use cases

• Subscription services: Many media streaming services, such as Netflix, have used a flat-rate model where subscribers can access all available content at one monthly price.

• Software licences: Some software providers set a one-off purchase price for the lifetime use of a product, as opposed to a recurring subscription. This gives users full access to the software's capabilities and any updates.

• Service providers: Various service-based businesses, such as internet service providers or mobile phone operators, sometimes sell unlimited access to their services for a flat monthly rate.

Benefits for businesses

The model is easy to communicate and can be highly attractive to customers who prefer predictable billing. It simplifies the accounting for both the provider and the customer, as there is no need to track usage or manage complex billing cycles.

For businesses, a flat-rate model can facilitate a stable and predictable revenue stream. It's easier to project earnings when you know exactly how much each customer will pay each month or year. This stability can be attractive to investors and helpful for long-term planning.

The flat-rate model doesn't account for variations in customer need and usage. Some customers may see the model as a great value, while for others, it may seem like they're paying for more than they need. This model also runs the risk of limiting revenue potential from high-usage customers, who would be willing to pay more under a tiered or usage-based model.

To counter these issues, businesses must make sure what they're providing has enough value to justify the flat fee. They also need to be adept at customer acquisition to maintain and grow their subscriber base, as the flat-rate model relies on a consistent inflow of new customers to sustain and increase revenue.

Per-user pricing

The per-user pricing model charges customers based on the number of individuals who will be using the service or product. It's similar to a group discount ticket scenario – each person pays their share to access the event or service.

How it works

In the per-user model, also commonly referred to as per-seat licensing, businesses set a price for each individual user of the service. If a business has 10 employees who need access to the software, they pay for 10 users. Pricing can sometimes scale – the cost per user might decrease as the number of users increases, which can encourage larger organisations to get more users on board.

Common use cases

• SaaS: Many SaaS products, such as project management tools or customer relationship management (CRM) software, are priced on a per-user basis. For example, Salesforce charges organisations based on the number of users accessing the platform.

• Business services: Legal or financial subscription-based services can operate on a per-user basis, providing access to resources or expert consulting per individual in a business.

• Online platforms: Educational platforms or online course subscriptions often use a per-user model, charging per student or per educator for access to their learning materials and tools.

Benefits for businesses

This pricing model can be particularly advantageous for providers as it scales linearly with the customer's size. As a client's team grows, the provider's revenue from that client increases correspondingly. It also allows for a degree of personalisation and individual user tracking, which can be beneficial for providing support and for getting to know user engagement at an individual level.

The per-user model is also transparent and easy for businesses to budget for, since they know the cost associated with each new employee they onboard. It can also promote wider adoption within an organisation as each user has their own access and personal stake in the tool's utilisation.

One challenge with this model is making sure that the cost per user remains reasonable as businesses scale. If the price is too high, larger organisations might look for alternative solutions that give bulk or enterprise deals. Businesses using the per-user model also need to prevent unauthorised sharing of credentials, as this can lead to lost revenue.

Businesses looking to use this model effectively often invest in feature development to solidify that their product is indispensable to as many users within an organisation as possible. They may also need to create pricing tiers that provide volume discounts to avoid pricing themselves out of larger enterprises with many potential users.

How does subscription pricing work?

Regardless of which pricing model a business is using to structure its subscriptions, the following is a basic breakdown of how it works:

• Sign-up and activation: Customers choose a subscription plan that suits their needs and sign up, often providing payment details up front. This initiates the subscription, and customers are usually charged immediately for the first billing cycle.

• Recurring payments: After the initial payment, customers are charged on a recurring basis – monthly, quarterly, annually or at another interval specified by the service. The recurring payment ensures continued access to the service or product.

• Access to service/product: Subscribers gain access to the product or service as long as their subscription is active. This access is often continuous and uninterrupted, as long as the customer continues to pay the subscription fee.

• Renewal and cancellation: Subscriptions continue with automatic renewals until the customer decides to cancel. Customers can typically manage their subscription preferences through a user portal and decide whether to upgrade, downgrade or cancel entirely.

• Customer engagement and retention: Businesses work to keep customers subscribed by providing updates, customer support and ongoing value. Retention strategies are important since the customer can often cancel at any time.

• Billing management: The provider manages the billing cycle, sending reminders or notifications about upcoming charges, processing payments, and handling failed transactions or payment updates.

Benefits of using subscription pricing for your business

Subscription pricing provides a wide range of strategic advantages for businesses, including:

• Predictable revenue: Subscriptions offer a steady revenue stream. Businesses can forecast earnings with greater accuracy since they know the subscription fees and the number of subscribers. This predictability aids in budgeting and financial planning.

• Customer retention: The recurring nature of subscriptions encourages longer customer relationships. Once a customer subscribes, they're more likely to stay engaged over time, providing businesses with an ongoing opportunity to deliver value and build loyalty.

• Up-front cash flow: Because subscription fees are paid at the beginning of each period, businesses benefit from immediate cash flow, which is key for covering operational costs and investing in growth.

• Scalability: Subscriptions can scale with the customer's needs. As clients grow and require more from a service or product, businesses can move them to higher-tier plans, increasing revenue without the need to acquire new customers.

• Data and insights: Continuous customer interactions generate valuable data on usage patterns and preferences. This helps businesses refine their products, personalise marketing efforts and develop new features that meet evolving needs.

• Enhanced customer relationships: The ongoing customer-provider interaction creates a deeper awareness of customer needs, enabling more personalised service and the ability to anticipate and respond to issues promptly.

• Reduced marketing costs: Acquiring new customers is often expensive, but subscription models focus on retaining existing customers, which can be more cost-effective than chasing one-off sales.

• Cross-selling opportunities: With a captive audience, businesses can introduce additional services or products to their subscriber base, using existing relationships for new revenue streams.

• Community building: Subscriptions can create a sense of community among users and strengthen the brand, especially when coupled with exclusive benefits or member-only content.

• Simplified sales process: Easily defined subscription plans allow sales teams to focus on conveying the value of each plan to the right customer segment, potentially shortening sales cycles.

• Adjustability to market changes: Subscription models can be adapted quickly in response to market feedback or shifts, allowing businesses to stay relevant.

Businesses employing subscription models need to maintain a high-quality product and excellent customer service to prevent churn, which is where customers drop their subscriptions. The focus is not just on making the sale, but on continually re-earning the customer's business.

Challenges of using subscription pricing

Adopting a subscription pricing model isn't without its challenges and potential drawbacks. Here are some potential ones you should be aware of, regardless of what pricing model you choose:

• Customer churn: One of the biggest hurdles is customer turnover. The average annual churn rate for subscription businesses is between 5%–7%, according to Recurly Research. If subscribers decide to cancel, businesses must constantly acquire new customers to fill the gap. This can put pressure on acquisition strategies and customer service standards.

• Value justification: Continuously proving the worth of a service can be demanding. Subscribers need to feel they're getting their money's worth on a regular basis, or they'll stop paying.

• Subscription fatigue: As more businesses move to subscription models, customers can get overwhelmed with the number of subscriptions they manage, leading them to evaluate and potentially cut back on recurring expenses. In fact, a 2022 survey found that 22% of American consumers reported feeling overwhelmed by the number of subscription services they pay for.

• Pricing sensitivity: Finding the right price point is key. Charge too much, and you scare off potential customers, but charging too little might devalue your service or leave revenue on the table.

• Billing complexity: Managing recurring billing can be involved, especially with various plan tiers and promotional discounts. It requires reliable systems and processes to handle the billing cycle, payment failures and renewals.

• Competition: In crowded markets, there's a race to provide more value, better service or lower prices. Standing out and retaining customers in such an environment is a challenge that requires innovation and agility.

• Revenue recognition: For accounting purposes, revenue from subscriptions may be recognised over the life of the subscription – not when the payment is received. This can affect financial reporting and forecasting.

• Legal and compliance issues: Subscriptions are subject to various laws and regulations, including those related to consumer rights and data protection. Businesses must make sure they remain compliant to avoid fines and reputational damage.

• Upgrade or downgrade management: Customers may change their subscription levels, upgrading for more features or downgrading to save money. Managing these changes requires flexibility and can affect revenue.

• Content and feature refresh: Particularly in tech and media, there's an expectation for regular updates and new features. Keeping a service fresh and engaging requires ongoing investment.

• Cultural shift: Moving from a sales-driven culture to one focused on customer retention can be difficult. It requires a shift in mindset and metrics, valuing long-term relationships over immediate sales wins.

• Customer service demands: Subscribers expect high-quality, responsive customer service. A 2022 Deloitte report found that after financial incentives and convenience, access to premium products, services or customer service has a substantial influence on customers' subscribing decisions. This can increase the burden on support teams and require additional resources.

Businesses need to be adept at managing these considerations to run a successful subscription service. It's about acquiring subscribers – but it's also about building a service so valuable that customers can't imagine going without it.

Subscription pricing best practices for businesses

Subscription pricing requires finding a balance of pricing, value and customer satisfaction. A high price point could turn away customers; but a low price point could hurt your revenue. It's a constant test of value – making sure subscribers get enough for their money to stick around.

Businesses looking to implement a subscription pricing model should follow best practices that can help optimise their revenue while maintaining customer satisfaction. Here are a few examples of how to do this:

• Make a clear value proposition: Make sure customers know what they're getting. The benefits of each subscription tier should be easy to grasp and compelling enough to justify the recurring cost.

• Simplify choices: Avoid overwhelming potential subscribers with too many options. A few well-structured plans are usually more effective than a confusing range of tiers.

• Provide transparent pricing: No one likes hidden fees. Be up front about costs, including how and when customers will be billed. Good communication can build trust and reduce churn.

• Offer flexible terms: Provide different subscription lengths and easy cancellation policies. Customers are more likely to sign up if they don't feel trapped.

• Engage and retain: Regularly engage with subscribers through personalised communication and updates. Customer retention is often cheaper and more effective than acquisition.

• Monitor usage and feedback: Track how customers use your service and listen to their feedback. This data is gold for improving your product and identifying the features that drive retention.

• Incentivise upgrades: Encourage subscribers to move to higher tiers with accessible pathways and strong incentives. Show them the tangible benefits of upgrading.

• Automate billing and renewals: Invest in a reliable billing system to manage subscriptions, renewals and payments. Automation can reduce errors and free up resources.

• Conduct regular updates: Keep your service fresh and relevant with regular updates, new content or features. This gives subscribers ongoing reasons to stay.

• Handle churn proactively: Identify at-risk customers and contact them before they cancel. Provide solutions or incentives to stay, and learn from those who do leave.

• Provide trials and onboarding: Free trials or onboarding periods allow customers to experience the value of your service firsthand, increasing the likelihood of conversion to a paid plan.

• Ensure legal compliance: Stay up to date with subscription laws and regulations to avoid legal pitfalls and protect your customers' rights.

• Invest in customer support: Provide excellent customer service, as positive support experiences can make the difference between a subscription renewal and a cancellation.

• Measure performance: Keep tabs on key metrics such as customer lifetime value (LTV), monthly recurring revenue (MRR) and churn rate. These metrics will guide your decisions and strategies.

Following these best practices, businesses can create a subscription model that not only attracts and retains customers, but also builds a solid foundation for sustainable growth.