In this episode of Startups For The Rest Of Us, Rob and Mike talk about how to evaluate per-seat and tiered pricing models. They give you their definitions and a list of pros and cons to each model.
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Rob: I’m Rob.
Mike: We’re here to share our experiences to help you avoid the same mistakes we’ve been. What’s the word this week, Rob?
Rob: Well, my first ever angel investment in 2011 was Jason Cohen’s WPEngine. They just passed $100 million in annual revenue and they secured $250 million investment from company, a private equity firm called Silver Lake and it bought out the series A and B investors. It’s my first exit, as they say.
Rob: I guess it’s my second exit because Drip and HitTail before that, but you get the idea. My first angel investment that has paid back any money, how about that?
Mike: Well, I’ve got a napkin folding company, if you want to invest in it.
Rob: Really? What’s the value? If it’s low in valuation, I think I could do it.
Mike: I don’t know, that kind of reminds me of the joke I just made. I think that it was Jason Fried who had put out a tweet a while back about selling a small piece of Basecamp to somebody for like a dollar, and he gave him 1/1,000,000 of a percent of the business in exchange for that dollar which may have valued at, I forget what it was, it was like $300 billion or something like that.
Rob: Oh, yeah. Right, right. Yeah, I remember reading that article just about how you reduce the numbers and it doesn’t make any sense when you’re raising a lot of these VC rounds, they’re just stupid, valued at whatever it was, 50 billion or just crazy, crazy numbers. But it doesn’t mean you’re actually worth that.
When I was sitting down to consider raising as Drip was growing and we were kind of bursting at the seams and we needed cash, we were evaluating raising an angel round versus an acquisition because we were being approached pretty regularly by folks who wanted to buy us. One of the struggles I had with raising that round or considering the round is the valuation that you’re gonna raise that right now given our growth rating, given our revenue, is gonna be high, it’s gonna be a lot of money.
In order to then do, in my opinion, to do right by those investors, you have to sell for at least twice that. Getting to a purchase price that’s 2x to 10x what your funding valuation was is hard. I’m gonna make up numbers here, but if you can raise at a $10-million valuation, you can’t sell at a $10 million valuation, you could probably sell for $1 million or $2 million, the actual cash sales prices are substantially less than funding valuations because funding is driven by the market and by FOMO, and by all this stuff, people making bets. Whereas someone putting cash on it, they really do look at more financials, they’re just more picky about things because they’re not making a bet. They are really trying to do something, do right by their business.
All that to say, if you raise at a $5 million or $10 million valuation, but you’re only worth in cash, if you could sell at a million today, you have a hell of a lot of work to get to that $20, $30, $40 million mark and that was a big question in my mind, like again, those are made-up numbers. Those are not the numbers that we had but I kept thinking are we in it for that many years or is it better to take some money off the table?
Mike: Yeah. I think that’s a big challenge not just for you at that time but for anyone who’s considering going down that road because if you do take that money, you’re basically committing yourself to down the road not just selling the business but putting the business in a position where you have to grow to that point in order to be able to get anything out of it. I think in most cases, the investors are going to need to be paid back their money first before you get anything or before you get anything substantial. Even if you sell it, as you said, if you’ve raised it at a $10 million valuation and you sold it, let’s say, for $12 million or whatever, they’re gonna make their money. Even though you sold the business for $12 million or $15 million, you’re probably not gonna make very much at all just because of the way that those numbers work out, which kind of sucks, you built that business, and yes, it was with somebody else’s money, but you just don’t get nearly as much out of it as you probably could’ve if you bootstrapped it. The flip side of the coin is if you didn’t get the money, would you have ever been able to get to that point?
Rob: Right, that’s always a challenge. I think we’ve been clear in the past that we’re not anti-funding, certainly not anti. As someone who is now investing in businesses, I believe that there’s a time and a place and there are rational and good reasons for raising fund. We did an episode on this, probably a hundred episodes ago where we really talked through the difference between Seed Funding and Angel Funding versus Venture Capital, and kind of the pros and cons to that. I think we talked about fund strapping during that time and about companies like Card Hook and Lead Fuse and Term Buster that I’m invested in. They don’t necessarily wanna do the implied series A. They really are raising that round up front to move quicker, but to get to profitability, and then to build an actual business that will either exit someday or will throw off cash in the form of dividends. It is a challenging question.
I think I’ve publicly stated several times that I have no plans to do another one. I don’t plan to do another startup, I just don’t feel like I have it in me at this point. But if in some theoretical world I were to do it, I would probably raise a round. I would either raise a round for myself and self-fund it but with a substantial chunk of money, or I would go to my angel network and the people that I know and get some money into it because it just makes things so much easier if you’re an experienced, knowledgeable founder and you know the path, it can get you there quicker.
Mike: The Bitcoin rage, I think right now the initial coin offering, you could do an initial [walling 0:05:44] offering.
Rob: Oh, my gosh. Oh, my gosh. The ICO stuff is so ridiculous. That’s a whole other show. If you wanna hear about that, go to https://p.nomics.com, that’s Clay Collins’ blog about Cryptocurrency and he has a podcast now, and he’s dived into that stuff. Yeah, there’s some serious insanity going on there. I think the SEC is going to crack down on people offering these – essentially they’re securities, they’re selling securities without vetting the people on the other end, and there are laws against that. I think it’s going to become a mess for some folks.
Mike: Yeah. I’ve seen some crazy things like some companies lately that are publicly traded companies where they have a price on the New York Stock Exchange, or on Nasdaq, or something like that. They come out with a press release or an article that says that they’re going to be creating their own digital currency of some kind, and then suddenly, I think it was Kodak, it was just last week and their stock price went up by 50%. I was like really, are you kidding me? This is Kodak. Yeah, I don’t know. Having spent a long time in Rochester, New York, Kodak goes through a cycle, every three years roughly. It’s Kodak and Xerox. It’s like one year a bunch of people are laid off and then the other company is hiring, and it’s just people bounce back and forth between those two companies like clockwork and it’s ridiculous. But neither one of them either really does anything.
Rob: Cool. Enough about ICOs and Angel Investing. What’s going on for you?
Mike: I had a bunch of customers to Bluetick this week. That’s a good feeling to get back on track and kick things off in the New Year. Right now, I’m dealing mostly with support issues and finalizing the website design I’ve been working on and the email course redesign. I think my biggest challenge right now is troubleshooting large numbers of requests that are coming into my server on occasion, so we’re trying to figure out either what’s going on and why certain things are being throttled. I’m sure it’s a configuration issue at some place, but I just don’t have the logs because it looks like certain things are just not getting through and I don’t see what’s going on, so that came up this morning.
Rob: Dude, if you have a segment.com integration, they have [00:07:50] so many time, accidentally. Someone hooks it up and they don’t respect our rate limits, and we’ve had extensive conversations with them and I’m just shocked that business at large, it’s 429 response that we give back and we say, “This is the rate limit. The next time you can send is in this many minutes.” It’s all in there, Zapier has rate limits and we parse them, we actually respond to them but Segment said they’re working on it, but man they have taken the RAPI down multiple times in the past year.
Mike: I’m the only one who’s like I’m getting API requests coming in and I’ve never really looked at the API limits in the past because before it was just my app and now as I’m starting to integrate into other things, as you said, you’re basically accidentally getting [00:08:33]. I’m seeing the logs, I’m responding to dozens of requests per second, but if something gets dropped, I don’t necessarily see it in those logs. I would just have to go poke around and see like are there other logs that I can go look at on the system itself.
Rob: Yeah. Once you have customers going and you start scaling up, these things take more and more of your time. Before we dive in, I had a couple of books that I want to just circle back on. As I say, I listened to a lot of audio books during the year. I recently finished WTF, What’s The Future and Why It’s Up To Us, and that’s Tim O’Reilly’s book.
I mentioned that I was maybe a third of the way through and was not digging it a few weeks ago. I came at it with a new mindset and I do think it’s a good book, but it didn’t blow me away. He analyzes how the future is gonna be. He looks at certain companies and how they’re operating and he did this back in the 90s. He did in the early 2000s with Web 2.0, and now he’s doing it here. He says, “Certain companies embody what’s going to happen, where the puck is going. He looks at several companies, Uber, and he talks about Amazon, he talks about a few companies that do it. It definitely got better for me towards the end, but not a resounding. It was good. It was just 6 or 7 for me out of 10, but it didn’t blow me away like I thought I would.
Another one is called Make Your Kid a Money Genius Even If You’re Not. I always like books that help me raise my kids better and give me advice about that stuff. Though I liked it, I think it’s worth listening to or reading. My one complaint is that it’s so much focused on teenage, college, and later. Since my kids are 7 and 11, there was a little bit on that topic but it was very, very limited, so I started skipping chapters towards the end about saving for college and all this stuff that I already have done, how to manage your money during college, how to do credit cards, and all that kind of stuff.
Then, the last one is a really interesting book I stumbled on, it’s called Accidental Superpower. This is if you want to feel good about the future of America. Not in like a nationalistic way, but in a, there’s always the thought or the threat of like, “Well, you know, India, and China, and Japan, and everybody, they’re just gonna eat our lunch and all of the jobs are going overseas,” and all that stuff. Read this fascinating book, it’s by a guy with a PhD in Geopolitics.
Geopolitics is how geography shapes the political climate and how it shapes our country and how it develops. It’s just a fascinating look at all the advantages that really North America has as this place that’s separate from Europe, about the navy, about the natural resources. I mean just on and on and on and it keeps going through if you really look at this, at least from his perspective that America’s gonna be fine, that United States is gonna be fine, and that there’s always gonna be challenges, but then it’s not as dire as so many people make it out to be.
Mike: Awesome. While you’re talking about that, it actually reminded me of something else. Do you watch Netflix at all?
Rob: Oh, absolutely.
Mike: Yes. There’s a new series on there called The Toys That Made Us.
Mike: If you haven’t checked this, it’s awesome.
Rob: I have.
Mike: There’s only four episodes for it, so for the listeners, it basically goes back to the 80s and 90s and takes a look at some of the different toys that became huge and really, really popular during that time frame. Obviously, some of them came about before that, but it goes through some of the history of toys like Star Wars, Barbie, He-Man, and GI Joe. Those are the four that they have. I don’t know if they’re gonna do another season or anything like that, but it’s a really fascinating look at the toy industry and how people weren’t marketing these toys, how they were getting them out in front of customers.
In some cases, it was the psychological hacks that they used in order to figure out what was gonna make a toy resonate with people and some of the struggles that they had to overcome in order to get the product out to market. It blew me away. It was awesome watching all four of them.
Rob: I’ve only done the Star Wars one, but definitely, I’d recommend, have the other three in my queue. What are we going to talk about today?
Mike: Today, we’re gonna be talking about how to evaluate per seat and tiered pricing models. This comes up, because yesterday I was talking to an entrepreneur about this exact topic and we also have a listener question in our queue about SaaS pricing models.
The short version of his question is that, on apps and services the post multiple projects, is project-based pricing a thing? What are the pros and cons and why would you not go down on one of these paths? He has a much longer version which I won’t get into but I thought that we could dig into the differences between per seat pricing versus tier pricing, talk a little about the pros and cons of each, and then also point people to a resource over on the cobloom.com website where they have what’s called the Ultimate Guide to SaaS pricing models, Strategies and Psychological Hacks. They dig really into I think about seven or eight different pricing models. Some of them are just variations on others, so instead of per user pricing, for example, there’s a per active user pricing model that you can look on. I thought that that’d be a good place to start our discussion.
Rob: Let’s dive in.
Mike: The first thing to talk about is what exactly is per seat pricing? The basic idea of per seat pricing is pretty straightforward. Each person that is using your software you’re going to charge the customer for. If they have one user, you’re going to charge them for one. If they have 25, you’re going to charge them for 25 users. Typically, each user has a given price for it, maybe it’s $5, maybe it’s $50 a month. But you can also have I’ll say a little bit more complicated model where you have different tiers for the users as well. Let’s say you have one set of features, it’s $5, or different set of features, it’s $10 per user and $15. I think that it gets really, really complicated, at least it has the potential to get really complicated, but at its simplest form, you have per seat pricing as just a set dollar amount per user that’s using the software.
Rob: Yup. Do you remember the rule for, I think we’ve talked about this, the rule for when you should use per seat pricing.
Mike: Yes. You mentioned it a couple of episodes ago, I think.
Mike: If I remember correctly, if somebody is going to see a different set of data or have a different view of what’s going on, then they should have a per seat pricing model versus a tiered pricing model.
Rob: There you go. Two examples is if you’re using a CRM system, then each sales person will obviously see different prospects and different flows and that’s why per seat pricing makes sense there. But if you’re using an email marketing system such as Drip or Mailchimp, typically, you don’t see anything different if you login. Limiting the number of logins or managing by users doesn’t really make sense because people will just share logins if they wanna do it.
I like per seat pricing a lot, but you should only use it when it fits that role, and if it doesn’t fit that role, then avoid it and do one of these other purchases we’re gonna talk about. It feels weird when it’s bolted on. It’s really obvious. It’s something like why are you limiting by this? It doesn’t make any sense.
Mike: Can you give an example of where somebody might try to bolt that on and it doesn’t make sense? Because honestly, it sounds like you’ve got a couple of examples in your head.
Rob: There’s 500 or 600 ESPs that we’ve kind of run across over the years, and I’ve seen ESPs, again, something like a Mailchimp or a Drip have maximum, you can invite users in, up to five users to this tier, and then if you have more than five logins, then you have to jump up to a higher tier. It just doesn’t make sense, your customers are not getting value out of that, they’re getting value out of either how many subscribers they have, how many emails they send, how much money they make, there are other things to base your pricing on that are not a number of logins. Whereas, if you have something like pager duty where it’s monitoring software that pages your DevOps team or a CRM system, the more people you have on there, the more value you’re getting and be the more kind of willingness to pay that you should have. Those are kind of two examples both against and for per user pricing.
Mike: A couple of different cons for the per seat pricing that you already called out was that people will share accounts if there’s no real value associated with having a dedicated log-in for them. I think the other thing, and I’ve personally seen this as well is, if you are charging on a per user basis, it in some ways limits the adoption of that particular product, because then you’re basically forcing the company or the customer to make a decision every time they have either a new employee, or a new contractor come in, do we create a user account for this new person because it’s going to cost us money to do that. By pushing that decision on them, a lot of times the answer’s gonna be, “Well, no, we can get away without it.” Or, they go towards what you had pointed out, they just start sharing logins and it becomes a detriment to you because then you have to just evaluate, are you gonna enforce the logins on a per user basis, or you’re gonna make sure that the only one session is connected at a time, or you’re just gonna ignore that issue?
Rob: Another con to per seat pricing. Again, per seat pricing works, but these are some potential negatives. You do have a potential for increased churn as a result of fewer people in an organization using it if they are trying to save money by not having everyone login. It’s one way that people might churn out of your app.
Mike: If we look at the benefits of the per seat pricing, it’s really easy to understand. It’s x-dollars per user, per month, and there’s really no complicated explanation for it. Another nice side of it is that it does scale with usage, you are not really leaving money on the table if somebody has 5 people signed up, you’re gonna get paid for 5 people, if they have 500, you’re gonna get paid for 500. You don’t have to worry as much about whether you’re leaving the money on the table or you’re selling yourself short inside the app.
Then, the last thing is that when you have a number of users who are using your product, the revenue itself is generally predictable, because you can see, not just that you have that number of users and it’s a month to month subscription of some kind, but also you can see when people are not using the product. If they’re not using it, chances are good that you can forecast a little bit and say, “Well, how long after they stop using it does this particular user or account fall-off, and then we no longer start getting revenue from it?”
Rob: That’s where this variant of per using pricing started to come about, it’s called per active user pricing and we’re not gonna dive totally into this but Slack does this. If you have a team of 50 people, 50 logins into Slack, but five people don’t use it at all during a month, they actually don’t charge you for that. That’s kind of cool way to do it.
Mike: Yeah. That is kind of a cool way to do it, and I think if you’re large enough where you don’t necessarily care whether all of your users are on the system or not, then that’s fine. But I think for a lot of smaller companies, that also creates some pain points around when you like somebody says, “Hey, can you cap on Slack and go take a look at this?” “Oh, I didn’t get that.” Or, “I haven’t logged in.” Then, they log in to check one thing and now you’re getting charged for them, it’s like okay, well, if they didn’t have the login to begin with, then you wouldn’t have to worry about that.
But, I don’t know, I think for smaller businesses, if you’re between one and five people, it can be kind of painful, especially if the price point is more than like $5 a month. $5 a month is not a big deal, but if it’s $50 or $100 a month per user, and suddenly you have two or three people log in extra just to check something, now you’re getting charged for them because they’re considered an active user
Rob: Cool. What’s next?
Mike: The next one to talk about is tiered pricing. I think that if you look back historically, I think it was Hiten Shan with Crazy Egg, they’re the company that I think you can kind of point to as putting together those different tiered pricing models, another one is Basecamp obviously with all of their different pricing tiers that they have. Being able to maximize revenue inside of their apps by offering a tiered pricing model.
The whole concept of the tiered pricing model is that within a given pricing tier, you have access to a certain set of features, and a certain number of users, maybe you have features in between the tiers, or maybe you have the tiers based on number of users, combination of those things, but essentially it allows you to put those things in different pockets, so to speak, and let people self-select which one is the most appealing to them. I think that this is interesting from the standpoint that you can allow the user to select those but the downside is that because you’re allowing them to select it, they could easily select the wrong things or they may have problems deciding because you didn’t put the gates between the different tiers on the thing that is most important to them, so there’s pluses and minuses to this approach.
Rob: Yeah. I would say when I think of tiered pricing like a strict definition, I think of it being based on a single metric or maybe two. An example to come back to ESPs is Mailchimp and Drip charge on the number of subscribers. That’s all the tier. The tiers go up and they go down based on that, and it’s not also based on features because I see feature dating as a separate or a more complex version of tiered pricing. True purest tiered pricing, remember Kissmetrics was based on, I think, it was the number of events in a given a month. Segment used to be based on the number of events, and I think it’s actually different now. They changed it. Zapier was like that. It’s not metered because meter would mean like AWS where you get charged for exactly what you’re using but it’s these tiers up to 100 subscribers and then 1,000, and then 2,000, and then 3,000.
Mike: I think the interesting thing is that if you go over to Basecamp’s website right now, the only pricing that I see listed is it’s $99 a month all inclusive. What used to be when you went to Basecamp and you sign up for their product, you get X number of projects and let’s say it was up to 10 projects and unlimited users, but then you had a limit on the file storage, for example, with limit on the number of active projects that you can have at one time. It’s just $99 a month flat rate as many users as you want, as many projects as you want, and they’ve gotten away from all of the pricing tiers. I think it’s interesting to see the evolution that they’ve gone through for their pricing.
Rob: Yeah, and that’s something that’s really common. If a founder comes to me and says, “Look, I’m just launching, or I have 5, 10, 15 customers, how should I structure my pricing?” My advice would be go as simple as possible to start with and if you’re gonna do per seat, then just do per seat. Don’t do tiers to start with and do $10 per seat, or whatever you’re gonna charge, or if you’re going to meter it, then do your tiers and see what happens.
Get 50 customers going and see what the complaints are, see how the revenue stacks up, see if there’s an opportunity to make it more complicated, but don’t start out with complicated pricing because it’s hard to simplify things. It’s easier to make it more complicated. Easier to add a V2 Pricing that has some differentiators once you have the data. That’s the thing, when you have no data or very limited data, it’s really hard to make choices and you’re likely to make the wrong choice the more complicated you make things. I do think that pricing should evolve overtime. If you look at like I said segment.com, pricing is way different than it used to be. It’s not even based on the same metric it used to be. As you said, Basecamp is different.
Most SaaS apps, if you look five, six years ago, their pricing is probably substantially different than it used to be. Even Mailchimp used to have a fairly linear pricing model, but now if you look at it, it’s a very choppy thing that it’s linear and then it flattens out for several thousands subscribers. Then it goes up linear and then it flattens out. I’m sure that they’re really smart over there at Mailchimp. I’m sure there’s a reason that they did that and it’s probably based on data.
Mike: Yeah. If you look at even at the bottom of Basecamp’s pricing page, it shows how many subscribers or how many customer they’ve had over the years. Back in 2004, it was 45, and then 2006, it was 100,000, and now it’s up to 2.5 million. I would imagine they have a lot of data to be able to back up their justifications for making some of these decisions. It’s not that they really need the money either, so sometimes it could be just that they got no point where they don’t necessarily care about it as much and they just want to attract as many users as they can especially on the higher end because if you’re only charging $100 a month, then it makes it very easy for larger companies to justify it and say, “Oh, let’s jump on this because it’s only $100 a month.” Then you just get it for the entire company.
Rob: Yup, makes sense.
Mike: If you look at a company like Crazy Egg, you go to their pricing page, they still have four different pricing tiers. This is what I was talking about where they will segment based on a couple of different metrics. There are two lower ends plans that’s visits per month, and then active pages, so it’s 25,000 visits and 20 active pages for their standard. Then below that, it’s 10,000 visits and 10 active pages. Depending on which of those two metrics you need to pay attention to, you’re gonna have to choose either basic or standard. If you go over one, you’re probably gonna have to switch over there. Then their plus and pro-plans, there’s also advance features that they use for that as well. Instead of daily reports, you can get hourly reports, and then there’s advanced filtering, mobile heatmaps, etc. You can get more complicated but as Rob pointed out, you have to have the data first. At the beginning, you’re just guessing and throwing things at the wall and seeing what sticks, and sometimes that’s what you have to do, but that helps you get the data.
One thing about tiered pricing that had come up at Microconf, Patrick McKenzie had mentioned this where he was working with the customer and he ended up sending out an email on their behalf to their customer based and had offered them an upgrade. Essentially, he looked across the customers’ customers and said, “How many of these people are close to the limit?” When he found that information, he sent out an email or helped him send out an email that basically said hey, “Hey, you are close to the higher end of your pricing tier, why don’t you upgrade and give yourself a little bit of headroom?” That was a very clear upsell to the customers and that consulting client of his ended up making a, I don’t know exactly how much revenue was from it, but it was sizeable enough that it made a difference and helped them justify bringing him on and moving the business forward.
Rob: Yeah. I always felt like that was an interesting tactic. I’ve never used that. If I got an email like that, I would think to myself, “Aren’t they gonna be auto-upgraded anyways?” But apparently, it works and it’s something that I know Patrick did with his consulting gigs and got the people to upgrade. Looking at this Cobloom article, they have I think six or seven types of pricing models.
One is flat rate pricing and that’s essentially what you said with Basecamp. Most companies, that’s not gonna be what you wanna do. You’re gonna probably wanna do a per seat or do a tiered model that’s based on one metric to start with. Another type is usage based which is pay as you go. Think of this like Amazon AWS or Google Cloud Hosting and Microsoft Azure. This is not something that I’d recommend for bootstrapped startups frankly because hearing winds up being a better way to go, it will make you more revenue and revenue, so critical for you at the time.
Of course, there’s tiered pricing, there’s per user pricing which we talked about. There’s this per active user pricing they have and then they have per feature pricing which can be done totally separately from tiers but I’ve typically seen it as you have tiered pricing based on a certain metric and then you also start sprinkling per feature pricing in there. I think kind of think of who, I know Zapier has done this. They used to have number of event executions per month and then if you wanted to use Drip or Hubspot, then you had to move up to a higher tier even if you had a small amount of events because they figured that if you’re using those tools, that you’re a more sophisticated marketer and you have a bigger budget. That’s one example.
The last one is Freemium, although I see Freemium as working with any of the above. You can have tiered pricing and then just have a forever free plan that is below those. Those are the seven models that they threw out just for completeness.
Mike: Yeah, I forgot who it was who was talking about Freemium and then referred to it more as a distribution model, not necessarily a pricing model.
Rob: Right, yeah. That’s how I feel about it and it’s a marketing approach more than anything else. That’s where my quote is that the Freemium Pricing model’s like a Samurai sword; if you know what you’re doing, you can wield it with great expertise, but if you don’t, you’re likely to cut your arm off. That’s how you see a lot of bootstrapped startups that just launch with Freemium because that’s what the big guys do, and then boom, that goes away, they shot their free plan down. I’ve seen dozens and dozens of companies, including Basecamp used to have a free plan, and they do not.
Mike: Cutting your arm off sounds like a great place to leave off this episode.
Rob: It sure does. If you have a question for us, you can call it into our voicemail number at 1-888-801-9690 or you can email it to us at firstname.lastname@example.org. Our theme music is an excerpt from We’re Outta Control by MoOt used under Creative Commons. Subscribe to us in iTunes by searching for Startups and visit startupsfortherestofus.com for a full transcript of each episode. Thanks for listening, we’ll see you next time.