This article is based on a video from the "SaaS Fundamentals" series featuring Akil, a pricing strategy expert, who explains the various subscription models that power SaaS businesses and how they generate recurring revenue.
The Critical Importance of Recurring Revenue
Unlike traditional software sold as a one-time purchase, SaaS (Software as a Service) companies operate on a subscription model where customers pay monthly or annually for ongoing access. This approach creates a predictable, steady income stream that compounds over time.
As Akil explains in the video, "Monthly recurring revenue or MRR as we discussed in our previous video is truly the lifeblood of SaaS businesses. When MRR is growing, it typically signals a healthy business. When it's declining, that raises red flags."
This subscription-based approach provides stability for planning and investment in product development. However, it comes with a significant responsibility: "The beauty of recurring revenue is that it provides stability for planning and investment in your product. But there's a catch. To keep that revenue flowing, you must consistently deliver value month after month."
This reality explains why SaaS companies are deeply focused on customer satisfaction and reducing churn. Maintaining existing customers is just as crucial as acquiring new ones when your business model depends on ongoing subscriptions.
The Five Most Common SaaS Revenue Models
1. Freemium Model
The freemium approach combines free basic access with premium paid features. It offers users a functional but limited version of the product at no cost, while charging for advanced capabilities or increased usage.
Akil cites Slack as "a perfect example of freemium in action. They let teams use their messaging platform for free with limited message history. Once a team grows or needs access to those older messages, they're motivated to upgrade to paid plans."
From a business perspective, freemium is powerful for rapid user acquisition and viral growth. However, conversion rates typically remain low: "The conversion rates are typically low, often between 2 to 5% of free users ever convert to paid. This means revenue growth is slower initially, even though user growth might be explosive."
Akil uses an apt metaphor: "Think of freemium as casting a wide net in the ocean. You'll catch many fish, but only some are keepers that generate revenue. The rest are still valuable for word of mouth marketing, but they don't directly contribute to your bottom line."
2. Free Trial Model
Rather than providing a permanent but limited free tier, the free trial model gives users complete access to the full product for a defined period (usually 7-30 days), after which they must subscribe to continue using it.
"Services like Salesforce, Adobe Creative Cloud, and even Netflix use this approach. They let you test drive your complete product before deciding whether it's worth your money," explains Akil.
Free trials typically achieve higher conversion rates than freemium because users experience the product's complete value proposition and are often more qualified prospects. The challenge is demonstrating value quickly: "If users don't see the benefit within the trial period, they'll most likely disappear."
This model works best for products with immediately apparent value rather than those requiring long-term use to appreciate their benefits.
3. Usage-Based Pricing
Usage-based pricing charges customers based on their actual consumption of the service. As Akil puts it, "The more they use, the more they pay. It's that simple."
"Amazon Web Service (AWS) is the classic example here. They charge based on computing resources used like server time or storage space. Similarly, Twilio charges per text message or call sent through their platform," he explains.
The main advantage of this approach is its perceived fairness: "The beauty of usage pricing is that it feels fair to customers. They only pay for what they actually use. This creates a low barrier to entry since anyone can start small."
For businesses, revenue naturally scales with customer usage, though this can make monthly income less predictable. This model aligns particularly well with infrastructure or API services where consumption varies significantly between customers.
4. Per User (Seat-Based) Model
Perhaps the most straightforward approach, the per user model charges a fixed amount for each person using the software.
"Microsoft 365 and Salesforce both use this model charging a set fee per user account. As more people in the organization need access, the company pays for additional seats," Akil notes.
This model creates highly predictable revenue that grows linearly as customers add users, making financial forecasting simpler. The primary challenge is that it may discourage full adoption: "Customers might limit the number of seats to save money, potentially reducing the software's impact."
Per-user pricing works exceptionally well for collaboration tools where value increases with broader adoption.
5. Tiered Pricing
Tiered pricing offers distinct packages at different price points, with each tier including specific features or usage limits designed for different customer segments.
Akil points to Notion as an example: "Notion illustrates this approach well with their individual (which is free), team ($8 per user) and enterprise plans. As customer needs grow more sophisticated, they can upgrade to higher tiers."
This model's strength lies in capturing varying levels of willingness to pay across customer segments. Small businesses or individuals can start with affordable tiers while larger organizations access premium features at higher price points.
The challenge is in designing tiers that effectively drive upgrades: "If your basic tier is too generous, customers may never feel the need to upgrade. If it's too limited, they might leave entirely."
Selecting the Right Revenue Model
How do you choose the right pricing model for your SaaS business? According to Akil, it depends on three key factors:
- Target Market: "Freemium or low tier offering works well for individuals and smaller teams who are price sensitive. Per user and tiered models appeal to growing businesses that need more functionality. Enterprise customers often expect completely customized pricing that reflects their unique needs."
- Product Usage Patterns: "Team collaboration tools naturally fit with per user or tier pricing. Infrastructure or API services align better with usage-based models, and complex products with learning curves might benefit from freemium or longer trials to give users time to experience the value."
- Cost Structure: "If your per-user costs are high, freemium might be unsustainable. With low marginal cost, you have more flexibility to offer free tiers. And if your expenses scale with data storage or processing, usage-based pricing or tiered plans with usage limits make more sense."
As Akil emphasizes, "The best model is one that aligns with how customers derive value from your product while ensuring sustainable growth for your business."
Hybrid Approaches for Maximum Impact
Many successful SaaS companies combine multiple pricing models to optimize both user acquisition and revenue generation.
"Take Dropbox for example. They use a hybrid of freemium, tiered, and per user pricing. They offer a free basic storage to get users in the door, paid tiers with more space for power users, and business plans priced per user for organizations," explains Akil.
Similarly, "HubSpot is another great example, combining freemium with tiered pricing. Their free marketing tools attract users into their ecosystem while increasingly powerful and expensive tiers serve growing businesses with more sophisticated needs."
These hybrid approaches allow companies to attract a wide user base while maximizing revenue from customers willing to pay for additional value.
Conclusion
The revenue model you select fundamentally shapes your SaaS company's growth trajectory. As Akil concludes, "Recurring revenue is the engine that powers companies. And these pricing models are different ways to fuel that engine."
There's no universally optimal model – the right choice depends on your specific product, target customers, and business objectives. Furthermore, your pricing strategy should evolve as your company grows and your understanding of customer value deepens.
By selecting a pricing model (or combination of models) that aligns with how customers derive value from your product, you can build a sustainable, scalable SaaS business with healthy recurring revenue.