What is Tiered Pricing?
Tiered pricing is a pricing strategy where businesses offer incrementally more expensive packages of goods or services. Each tier offers additional features, benefits, or services at a higher price point than the one before it.
Although there is a lot of flexibility with price tiers, most businesses use the three-pronged model, which includes a basic, standard, and premium version of their offering.
- Basic: The lowest-cost option that only includes fundamental components of the product or service. Sometimes, this is meant to be an introductory product. Others, it meets the needs of basic customers without making them feel as though they’re overspending.
- Standard: The middle ground choice with a wider range of features, benefits, and services. It offers the best value for money and embodies the company’s value proposition. Most of a business’s target customers should find it the most attractive.
- Premium: The “VIP” experience, generally seen as the most a business can offer its customers. It provides extra product features and top-of-the-line benefits like specialized services, priority access, and add-ons.
Businesses use tiered pricing to serve as wide a customer base as possible. Scaling down a product or its benefits to meet the demands of customers that don’t have the need (or budget) for a full-fledged solution widens the total addressable market and maximizes top-line revenue growth without having to add new products to their catalog.
- Subscription billing model
- Tiered pricing model
Benefits of a Tiered Pricing Strategy
A tiered pricing strategy is advantageous for businesses because it offers customers a range of pricing options that fit their needs and budget. This, in turn, helps businesses optimize revenue by maximizing the value of each customer.
Easy for Customers to Understand
At the end of the day, it’s all about the customers. Pricing that’s easy for them to understand maximizes conversion rates and improves the chances of them seeing the value in a product.
It also breaks down what they can expect to get for their money based on how much they spend which makes them considerably likelier to be satisfied with the end result.
Suppose someone visits a local car wash business to have their car cleaned. Before leaving it to the professionals, they’re offered three different packages: a basic option, a mid-level package, and a premium service.
If they choose the basic option, they’re generally happy with the ability to save money while still receiving a valuable service. They are not, however, thrown off by the fact that their car didn’t get the same treatment as those that opted for the premium package.
In that sense, customers understand tiered pricing structures better. For businesses, this makes it easier to meet customer expectations.
Increases Average Order Value
Human psychology dictates people tend to gravitate toward the middle option when presented with a selection of packages. There are a few distinct ways companies use this to their advantage.
McDonald’s, for example, offers three price tiers for fries, drinks, and other items: small, medium, and large. The large item is always very close in value to the medium-sized one, which people often look at first. But the medium product is just a decoy, priced higher than it should be to make the large item look like a better deal.
Some companies use the same pricing strategy to drive people toward the middle option by adding an exorbitantly-priced “VIP” package that most customers will probably skip. When buyers see an extremely high-priced option, the middle one seems much more affordable.
Plenty of organizations also use freemium pricing — a strategy combining free and premium services — to incentivize customers to upgrade. Freemium accounts offer basic features at no cost while the paid versions include specialized or extended functionality.
This kind of model is beneficial because it allows companies to keep acquiring new customers through their free plan. It turns them into long-term paying customers as they realize they need additional product features after they’re already familiar with using the product.
This isn’t “manipulation,” per se. Customers still get the value they’re looking for. It just so happens that tiered pricing is the conversion mechanism.
Scalable for Customers
The ability to choose from product or service levels makes meeting a customer’s changing needs considerably easier.
For instance, a customer who purchases the base price tier offering might want to upgrade later on as their needs change. If they already have experience with the product, it’s much easier for them to commit to an upgrade when compared to trying out something new from another business.
Alternatively, a customer using a premium product might want to downgrade. Without a lower pricing tier, they would churn. But with a basic or standard tier below it, they can keep doing business with the same vendor.
This is a win-win for both the customer and the business. The customer gets to keep using the product or service they already know and trust, while the company retains their patronage and avoids statistically high acquisition costs associated with finding potential customers.
When there are only a few pricing options to choose from, automating the billing process is as simple as inputting each price point into the payment system and letting it do its job as new customers are onboarded.
Now, third-party applications often handle the time-consuming billing and payment collection processes. With the tiered pricing method — which entails a flat one-time or monthly price — billing workflows are easier to set up, maintain, and scale.
Examples of Tiered Pricing Models
There are several different types of tiered pricing. The business model that works best for a company depends on its customers, industry, and the overall nature of the product (and how others use it).
With volume-based pricing, customers pay incrementally less when they purchase in higher order volumes. It works well for retail, ecommerce, and B2B manufacturing and wholesaling companies because it rewards large-scale purchases.
For businesses with large quantities of the same product, the volume pricing model ensures inventory sell-out, reduces costs, and increases order size.
Buyers in these areas also love volume-based pricing because it gives them the ability to run their businesses at a higher profit margin (or, in the case of individual purchases, attain more value from products they already use).
Feature-based pricing is the most widely-used form of price tiering. Businesses divide multiple levels of service by their features and pricing increases (or decreases) based on the feature set.
Breaking an offering into service tiers could translate to different levels of customer service, storage space, or usage limits.
Professional service providers (e.g., CPA, lawyers, etc.) often use feature-based pricing for different service levels and attention. For example, a CPA might offer two packages: one with basic tax filing services and another with the same plus financial advice from an expert.
This model works well for services and service-based products because it allows customers to pick and choose the value they benefit most from without going out of their price range.
Subscription-based pricing retains most of the characteristics of feature-based pricing — that is, customers pay for service levels tailored to their needs. The difference is that users subscribe to the service and make monthly or annual payments.
For example, Hulu offers a basic package with advertisements, a mid-level package for commercial-free streaming, an advanced package that includes the company’s ad-supported live TV service, and an even pricier option with no ads.
This works well for SaaS products and streaming services because it capitalizes on long-term customer loyalty. It also gives customers more freedom to upgrade and downgrade plans as their needs change, which improves customer retention rates.
Usage-based pricing (sometimes abbreviated to UBP) is a model based on the amount of resources customers use and pay for. Customers are only charged for what they actually consume, making it an ideal option for businesses with highly variable usage rates like telecom providers, utilities, and cloud services.
For instance, cloud services providers often offer storage space and computing power in bursts, with a certain fee per unit of consumption. Under this system, prices vary depending on customer demand — meaning that the more they use, the more they pay (and vice versa).
This model is beneficial because it allows customers to pay only for what they use, which can save them money in the long run. It also reduces the risk of over- or under-utilizing resources.
The usage-based pricing model is by far the most complex because it requires an absolute understanding of which customers are using a product and how much. Without a system continuously tracking customer usage, it would be nearly impossible for a business to accurately charge customers.
The upside is businesses can adjust pricing based on customer behavior and resource availability. This makes it easier for them to optimize their revenue streams and offer discounts when demand or usage drops.
Use Cases for Tiered Pricing
Price tiers are common in countless different business models. Although people typically discuss them when referring to subscription-based services, they’re also useful for ecommerce and retail businesses, professional services, and just about any type of business that offers a variety of products, packages, or services.
Here are a few tiered pricing examples:
They’re especially prevalent in the SaaS subscription model, where individuals/freelancers might use a bare-bones version of a platform for a low cost (or free). That same SaaS product may be sold to enterprises that subscribe for five or six figures per month.
The enterprise version would include API access, AI-based insights, personalized customer service reps (CSRs), and other features an individual buyer (or smaller business) wouldn’t need.
Physical Service Businesses
Car washes, gyms, and numerous other physical services always offer tiered pricing plans.
For example, a gym might allow people to pay on an as-needed basis or opt for monthly/yearly memberships at various price points.
The lower-priced membership may only provide basic access to equipment, while higher tiers come with free classes, designated parking spots, and other perks.
Productized Professional Services
Consultants, lawyers, and graphic designers (to name a few) use tiered pricing to meet the scale of requirements for multiple types of clients.
Their pricing models may vary wildly depending on the type of service, but generally speaking, they offer three to four tiers based on their expertise and the complexity/duration of a project.
A consultant, for instance, may offer a basic package for strategy advice, while bigger projects like a company rebranding would require more of their expertise and incur higher costs.
Cloud Services Providers
Like SaaS products, cloud services providers use tiered pricing models to offer different levels of service.
Usually, they require some sort of usage-based model, though. Since customers typically pay for the amount of storage and computing power they use, pricing tiers are usually based on the size/amount of resources a customer consumes.
For example, Amazon’s AWS offers multiple tiers based on users’ needs for computing power, storage space, networking capabilities, etc. The more you need (or use), the higher your bill will be.
Telecommunications providers like Verizon and AT&T use tiered pricing plans for cell phone plans.
These typically come in the form of monthly subscriptions that include a certain number of minutes, texts, and data packages.
Customers can choose the tier that meets their needs best — whether it’s an unlimited plan or a pay-as-you-go option.
Even physical products can benefit from tiered pricing models (though it depends on the product).
- Apple releases several iterations of each iPhone model.
- Automobiles come in multiple trims (or the same trim with different features).
- Winemakers offer $5, $50, and $500 bottles from the same vineyard.
- Brands give price breaks to vendors but keep products at retail price in their stores.
The goal is to offer a wide range of prices to accommodate customers with different budgets and needs.
Steps to Implement Tiered Pricing
A tiered pricing strategy only works when it’s well-executed, which is harder than it looks. Here are some steps to consider when planning out your pricing tiers:
Understand Customer Segments
For customers to respond favorably to tiered pricing, you need to understand who they are and how they will use your product.
Put yourself in your customers’ shoes. What features would they find most valuable? How much are they willing to pay for those features?
It helps to start with your product’s most critical features. For example:
- Trello’s claim to fame is its kanban boards, but larger customers might want more templates.
- HubSpot offers the best free marketing and sales tools, but a brand-new business won’t need custom reports or workflow automation.
- Apple’s lower-cost phones don’t have much storage, but that’s okay for casual users.
To figure out where customers are willing to spend more, you need to know their pain points and how your product solves them.
The best ways to accomplish this are through interviews, surveys, focus groups, and A/B testing.
Determine Pricing Tiers
Pricing tiers should be sensible from the customer’s perspective — they should easily differentiate one plan from the next. Focus on creating a hierarchy that makes sense to your target market.
As a rule of thumb, your product or service should be in full swing in the middle tier most customers will select. Stripping it down to its core features makes sense for the lower tier, while the top tier should come with bells and whistles.
Define Pricing Structure
Your tiered pricing structure (e.g., volume-based, usage-based, subscription-based) is a little more difficult to determine because you’ll probably use more than one.
For instance, an ecommerce vendor might offer a volume-based pricing tier to reward customers who buy in bulk, while its product catalog available to individual buyers would use a more straightforward feature-based model.
SaaS companies sometimes need to use feature-based and usage-based models simultaneously to meet customer needs. One tier might have a certain feature set, but the number of users a customer has within their company adds another layer of complexity.
Communicate Value Proposition
Pricing is essentially an extension of a company’s value proposition. The goal is to communicate the value of your product at each price point and why customers should upgrade or downgrade accordingly.
Your pricing page should reflect that message from the language you use to how you present different plans (e.g., side-by-side) so customers can compare them easily.
Test and Refine
Since product pricing isn’t an exact science, you’ll have to closely watch how your potential customers respond to the tiers you set up.
There are a few ways you can test your prices:
- A/B testing. In an A/B test, you test two different prices against each other to see which one yields a better response. It’s best to avoid this strategy if you’re only testing one product — offering a lower price to one customer segment can damage your company’s image and frustrate your buyers who paid more.
- Cost-plus pricing. If you aren’t sure what to test your price against, you could use the cost-plus method (calculating fixed and variable costs, then adding a percentage markup). Ecommerce brands and retailers commonly use cost-plus because it guarantees them a profit.
- Surveys. Asking customers directly about their willingness to pay (WTP) can give you better insight into what they’re looking for in terms of pricing tiers. It also helps you understand how closely the price reflects the value they receive.
Although competitors shouldn’t be the only data source for a tiered pricing strategy, they certainly provide valuable information.
You won’t have access to internal data, but you can use their websites, product reviews, and customer feedback to understand their success and what’s behind it.
When evaluating competition, make sure to look at both their prices and product differentiation. Ignoring the latter can lead to misinformed pricing decisions that don’t reflect the uniqueness and quality of your offering.
Provide Clear Options
Each pricing tier should be clearly differentiated. On your website’s pricing page and internal documents, clearly outline the features, benefits, and value proposition for each pricing tier.
Begin with who the product tier is for, e.g., “Basic plan for budget-conscious customers,” and include a bulleted list of features for each tier.
Adding pricing comparison tools and feature comparison tables can also make it easier for customers to choose the plan that best fits their needs.
Monitor and Optimize
Again, tiered pricing isn’t an exact science. Market dynamics are continuously changing, so monitoring your strategy and adjusting prices is paramount.
Look closely at sales metrics like the number of sales per tier, conversion rates, and average sale/deal size. Then, compare them to profitability metrics like customer lifetime value (CLV), customer acquisition cost (CAC), CAC payback period, and revenue growth rate to know whether or not you can sustain your pricing long-term.
Technology Requirements for Tiered Pricing
Implementing and scaling tiered pricing is only possible with the right technology. The following are critical tech pieces for setting up, managing, and optimizing tiered pricing models:
Configure, Price, Quote (CPQ)
The CPQ process includes product configuration, pricing, and quoting customers. Whether a sales rep carries it out through demos and consultations or a buyer uses an interactive website or customer portal, automating the process with CPQ software is easier than sifting through mountains of product data every time a new customer comes through the funnel.
With CPQ, businesses can set price tiers inside the system and automatically apply them to every purchase. CPQ’s rules engine also supports usage-based models, so brands can adjust prices dynamically based on customer usage (among other factors).
Subscription Management Software
Subscription management software is a complete package for running recurring revenue models. It automates subscription billing, customer onboarding, and retention processes to help businesses scale their subscription-based tiered pricing model quickly.
Since many subscription businesses use tiered pricing, subscription management software usually supports multiple pricing models (e.g., flat fee, usage-based) and allows businesses to adjust prices up or down based on customer demand.
Billing software takes care of collections, payment processing, and (partly) bookkeeping procedures.
For subscription businesses using tiered pricing, billing will already be integrated into the platform. For other types of businesses (such as online stores), integration with a third-party billing platform is a requirement.
Integrating multiple payment methods, offering discounts when customers prepay, and handling currencies are all possible with the right billing solution.
The main disadvantage to tiered pricing is it doesn’t guarantee profitability. When testing different price tiers, the one that customers respond to might not be sustainable for the business. Companies should also be careful not to force customers into a plan they don’t need or confuse them with too many options.
Although volume pricing is a form of tiered pricing, there is one critical difference: volume pricing discounts are based on the total quantity of items purchased. If a customer buys more items, they get a discounted rate per unit. Tiered pricing usually involves offering different (discounted) prices for certain product features or services.