Hey there, I'm the founder of a site that helps families keep in touch. We're going to be buying our cash register soon, so we're figuring out our revenue model.
We're deciding between two types of incoming revenue: $40 a year or $3-5 a month. Pros and cons:
$40 a year
There's also the option of both.
I don't understand why you can't offer both. In fact, almost all monthly recurring services with fixed monthly rates typically offer an annual rate including some discount.
The extra expense for monthly billing is significant for you because the total is so small. At e.g. $40/month the pennies don't add up, but on just $3 of revenue a charge of e.g. $.40/transaction is a huge cost.
Also the "constant stream of revenue" isn't a pro. If you got all the money up front it's even better timewise. And they can cancel. So it's actually more constant to charge annually.
Generally speaking, the sooner you can get the money, the better. In this case, get the $40 as soon as the sign up. Realistically speaking, $40 is nothing: half a month's cable bill, lunch for two at Applebees, etc. If you think or find that people say $40 is too much for a year's worth of service, then you need to work on reframing the value.
That said, you should consider going with both options, but have a fairly high "penalty" for going month-to-month. Obviously, you can't frame it that way to clients (it's a "discount" for paying annually), but you need to think of it like that. Your goal is annual sales, and the extra 50%-per-month you get is your cost to assume the risk of less than year and not getting the year upfront.
Also, recurring annually is not evil (especially if they use your service): if you're concerned about that, make it easy for them to get a refund. I'd immagine that the cost of charge/refund will be offset by the new renewals.
Sounds like A/B testing would give you some very useful data. Split users into monthly-subscription or yearly-once-off and capture convesion rates. Alternatively, if this feels a little too 'harsh' for your users, you could do A/B testing with checkout pages offering both options but alternating (monthly/yearly) which option is default and given more prominence. You can then mine both conversion data and option-selection data.
If you do this and your results aren't too sensitive, we'd all be very interested in hearing your conclusions!
Whichever approach you take, test it before you launch.
The smaller monthly charge definitely makes it more appealing to some users. BUT there are a set of people who absolutely won't sign up for anything that has a recurring charge. I've learned that in my current company. Plus you've listed some of the other cons such as transaction fees.
Obviously better for you to get the money upfront and have a longer term commitment. This option could be offered with a discount over the monthly because of the longer commitment. Possibly a 6 and/or 12 month option that's discounted some amount.
Without knowing your market, competitors, cost structure, etc. I'd generally say that offering both options is probably the route to explore.
Closely monitor from the time you launch to see the results and monitor what's working and what's not.
Best of luck!
The biggest con for annual renewing charges is that they don't renew.
1) Credit cards expire.
2) Credit cards get canceled.
3) Larger charges are more likely to be declined.
4) Instead of before-hand cancels, you'll get charges, cancels, and send refunds.
These problems will happen on a monthly basis too, HOWEVER, as a brand new startup, it's easier to stomach a handful of failed $5/$20 charges than MANY $40/$200 charges.
There's a problem with charging $3 per month. The credit card processing tax will eat up a large percentage of the money.
So, you have to make some calculations - how much of the $3 charged monthly will be in your pocket.
How did you come up with your price points of $40 for the year or $3-5/month. Is it based on your experience in the industry, feedback from potential clients in your market, etc? I think Alex did a good job putting the proposed amount into perspective. It is possible the perceived value of the service from your customer's perspective could be much higher. Market research can never hurt.
If you are set on your pricing you may want to consider adding a third quarterly option:
Monthly: $5 (good value)
Quarterly: $12 (better value)
Annual: $40 (best value)
Best of luck.
If you're an early stage startup, try for the annual membership. You want working capital, and getting 12 months money day1 helps delay your need for external investment.