The pricing question presents a real challenge to SaaS founders and is an area many of my clients struggle with.
You want to capture as much value as possible, but do not want to undersell your solution and leave money on the table.
Getting it right is key to growing your business and reaching your revenue targets.
I recently came across a helpful report, “The Anatomy of SaaS Pricing Strategy”, published by Price Intelligently, which looks at the challenges around pricing SaaS.
As the report makes clear, pricing is often overlooked as a growth lever, with the default focus among SaaS founders being on customer acquisition.
In this blog, I will summarise the main findings of the report and provide some tips on getting your SaaS pricing right.
Most founders and the software industry as a whole are obsessed with getting more clients as the main way to grow revenue.
However, the Price Intelligently report presents findings from a study of 512 SaaS companies that shows that monetization (i.e. getting your SaaS price right) has the biggest impact on the bottom line and improving growth.
Compared to the other growth levers, monetization had a 12.7 percent impact on the bottom line (whilst retention had a 6.71 percent and acquisition had a 3.32 percent impact).
The takeaway is that concentrating on getting your pricing right will give your SaaS company the best chance of success. See Impact of improving each growth lever graphic below. Source.
Successful Model Graphic: Source
According to the same report, pricing is the foundation of your company’s unit economics. Getting your company’s unit economics right is the difference between success and failure.
Unit economics depends on two variables:
CAC is the sum of your marketing and sales spending across all channels divided by the number of new customers acquired.
LTV is the total you will earn from each customer over the time they are customers. This is calculated as monthly average revenue per user (ARPU) divided by your churn rate.
The Successful Model Graphic from the report (see above), communicates elegantly what successful unit economics looks like. Theoretically, the idea is to make the line as steep as possible by minimizing your customer acquisition costs (CAC) and maximizing your customer lifetime value (LTV).
According to Price Intelligently:
“Based on the experiences of successful (and unsuccessful) SaaS companies, you need an LTV/CAC ratio of at least 3:1 to run a successful business. But with continual pricing optimization, you can push that ratio to 11:1 and beyond. This is because with effective pricing, you can reduce your CAC through better positioning and packaging targeting ideal customers, and increase LTV through higher prices and better retention. This leads to increased growth and increased revenues.” Source.
The report recommends that, in practice, you focus on increasing your LTV rather than decreasing CAC. This is because customers, especially the high-value ones, cost money to acquire. Making cuts here is likely to affect your acquisition rate creating further problems.
When SaaS companies face problems growing their revenue, there are 5 main causes, according to the report:
With the exception of poor acquisition, all of these can be addressed by improving your pricing strategy.
Price Intelligently advocates a data-based approach to defining the problem.
This involves engaging with your customers and understanding what they value and do not value about your solution. This takes time and effort, but is essential to tackling your revenue challenge head on.
The report recommends engaging with your target customers and asking questions.
A key component of the process is the Van Westendorp Price Sensitivity Meter. It relies on 4 questions focused on willingness to pay:
Cost-based pricing: here, prices are determined by the cost to produce and service your solution plus a markup. This is often the model used for commoditized services. It can be tempting for SaaS companies to adopt this approach because it is simple to understand, but it is not going to create a sustainable business long term.
Market-based pricing: here, you let alternatives/competition dictate what you charge. You consider what the market will bear, what your competitors charge and where you fit within the budgets customers have set aside. This approach gives transparency to your clients, but can make you come across as “just another vendor”. This approach is popular with SaaS founders as it is easy to understand, however, it is not optimal.
Value-based pricing: this is based on the ROI your solution delivers. In simple terms, think about the amount of time and effort your solution saves a client. For example, if you have a reporting tool that saves a data analyst 5 hours of his/her time, you could calculate what this means in terms of his/her salary. Your price should reflect a good part of this cost saving, whilst representing good ROI.
Price Intelligently firmly believes that value-based pricing is the only viable option over the long term.
“In SaaS, the only viable option is value-based. Your SaaS company exists to offer value to your customers. By finding out how much they are willing to pay for your product and what features they want to see you develop, then you will be able to not only give customers what they want, but you’ll also be able to attract and retain these customers better. All while making more profit.”
A fundamental part of your pricing model is a clear value metric. This is the variable that determines the different pricing options you offer. For example, for an email marketing SaaS solution, you might define your packages in terms of the amount of emails users can send per month.
With other types of SaaS solution, metrics based on the number of users might be more appropriate.
The thresholds of your chosen metric(s) need to be clearly communicated. For example, after a client reaches a certain limit of 100 emails a month, what is the next package he moves onto? You might want to think about reducing the thresholds so that your clients move onto your next package sooner.
Your pricing structure should offer progression as usage grows. This lays the groundwork for your future growth. The idea is that as the client grows, so does your business.
Put your value metrics centre stage on your pricing page. The design should be simple and easy-to-understand.
If you have created buying personas, consider putting these centre-stage on your pricing page. Zubtitle does this well by defining different user types as: Free, Influencer, Guru and Agency. By doing so, your target audience can quickly self-identify which category they fall into.
When creating your pricing page, you can encourage users to sign up to your annual plan by displaying the annual plan pricing by default (instead of monthly).
This is a good idea because more annual users is better for your cashflow and future business growth.
With value-based pricing, you can demand higher prices if you have shown that there is willingness to pay from your customers.
You can also charge higher prices as you add more value to your solution and find out more about your customers.
Price Intelligently recommends that you re-evaluate your pricing strategy every 6 months to see if there is room to raise prices.
It can be tempting to offer discounts to onboard new clients quickly. However, over the long term, offering discounts ends up damaging your business because it takes longer to recover CAC. Even if the discount brings in more business initially, you may never recover the CAC for these discounted customers and end up losing money overall.
Perhaps more importantly, discounting trains your customers and team to devalue your product.
By offering the same product at a discount, your potential clients will think that your solution is not worth the original price.
Also, your sales team are likely to push through discounts indiscriminately to reach target. This directly impacts your profit and long term survival.
However, there are some instances where offering a small discount is appropriate.
For example, you could offer a 5% discount on the first year fees if they sign up for an annual plan. The advantage of this approach is that you secure 12 month’s worth of fees upfront, which is great for your cashflow. Pushing an annual commitment also gives you more money to invest in your business rather than waiting month-to-month for more cash.
My advice is to try and be consistent when offering discounts as clients talk to each other. No one wants to find out that another client is getting a better price than them.
Also, ideally, offer discounts on a time-basis only. This means that after an initial period of, say, one year, they pay the full list fee.
When looking to grow your company, the default approach is to chase new customers. However, according to the study by Price Intelligently, “monetization” has the biggest impact on the bottom line and revenue growth.
Many SaaS companies approach pricing from a cost-based or market-based standpoint. Whilst these approaches are simple and quick, they leave money on the table and are not sustainable for SaaS companies over the long term.
Instead, it is recommended that you build a robust pricing model, which focusses on capturing the most value.
Whilst value based pricing involves a lot of work, in terms of engaging with your target audience and collecting data, it is the most powerful lever in delivering growth and profitability.
Crucially, your pricing sits at the heart of working out your unit economics, which is key to ensuring your firm’s survival.
Given the importance of getting your pricing right, it is recommended that you invest time in engaging with your audience and collecting data. As you gain feedback, it is likely that your pricing strategy will change over time. In any case, you should review your pricing at least twice a year.
For further useful insights into SaaS pricing, check out this blog.
Now you have a good idea how to approach your pricing strategy, you might want to take a look at how to best position your SaaS.
Daniel Feander – Founder & CEO, salesmentor.