Sure, software buyers never expect to pay list price, but SaaS companies are exposing themselves to eight times lower customer lifetime value when they follow the usual on-premise discounting practices.

Not to put too fine a point on it: they’re taking a hit on annual recurring revenue per customer, and suffering from uncomfortably high churn. Ouch.

The upshot? SaaS companies have got to figure out how to control discounting if they expect to maximize customer lifetime value (CLTV). If they don’t factor in the impact of discounting on future monthly revenue streams, there’s a real risk that they won’t be able to recover their customer acquisition costs (CAC). One hint on how to do this: be willing to pay for good reps.

Traditionally, buyers of on-prem software have been used to getting discounts of 60-90% on the license price. In subscription models such as SaaS, the offerings are usually aligned to value metrics, which should limit the risk of “shelf-ware” and reduce the need for discounting. But the truth is that customers aren’t about to let go of those big discounts, and that makes negotiations tough.

To understand these issues better, we looked at 30 companies in our SaaSRadar benchmark database and found that discounting has a big impact in SaaS.

Our research found a “sweet spot” in which SaaS players can discount just enough to attract bigger customers. Those in the ‘mid-discount’ cluster—10-30% off list—are seeing revenue per customer grow by 4% per quarter.

By contrast, the deep discounters (offering 30% and more off-list) do get faster annual customer growth—50% versus 25% for the mid-discounters—but their growth in ARR per customer is half that of the mid-discounters. And those that discount little or not at all get almost no growth in this metric.

Our work also revealed a clear correlation between rates of revenue churn and levels of discounting by SaaS companies. Interestingly, there’s not much difference in actual customer churn across SaaS companies, regardless of how much they go off-list. But there’s a definite 30%-plus hike in revenue churn for those that offer deep discounts, suggesting that discounting pulls in lower-value customers.

Getting discounting right

So what does it take to establish discounting levels that drive growth in revenue and profit? We have identified three best practices that SaaS companies can follow:

• Reduce discounting when switching costs increase. Discounts can and should be reduced as their leverage diminishes. One way that companies do this right is to allow customers a sizeable discount in year one, a lower discount in year two, and no discount at all from year three onward.
• Strengthen the capabilities of the sales team. It appears that low discounters are hiring (and retaining) more skilled and more experienced sales reps: the SaaSRadar data reveals that reps at the low discounters are typically being paid twice and three times more than those at the firms that discount more. This finding is very relevant for legacy software companies that are moving into SaaS; they must retrain their reps to prevent them from reflexively giving the huge discounts that they were used to offer.
• Formalize discount thresholds for sales teams. As a rule, SaaS companies have not yet mastered laddered discount strategies—but they must. The SaaSRadar data tells us that companies that rely on direct rather than online channels typically offer much higher discounts. The difference? Online discounts are fixed because prices are public, but sales reps sell direct—often with inadequate guidance about what levels of discounting must trigger intervention by senior sales managers.

What are you going to do today to get your discounting practices under control?