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In many cases, SaaS companies underprice their offerings because they lack the right processes for updating pricing as quickly as they’re increasing value for their customers. A 2013 survey of 270 SaaS companies by PriceIntellegently provides some blunt findings: at 41 percent of those companies, the founder sets the prices—a statistic which exposes an alarming lack of progress since the ‘90s when Jim Barksdale, then CEO of Netscape, famously declared: “If we have data, let’s look at data. If all we have are opinions, let’s go with mine.”
Worse: the study finds that nearly one in five SaaS companies set their pricing by guessing what the right price might be.
It’s not an exaggeration to say that many SaaS firms don’t price as scientifically as they could. The most common mistake is that companies price for their initial markets and don’t change their pricing as their products’ roadmaps change.
Price points that worked well in the early days often underprice the product over time, for two good reasons. First, as young SaaS companies begin to serve larger clients, moving into the enterprise space, they typically don’t adjust the pricing plans that were originally structured to serve small and mid-sized businesses. Second, as their products’ capabilities expand, most startups don’t increase their prices to match the greater value that the more capable solutions now generate for their customers.
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To set pricing correctly, SaaS companies should take these six steps, at least annually, and maybe more often than that:
It’s essential to tailor pricing to each customer segment. That presupposes that SaaS firms understand how their customer base is segmented. (Many of our clients in this space lack good data on this, so if you have some catching up to do, you’re not alone.)
A good first step is basing customer segments on potential spend (that is, by potential budget available), the nature of the solutions (which may vary by industry or customer size), and by type of buyer (line of business, engineering, IT, etc.) With that groundwork in place, it’s possible to use analytics and interviews to dive deeper into each segment.
There are three main objectives for the interviews: first, to identify why customers value the service; second, to understand the best mechanism to charge for that value creation; and third, to determine which products and processes customers use that can be augmented or replaced by your product.
There are many ways of getting at this data, ranging from in-person interviews to Web-based surveys. Web analytics specialist Qualaroo has a useful survey tool that asks this key question: “How would you feel if you could no longer use this product?”
When probing into pricing, it’s much easier to ask relative pricing questions—not absolute ones. Is this product more or less valuable than another product? That will elicit more candid and useful responses than a question that sounds like it’s fishing for praise. For more on this topic, check out this presentation from KissMetrics:
You should also focus questions on how customers will pay. Because SaaS solutions are connected by definition, it’s easy to measure and bill based on value-aligned metrics that may be able to extract more value than the old on-prem metric of “seats.”
The best pricing models match a customer’s “time to value” with its “time to expense.” Let’s compare a couple of examples: Twilio, a SaaS offering that saves developers time to get products to market, and a PBX solution that slowly reduces datacenter costs year over year. In the first example, savings in developer time are an easily quantifiable value driver that customers get almost right away. Hence, customers are happy to use pay-as-you-go pricing to get the ease of use that Twilio offers. In the second example, customers may need to be educated to see how and when they’ll save by using the PBX solution. They may also be more comfortable paying a higher price if payments are pushed into the future and aligned more closely with the timing of value capture.
Best practice bundling calls for each bundle to meet a particular set of customer needs while balancing two important concepts. The first is to ensure that every customer has a great experience. The second is not to put so much into the low-tier bundle that customers have no reason to upgrade to higher tiers and more valuable packages!
Hence, SaaS companies need to put critical features for usability in all bundles but identify features that allow top-tier certain customers to extract top-tier value and restrict those to more expensive packages. Often simplicity is key here as it helps potential customer self-sort into the right package rather than giving a long, complex feature list, which can be incomprehensible to potential customers unfamiliar with the product.
One relevant example was a client that had included unlimited use of a valuable feature across all of their bundles. The feature was also quite expensive to provide as it relied on a human to be in the loop. They noticed that many customers who should have been in the top tier were instead buying at a low-tier price and using this feature like crazy! By limiting use at the low tier and moving “unlimited” to the higher tier they were able to properly align value created with the price point their customers paid allowing them to capture more revenue and rescue profitability.
While we always recommend pricing to value, unit economics are terrifically important in SaaS. A common rule of thumb is that [Annual Contract Value] / [Customer Acquisition Cost] > 1. However, looking at McKinsey’s SaaSRadar database, only about 45 percent of companies manage to hit that ratio!
When setting pricing, it’s important to understand the costs of acquiring and supporting a customer. After all, the business must ensure that prices are high enough to enable the company to achieve certain margins. Otherwise, it won’t be much of a business!
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As noted earlier, pricing has to be handled dynamically—as an ongoing business process that reflects continual changes in the marketplace, the competitive landscape, the value and range of offerings, and the size and sophistication of customers.
Hence, it’s crucial to have a process for regularly testing new prices. Some of this can be done the “old school” way: pushing proposed prices to the point at which customers cry out. It can also happen on the web site, using A/B testing or other feedback tools to quickly gauge how possible price tweaks are affecting the numbers and types of inquiries, leads, and lead conversions.
The bottom line: once you’ve set your pricing, you’re not done. Pricing should be an essential and frequently used tool in the toolbox of every SaaS company.